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April 6, 2008

Investment banking in worst predicament in 30 years

by Dave Nixon

Story link: Investment banking in worst predicament in 30 years

The investment banking industry is in its most terrible crisis in 30 years, and could see revenues plummet as much as 45 per cent this year, according to an extensive study released this week.

A mixture of write-downs on exposure to the anxious US mortgage market and weaker revenues across many investment banking business lines has already cost the industry the comparable of six financial quarters of earnings.

On that gauge, the crisis is worse than the dotcom collapse, the Russian and Asian crises of the late 1990s, the 1994 Mexican dip and the fallout from Black Monday. It rivals the junk bond crisis of 1989-90, the most severe of the industry slumps in the past 20 years.

The dismal findings come in a report by Morgan Stanley, the US investment bank, and Oliver Wyman, the financial services consultancy.

Investment banking revenues will fall 20 per cent this year, even not including an estimated $75bn of additional markdowns, the report warns. Total revenues, including markdowns, are anticipated to fall 45 per cent. Credit business will be worst hit, with revenues falling 60 per cent. Meanwhile, mainstream investment banking revenues, mainly from corporate clients, are estimated to drop by about 40 per cent.

“Major crises in the last 20 years have lasted just four to seven quarters before industry earnings have hit the prior run rate. Only once in 20 years have revenues fallen for two years in a row, as we think is likely to happen in 2007 and 2008,” the report says.

The medium-term viewpoint is similarly insipid. Investment banks’ return on equity is expected to drop significantly as a direct outcome of banks reducing their leverage under pressure from regulators. About half of the rise in their return on equity in the past four years has come from higher leverage, the report argues.

But investment banks should return to growth in the long term: “We are hopeful that a return to prior earnings levels is still possible in the next six to eight quarters from now”


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