It’s turning into one of the themes of the summer: how a shrunken financial pie might be re-cut post-Crunch. And on Thursday analysts at Bernstein went so far as to suggest that this reallocation of revenue could prove to be the most significant longer-term consequence of the current IB mess.
So who does the firm see as the likely victor? Step forward Deutsche Bank, which is already piling on the business (in relative terms):
In short, Bernstein’s Dirk Hoffmann-Becking reckons Deutsche’s exposure to those areas of forex and fixed income relatively unscathed by the credit crisis - coupled with its relatively low exposure to cash equities and corporate advisory work - should see immediate gains in market share. What’s more, Deutsche’s major continental rivals, Credit Suisse and UBS, both have significant exposure to wealth management - an area where Bernstein sees problems.
We believe the biggest impact from the current crisis should be a reshuffling of the cards amongst the (remaining) investment banking franchises. In this game we prefer banks with a product mix geared towards flow and volatility driven products such as foreign exchange, rates and equity derivatives and who are underweight advisory and underwriting and cash equities. As the market leader in Foreign Exchange, top-five player in rates and equity derivatives, and a still relatively small advisory, underwriting and cash equities business, Deutsche Bank fits this description to a T. We see Credit Suisse likely to lose market share in this environment, as their business is far more dependent on structured credit, cash equities and advisory. UBS is in the process of downscaling their investment banking activities…
We remain more cautious on the wealth management oriented banks Credit Suisse and UBS, as we expect that Wealth Management operating performance is likely to suffer as asset valuations decline, which in turn drives margin compression and — given the fixed cost base- results in materially impaired operating leverage. We are particularly cautious on UBS where we believe performance pressure to extend across all business divisions, with some issues predating the crisis, in particular in Asset Management and US Wealth Management, leaving management in a particularly stretched situation.
One intriguing aspect of the 20-page Bernstein note concerns the way various banks have used falls in the value of their own debt to offset writedowns in structured credit. As Hoffmann-Becking observes:
As a bank’s CDS spread increases, the cost of re-purchasing its own debt in the open market decreases (since the debt is seen as more risky) and banks are allowed to book this re-valuation of credit as revenues. However, on the downside, as CDS spreads fall as they have done in recent months the cost of repurchasing debt increase and losses must be booked. Credit Suisse have used this re-valuation technique to support revenues in Q3 07 to Q1 08, and UBS in Q4 07 and Q1 08. Given the sharp increase of CDS spreads from the start of the year to the end of March, Credit Suisse generated CHF 1,362bn of revenues in Q1, and UBS CHF 2,103m from this method alone. Credit Suisse & UBS have used these additional revenues to help offset write-downs. Notably, DBK hasn’t used this method, saying it’s the same as “mortgaging the future”. After all, once credit spreads come in Credit Suisse and UBS will have to post negative revenues from debt revaluation.
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