Is it cyclical or secular? In 2015, this was the most frequent question most investors asked leaders of the industry? The question was superimposed on the industry structure for fixed income, commodities and currency (FICC) trading and record M&A advisory fees fueled by investor activists and more active companies. With some challenging headline news and regulatory pressures that have led to increased capital and de-risking, the S&P Investment Banking & Brokerage Index, which includes Goldman Sachs (GS 180 *****), Lazard Ltd. (LAZ 45 *****) and Morgan Stanley (MS 32 ****), declined 5.2% in 2015.
Last year, there were many key developments in the Investment Banking & Brokerage segment. Equity trading had positive growth while debt and equity underwriting, particularly IPO fees declined. The total IPO proceeds raised in 2015 was about $30 billion, a 65% decline from a record $85 billion in 2014. There were 60 withdrawals for IPO 2015 filings related to difficult pricing in the equity market. In the last ten years, only 208 with 106 withdrawals and 2012 at 75 had a higher number than 2015.
Major firms such as Goldman Sachs and Morgan Stanley remain optimistic about investment banking for 2016. The industry will often talk about the size or quality of its deal pipeline. This gives some indication of industry wide confidence in investment underwriting and advisory fee momentum expected.
Brokerage commissions for Investment Banking & Brokerage firms did benefit in 2015 from investors preference for equities over bonds that boosted increased equity trading volumes, but still in the single digit growth range. Fixed income trading volumes experienced double-digit declines from a low rate environment and a low risk profile by institutions in their fixed income trading strategies, in our view.
The swashbuckling days swinging to hit the ball out of the park is over for this industry.
The Investment Banking & Brokerage industry generates low return on equity (ROE) compared to the 20% plus levels it realized before the 2008 financial crisis with significantly higher leveraged balance sheets. ROE came in at the 9% to 10% level in 2014, and modest gains in ROE are anticipated for the industry group in 2016 from the estimated range of 10% to 13% in 2015.
So, what's to expect in 2016? Here are our 10 predictions for 2016.
- We think a surge of power in Congress by Republicans will not lead to less restrictive regulation from Dodd Frank and the Volker Rule. Some of the Republican leadership may desire to relax regulation, but the party at large is now driven by populist agendas that are not likely to lead to free market policies.
- We believe any surge of trading in fixed income, commodities and currency (FICC) in 2016 will benefit the few that remain steadfast to not take capital off the table. Firms that come to mind to potentially reap significant trading profits are Goldman Sachs, JP Morgan (JPM 66****) and Deutsche Bank (DB 24***).
- We will be surprised by the strength of robo advisors which is having traction with millennials. Fueled with venture capital investments in the FinTech industry, start-up firms are not going away. From the industry 's establishment, smart firms like Charles Schwab (SCHW 33*****) are creating their own robo advisor platforms, while the major brokerage firms with thousands of financial advisors wish this trend would just go away.
- We see a rising rate environment driving higher net interest income, especially for a few firms. Based on the percentage of net interest income to total net revenues, we identify E*Trade Financial (ETFC 29 ****) at 40%, Charles Schwab at 30% and TD Ameritrade (AMTD 35***), just below 20% as most attractive in this industry.
- We anticipate the M&A market having another banner year in 2016 staying above $4 trillion in global advisory fees. Investor activism, a slow growth global economy, modest organic enterprise growth and high levels of cash on the balance sheet should support our outlook. Even if there are more restrictive U.S. federal tax policies, we do not see tax inversions tripping up the bigger M&A picture.
- We believe China moves from being a negative in 2015 to a positive in 2016 for the Investment Banking & Brokerage industry. Here's why. The Chinese government remains committed to diversify its portfolio with real property and financial investments in developed and emerging markets around the world. Inside China, the consolidation of state companies into several monolithic industry leaders may boost their global competitiveness and may lead to more IPOs.
- We think one market disruptor could be breaking the electronic messaging lock Bloomberg has on the fixed income trading floors. Symphony has been created to allow financial firms, corporate customers and individuals to put all their digital communications on one platform. This initiative was launched as a partnership led by Goldman Sachs and 13 partners from investment banks and that also includes data and analytic firms such as McGraw Hill Financial (MHFI 98 NR) and Thomson Reuters (TRI 37***).
- We see the NYSE, wholly-owned by IntercontinentalExchange (ICE 256*****) and other cash equity market exchanges going on the offensive in 2016 with improved technology and lower trading commission rates. The entry of dark pools and high frequency trading that use algorithmic models have materially changed the market structure of cash equity trading.
- We would not underestimate the smarts and capital available to the leading private equity firms. While 2015 was a rocky year with poor returns from energy and natural resource investments, fundraising remains strong for alternative investments on a global basis. We see investment banks benefiting from the activities of private equity firms that may be acquiring and divesting investments through M&A or IPOs as well as new leverage buyouts. We are positive on The Blackstone Group L.P. (BX 29*****) KKR & Co. L.P. (KKR 15*****) and Carlyle Group (CG 16***).
- And finally, we have a positive outlook for the Investment Banking and Brokerage sub-industry. Most of the stocks in this sub-industry underwent a major correction in the third quarter of 2015. In order for this group to regain their mojo, we believe the companies have to execute in driving higher earnings growth coming from operating performance, balance-sheet deleveraging and share repurchase programs.
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Copyright©2016. For important regulatory information, please go to www.capitaliq.com/home/legal-disclaimers.aspx.