In the past year, the long-predicted shakeout in the investment banking sector has begun in earnest.
Bulge-bracket banks in particular have slashed costs, cut jobs and disposed of businesses amid a sharp drop in revenues, tighter regulatory pressure and the need to shore up their capital cushions.
But behind this frenzy of cuts and business-model adjustments, a long-term and fundamental trend is coming back to the fore: the perennial fight between smaller boutique advisers and their bulge-bracket rivals has picked up pace.
While it is far from clear which group will eventually emerge as the winner, it does seem that investment banking’s Davids are gaining ground against the Goliaths.
The trend is apparent in a number of business segments, from mergers and acquisitions to brokerage and fixed-income trading.
Take M&A: in January this year, the takeover and merger market saw a brutal drop in revenues and fees, with global announced deal value falling to the lowest level seen for nearly a decade.
But for some independent advisory firms such as Greenhill and Moelis, the start of the year shaped up to be a fairly good one. Both boutiques managed to crack the top-10 league table in January, pushing some of their much larger rivals to lower ranks. Greenhill’s advisory of Swiss drugmaker Roche’s $5.7bn takeover of Illumina, the US genetic diagnostic company, catapulted it into the top 10 after ranking only 122nd globally in the same period of the year before.
Other smaller, independent advisory firms have achieved similar successes in the past year. Perella Weinberg last year blindsided US bulge-bracket banks with its role advising NYSE Euronext on the exchange operator’s attempted tie-up with Deutsche Börse, which ultimately failed due to antitrust issues.
And Evercore has grown so fast in the past few years that the US firm’s founder, Roger Altman, a former deputy US Treasury secretary, refuses to label it a “boutique” any longer. In the past year, its revenues surpassed $500m for the first time in its 16-year history, boosted by its advisory role on high-profile deals such as Kinder Morgan’s $37.6bn takeover of rival energy group El Paso.
A 2009 presentation from Evercore highlighted the long-term trend: in the US, those firms labelled by the firm as boutiques have increased their M&A advisory market share against Wall Street’s bulge bracket from 3 per cent in 2000 to 16 per cent in 2008 and 2009.
Boutique firms argue that the larger banks’ model of providing debt finance alongside M&A advice is prone to conflicts of interest. They also say they are more attractive to work for at a time when large banks are firing staff and sharply reducing bonuses. The bulge-bracket firms are seen as less “fun”, given intense public scrutiny and added layers of bureaucracy in the wake of regulatory pressure on their compliance and risk models.
By contrast, boutique firms see themselves as more entrepreneurial, with the individual banker participating directly in the success of the firm and not feeling like a small cog in a big machine.
But from a customer perspective, big investment banks often have the advantage of being one-stop shops where clients can get finance, advice and other services in the same place.
Some observers say that in reality the fight will once again end with an impasse. A number of both small and larger firms could come out of the crisis stronger, while medium-sized groups might turn out to be the real losers.
Analysts say the fixed-income business, one of the big revenue drivers for investment banks since the financial crisis, could see such a bifurcation between the large bulge-bracket companies such as Barclays, Deutsche Bank and JPMorgan, and a string of new and old smaller firms.
Kian Abouhossein, an analyst at JPMorgan, says the trend would mirror what has already happened in equity trading businesses. “There are large global equity houses that provide a whole range of services such as prime brokerage, cash equities [and] equity derivatives with bulge bracket compensation, and then there are small boutiques that are focused and are highly profitable such as Autonomous and Redburn Partners, with high revenue per head,” he wrote in a recent note.
“We also note fixed cost is low – as illustrated by the low compensation ratios for Autonomous and Redburn, with profit being paid out to members purely dependent on profit performance. This business model is highly profitable [up] to a certain size of 100-150 people in our view.”
With competition increasing and revenues going down, the ones that lose out are the medium-sized banks that have the same pay structures and technological platforms to support as their larger peers, but lack economies of scale.
Bill Michael, UK head of financial services at KPMG, the professional services group, says: “The big question for the industry is how it will consistently generate a return on equity above the average cost of capital. This is a very tough ask in the current environment and the challenge for management will be to continue driving down costs to match reduced revenue levels.”
Some medium-sized investment banks, such as Japanese Nomura, which took over Lehman Brothers’ European and Asian operations a few years ago, are already cutting costs. Royal Bank of Scotland is scaling back its investment banking by shedding thousands of jobs. A few months ago, it sold Hoare Govett, its brokerage arm, to Jefferies, the US investment bank that has been one of the few global financial institutions to expand rapidly during the financial crisis.
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