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Investment Banking and Capital MarketsMarket Report — Third Quarter 2008

1

Contents

Overview of third quarter 2008 results 2

Market review• Fixed income and equity trading 8• Underwriting and M&A advisory 12

Focus: Managing through the downturn 18

BCG investment banking contacts 23

2

The third quarter of 2008 marked the end of an era in investment banking

Faced with a crisis of capital, liquidity, and confidence, the last of the independent investment banks disappeared in the third quarter

• The five major independent investment banks either collapsed or were bought or transformed• Lehman Brothers, suffering mounting losses and a liquidity crisis, filed for bankruptcy; Goldman Sachs and Morgan

Stanley found cover by becoming the bank holding companies; and Merrill Lynch sought a safe harbor through a merger with Bank of America

The crisis demands a rapid response by banks• What began as a subprime crisis has snowballed into a broad financial crisis that is now driving a downturn in the real

economy, which is likely to be prolonged and profound• Banks must act quickly by aggressively managing costs, undertaking a rigorous business portfolio review, scrutinizing

their risk management infrastructure, and examining their target operating model and their organizational structure

The crisis is transforming the landscape not only by eliminating or consolidating players, but also by changing the way banks will operate in the longer term

• Successful business models will have a clear focus on either client-centric transaction execution or active risk-taking and management, potentially complemented by advisory services

• Client-centric transaction players' activities will center around largely automated execution of client orders with risk-taking limited to client facilitation

– Players which follow this model will need a high degree of efficiency and scale in post-trade processes• Active risk takers will use top talent and superior risk management capabilities to take positions to exploit market

inefficiencies, related or not related to client flow business

3

Investment banks fell deeper in the red during the third quarterMarket conditions deteriorated rapidly during the third quarter

• The aggregate net revenues of the 12 banks included in the BCG Investment Banking Performance Index fell to $1.9 billion—a 90% drop from Q2 and a far cry from $27.1 billion a year earlier

– Only two of the 12 banks, Morgan Stanley and BNP Paribas, experienced a pick-up in revenues in Q3– Aggregate revenues declined across all businesses except M&A, where revenues were flat– Another round of write-downs in fixed income pulled net revenue into the red at five banks

• Gross operating expenses declined only 15%• As a result, the BCG Investment Banking Performance Index fell from -105 to -164 (Q1 2006 = 100)

– Three-fourths of the banks suffered negative gross operating profits– Only JPMorgan, Morgan Stanley, and BNP Paribas remained in the black

Performance varied widely across major investment banking activitiesFixed income and equity trading• Fixed income and equity sales and trading revenues went negative again (-$8.0 billion) after a recovery in Q2 ($7.0 billion)• Fixed income revenues dropped to -$17.5 billion, due to further write-downs• Equity trading activities fared better, generating revenues of $10.1 billion, down 34% from Q2 in part due to a decrease in

trading volume and consequently commissions

Underwriting (ECM and DCM) and M&A advisory• Underwriting and M&A advisory revenues fell to $7.9 billion, down from $9.6 billion in Q2• Although M&A activity increased, revenues were flat• As confidence left the market, underwriting activity and thereby revenues fell precipitously, particularly for bonds

Note: The survey was expanded from nine investment banks (Q2 report) to include Bank of America, Société Générale, and BNP Paribas. Revenues by activity exclude BNP Paribas, for which disaggregated data are not available. Source: BCG analysis

4

After two quarters of reduced losses, industry performance deteriorated during the third quarter

126 109163 158

127180

229 212

-551

-382

-207

100 9571

107135 128

-11

-327

-203-164-313

-23

-105

-650

-550

-450

-350

-250

-150

-50

50

150

250

Q4/05 Q2/06 Q4/06 Q2/07 Q4/07 Q2/08

Original Performance Index Updated Performance Index

BCG Investment Banking Performance Index

Index

(Q1/01 = 100; includes 9 banks listed in footnote)

(Q1/06 = 100; adds Bank of America,BNP Paribas, and Société Générale)

-207

-105

2005 2006 2007 2008

Note: The index tracks gross operating profit. The original index includes Bear Stearns (through Q1 2008), Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Lehman (through Q3 2008), Merrill Lynch, and Morgan Stanley. The updated index adds Bank of America, BNP Paribas, and Société Générale. For Q3 2008, the financials of acquired firms and operations were not yet consolidated into the acquirer's financials.Source: Company reports; BCG analysis

5

Investment banks battled to lower expenses as revenues continued to deteriorate

-10

-5

0

5

10

0 1 2 3 4 5 6

UBS

DB

CS

Net revenues($B)

SG

Gross oper. exp.($B)

JPMC

Citi

ML

BoA

BNPP

MS

GS

LEH

Source: Company reports; BCG analysis

Net revenues and gross operating expenses of 12 investment banks, Q2 and Q3 2008

= Q2 2008 = Q3 2008

Negative revenues

Break-even

6

Third quarter revenues were weighed down by trading write-downs

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

($B)

ML

LEH

CS

Citi

UBS

MS

JPMC

GS

BNPP*

DB

SG

BoA

Net revenues of 12 investment banks: Q3 2008 vs Q3 2007

Underwriting & M&A advisory revenuesTrading revenues

15.0

-8.0

10.5

7.9

25.5

3Q07 Total

-0.1

3Q08 Total

MS JPMC GS BNPP1 DB SG BoA CS Citi UBS ML2 LEH

Aggregated Net Revenues1

($B)

Q3 07

Q3 07 Q3 08

1. Excludes BNPP for which disaggregated data not available. Net revenues including BNPP totaled $1.9 billion.2. Excludes net gain from Bloomberg sale ($4.3 billion) in Q3 2008.Source: Company reports; BCG analysis

7

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8

Write-downs in fixed income trading erased gains elsewhere during the third quarter

Fixed income trading fell further into the red during the third quarter• Net revenues from fixed income markets were -$17.5 billion in the third quarter compared to

-$8.9 billion in the second quarter– Credit products continued to drag down performance whereas interest rate products,

foreign exchange, and commodities generated positive results at several banks– Seven of the banks in the BCG index suffered write-downs that eclipsed revenues – Average weekly US bond-trading volumes continued to fall but the rate of decline slowed

(-2% from Q2 to Q3 compared to -17% from Q1 to Q2)– Declines were recorded in corporate bonds (-12%) and treasuries (-1%)

Equity trading slid further in the face of heightened volatility• Revenues from equity trading were $10.1 billion, down 34% from Q2 and 26% from the same

period last year– Trading volumes declined 3% in the quarter and were 13% lower than the same period

last year

Note: Revenue figures are for 11 investment banks; figures exclude BNPP, for which disaggregates were not available.Source: BCG analysis

9

Fixed income revenues slid further into the red

-17.5

-8.9

-24.4

-54.4

1.8

28.031.0

23.322.824.925.9

-60

-40

-20

0

20

40

Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108 Q208

($B)

Q308

Fixed income trading

U.S. weekly average bond-trading volumesU.S. weekly average bond-trading volumes Fixed income trading revenuesFixed income trading revenues

0

500

1,000

1,500

Q107

1,179

Q207

1,277

Q307

1,226

Q407

1,411

Q108

1,173

Q208

1,1531,070

Q206

1,037

Q306

1,065

Q406

-2%

1,107

Q106

Treasury/Agencies

MBS/ABS

Corp Bonds

($B)

1,148

Q308

Note: Trading volumes single counted, includes investment funds traded at exchanges; aggregated revenues for 11 investment banks surveyed (excludes BNPP, for which data were not available).Source: Federal Reserve Bank of New York; BCG analysis

10

Equity trading revenues continued to slide

Equity trading

10.1

15.416.817.4

13.6

19.820.4

14.0

9.4

13.4

16.4

0

5

10

15

20

25

Q308Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108 Q208

-34%

($B)

Global-exchange trading volumesGlobal-exchange trading volumes Equity trading revenuesEquity trading revenues

0

5

10

15

20

25

30

18.7

Q206

15.5

Q306

18.2

Q406

22.1

Q107

25.023.6

27.0

Q307

26.3

Q407

26.2

Q108

24.3

Q208

EMEA

Asia

Americas

-3%($T)

Q308

17.6

Q106 Q207

Note: Trading volumes single counted, includes investment funds traded at exchanges; aggregated revenues for 11 investment banks surveyed (excludes BNPP, for which data were not available).Source: World Federation of Exchanges; BCG analysis

11

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12

As confidence and liquidity left the capital markets, so did the demand for new issues

M&A Advisory• M&A activity increased 16% over the previous quarter, from $551 billion to $641 billion,

while the number of deals fell 2%– Deal value grew strongest in the Americas (27%)

• M&A advisory revenues, however, were flat compared to the previous quarter and were down one-third compared to the same period last year

– Goldman Sachs and JPMorgan continued to take the highest share of global M&A advisory revenues

Underwriting• After a brief recovery in the second quarter, revenues from underwriting activities slid

during the third quarter, with DCM and ECM revenues falling 52% and 37%, respectively– Due to steep declines in originations in both markets– Morgan Stanley bucked the trend by growing both DCM and ECM revenues, while

Goldman Sachs was able to grow its DCM revenue• Equity origination fell by 35%, with sharp declines in EMEA and Asia Pacific• Debt origination declined 49%, with precipitous drops in the Americas and EMEA

Note: Revenue figures are for ten investment banks; excludes BNPP and Société Générale, for which disaggregates were not available.Source: BCG analysis

13

After a brief recovery, revenues from underwriting and M&A advisory activities fell

-5

0

5

10

15

9.5

Q106

10.5

Q206

9.5

Q306

12.6

Q406

12.5

Q107

14.4

Q207

10.1

Q307

12.5

8.6

3.8

Q1081

10.0

Q208

7.2

Q308

ECM

DCM

M&A

-28%

Q305

9.3

Q405

($B)

Q407

Global underwriting and M&A advisory revenues

1. DCM revenues were negative at two of the ten investment banks due to write-downs of highly leveraged finance commitments.Note: Revenue figures are for ten investment banks; excludes BNPP and Société Générale for which disaggregates not available.Source: BCG analysis

14

M&A activity strengthened in the third quarter while underwriting levels fell precipitously

Effective M&A dealsEffective M&A deals Equity issuanceEquity issuance Bond issuanceBond issuance

36

79

1653

43

61

43

73

70

76

29

29

27

59

14

0

100

200

300

100

Q308

149

Q307

216

Q407

88

Q108

155

Q208

Asia-Pacific

Americas

EMEA

-35%

($B)

384 359 406

634

709609 557

690

80

112 97

125

331

309

101

0

500

1,000

1,500

741

Q308

1,173

Q307

1,081

Q407

1,060

Q108

1,449

Q208

-49%

($B)

274

473392

240

470

579

254

231

126

134

80

80

273

294

75

0

500

1,000

1,500

641

Q308

870

Q307

1,186

Q407

725

Q108

551

Q208

+16%

($B)

Source: Thomson SDC; BCG analysis

15

Banks gained on the M&A leader, Goldman Sachs, but lost share to the underwriting leader, JPMorgan

Relative share of M&A revenuesRelative share of M&A revenues Relative share of underwriting revenues1Relative share of underwriting revenues1

0

20

40

60

80

100

0 20 40 60 80 100

GSJPMC

MS

MLCS

LEHCiti

DBUBS

BoA

Relative Market Position 3Q07


0

20

40

60

80

100

0 20 40 60 80 100

JPMC

GSMS

UBS

BoAML LEH

CSFB



Gained share relative to #1

Lost share relative to #1

1. Citigroup and Deutsche Bank recorded write-downs leading to negative net revenues in 3Q08; DB in 3Q07.Note: Market position expressed relative to market leader.Source: Thomson SDC; BCG analysis

16

The crisis has created a new order in the underwriting league tables

Share of global DCM, 2006 and Q3 2008 YTDShare of global DCM, 2006 and Q3 2008 YTD Share of global ECM, 2006 and Q3 2008 YTDShare of global ECM, 2006 and Q3 2008 YTD

Note: Market share based on share of proceeds. BarCap = Barclays Capital + Lehman's core North American investment banking and capital markets businesses; WF+Wach. = Wells Fargo + Wachovia. There was less shake-up in the M&A advisory field with Bank of America + Merrill Lynch moving up from 14th to 4th.Source: Thomson SDC; BCG analysis

0

2

4

6

8

10

% Market Share

BoA-ML

BarCap-Leh

JPMC-BSC

DB Citi RBS CS UBS MS GS

2006Q3 2008 YTD

0

2

4

6

8

10

12

14

JPMC-BSC

BoA-ML

Citi GS MS UBS BarCap-Leh

DB CS WF-Wach.

2006Q3 2008 YTD

% Market Share

Moved from 12th to 2ndMove from 6th to 1stMoved from 7th to 2nd

Moved from 11th to 1st

17

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18

Collateral damage: The credit crisis is driving a downturnin the real economy

… is driving a downturn in the real economy

… is driving a downturn in the real economyWhat began as a credit crisis …What began as a credit crisis …

Credit crisis in US real

estate1

Leverage crisis in the

securitization market

2

Global liquidity crisis3Solvency crisis4

Further reduction

in asset values5

Lower investment

1

Lower output2

Corporate defaults and job losses

3

Lower demand4And no capacity

for consumers to borrow more

(absent inflation)

Corporate credit crunch and cash flow/

liquidity crisis

Source: BCG analysis

19

The result is a recession exacerbated by a credit crunch, equity crash, and real estate bubble

Number of occurrencesNumber of occurrences

10

35

1

189

31

Credit/bankingcrunches

Housingpricecrashes

Equitymarketcrashes

Only 5th occurrence of simultaneous credit crunch,

housing price crash, and equity market crash

Financial stress worsens the effect of downturn

Financial stress worsens the effect of downturn

-1.6

-2.8

1.75×

Not preceded by financial

stress

-2

-4

2

0

Preceded by financial stress

-2.3

-4.4

1.9×

Not preceded by financial

stress

Preceded by financial stress

Slowdowns Recessions

Banking-related stress is typically 2–3× as

deep and 2–4× as long

Cumulative output loss median (in % of GDP)

Source: BCG analysis; IMF

20

Acting fast can create significant value

Label 1 10/08 Label 3 Label 3 Label 3 Label 3 Label 3 Label 3

OverreactsExpenses

Crisis

Example of two different companies –based on research from prior recession

Time

Weak crisis management results in overshooting: Too late! Too much! Too random!

Expensive recovery

Company A• Limited, tentative responses• Overreacts late in the game• Expensive recovery

Company B• Acts fast• Measured response

Fast, measured response

Limited, tentative responses


21

Five key levers in a rapid response to the crisis

Aggressively manage cost

Short term cost focus – discretionary spending

Structural changes to cost – coverage, research, technology platforms, etc.

1

Secure revenuesProtect core customers / franchises

Adapt product portfolio to changing customer needs

2

Review business portfolio

Portfolio choices – growth, profitability, capital requirements, riskAcquisition opportunities to build scale / capabilitiesDivestitures to enhance focus, free up capital

3

Redefine target operating model

Across key lines of business – organize by client segments, products, regions

Across key functions – centralized vs. decentralized, in-house vs. outsourced

4

Redesign organization('Delayering')

Redesign spans and layers for efficiency and effectiveness

Place right talent in redesigned roles

5

BCG has developed a set of tools to help clients address each of these levers


22

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23

BCG investment banking contacts

Achim SchwetlickPartner and Managing DirectorNew York+1 212 446 2800

Robert GrübnerPartner and Managing DirectorFrankfurt+49 69 9 15 02 0

Chandy ChandrashekharPartner and Managing DirectorNew York+1 212 446 2800

[email protected] [email protected] [email protected]

Ranu DayalSenior Partner and Managing DirectorSingapore+65 6429 2500

Shubh SaumyaPartner and Managing DirectorNew York+1 212 446 2800

Tjun TangPartner and Managing DirectorHong Kong+852 2506 2111

[email protected] [email protected] [email protected]

mailto:[email protected]






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