SOURCE: The Boston Consulting Group (BCG)

March 10, 2008 12:20 ET

Recent Performance of Investment Banks Sets the Stage for a Challenging Year

Midterm Recovery Seen for Markets in North America and Europe; Strong Growth Expected to Continue in Latin America, the Middle East, and Asia-Pacific

NEW YORK, NY--(Marketwire - March 10, 2008) - A difficult fourth quarter capped a challenging year for investment banks. Pre-tax profit margins of leading banks fell 30 percentage points in 2007, and revenues declined by 32 percent, according to The Boston Consulting Group's latest quarterly "Investment Banking and Capital Markets" report.

Write-downs stemming from the subprime crisis slashed investment banks' fixed-income revenues by about $100 billion in 2007. Trading revenues of ten leading players declined by about 46 percent, from $140 billion to $75 billion. Their corporate finance and advisory revenues were resilient, however, and increased by 19 percent for the year.

"The crisis will continue to cast a shadow over the industry in the near term," said Achim Schwetlick, one of the leaders of BCG's investment banking practice and coauthor of the report. "The industry's growth rate should rebound after 2008, but this will depend largely on the return of both liquidity and investor confidence."

Equities hold the greatest promise for growth in the near term, while growth rates for all products should reach high single digits over the next three to four years. The recovery will vary by region. "Emerging markets were largely unaffected by the problems that radiated from the U.S. mortgage market," noted Ranu Dayal, another of the report's authors. "Markets in Latin America, the Middle East, and Asia-Pacific, excluding Japan, should maintain strong growth." Despite their exposure to the crisis, North America and Europe will remain the dominant revenue pools for investment banks.

The industry's performance in 2007 was the story of two halves. BCG's Investment Banking Performance Index, which tracks the profits of ten leading investment banks, reached new heights in the first quarter before falling slightly in the second quarter. In the third quarter, revenues from fixed-income activities dropped by a staggering 93 percent. The index plunged, and the free fall continued into the fourth quarter.

The severity of the crisis intensified in the fourth quarter. Fixed-income and equity-trading revenues, in particular, fell by about 300 percent as a result of subprime-related write-downs. For the year, some players incurred losses that eclipsed their entire profits from 2006. There were, however, signs that other parts of the business were not only intact but healthy. Equity-trading revenues increased by about 26 percent over the previous quarter, and were 24 percent higher than they were during the same period in 2006.

Other activities were also insulated from the crisis. Corporate finance and advisory revenues grew by about 24 percent in the fourth quarter, owing to a strong backlog of M&A deals. The value of M&A deals increased by 35 percent in the fourth quarter and was about 20 percent higher than it was during the same period in 2006. In addition, equity origination increased by nearly 48 percent in the fourth quarter.

The report from BCG provides a brief overview of the root causes of the crisis, beginning with a global surplus of capital and easy access to credit, and culminating with the explosive growth of securitization activity and a dangerous lack of clarity about the risk acquired by banks. It also pinpoints the traits of players that were able to weather the storm. Banks with strong risk-management functions and cultures were careful to hedge their exposure. Diversified banks -- particularly those with a strong presence in emerging markets -- also fared better.

The crisis is still unfolding, but lessons are already being drawn from the missteps that set it in motion. Securitization is seen as one of the main causes. The report shows that the logic for securitization remains both clear and compelling. However, certain structural issues, such as inadequate credit and price discipline, must be resolved to ensure a return to normalcy.

To receive a copy of the report or schedule an interview with one of the authors, please contact Eric Gregoire at + 1 617-850-3783 or gregoire.eric@bcg.com.

About The Boston Consulting Group (BCG)

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