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					                                                                                                                                  special report           }



the end of the investment bank
and prime broker model?
As the bear market continues to tear down
investment banks around the world, Global Value
Investors’ Matthew Hegarty explores the new
battlefield.
The investment bank as we have come            flow. Additionally, any cash generated
know it is, if not yet severely impaired,      went towards investment bank fees and
then certainly forever changed.                servicing the huge loans used to purchase
   In the United States, we have seen          the assets in the first place.
investment banks being bought out by              The question that many people – from
other banks or being ‘asked’ by the
Government to obtain a banking licence
                                               governments to retail investors – are now
                                               asking is how was this allowed to happen?
                                               Is this just a natural part of the economic
                                                                                                                            m atth ew h ega rty
                                                                                                                                            easy money   }
or merge with commercial banks.
   This will place these institutions under    cycle or will financial markets be forever
much greater regulation and scrutiny           altered?                                                          Last month we witnessed the migration


                                                                                                  “
by federal and government authorities             If you look at the global economy’s                         of this disorderly unwinding of balance
to comply with essential capital               growth dynamics over the past 20 years,                        sheet leverage into other essential
requirements.                                  it does help in part to understand better           Strong     components of any financial market – the
   The end of the easy credit era, the         the previous financial cycle and the                           smooth and orderly functioning of cash,
catalyst for this current crisis, also marks   ‘normalisation’ cycle that commenced in             credit     collateral and counterparties. The pace
the end of the credit binging that had         2007.                                                          of readjustment now as banks continue to
grown exponentially since the beginning           The 1990s and up until 2003 was              growth was     manage down their risk and to deleverage
of the deregulation of financial markets. I    chiefly characterised as a period of falling   the glue that   further depends on how logjammed
met last month the chief financial officer     inflation and sharp interest rate cuts. The                    global credit markets remain.
of a major European bank who lamented          period of 2003-07 was characterised as          kept many         The banks that will be vindicated out of
that investment banks had led the              being a period that can only be described                      this crisis will be those banks that stuck
financial system into the current crisis.      as a liquidity bubble. A strong perception      economies      to a disciplined approach to banking and
He said that at an investment bank, five       of ‘easy money’ and a belief that there           globally     that did not compromise balance sheet
people in a treasury department could          was an environment of zero risk started                        quality for the sake of short-term growth.
generate US$100 million ($126 million)         to permeate global financial markets and          growing         Those that adopt the following
in earnings just by setting up a special       banks in particular. Strong credit growth                      priorities will most likely emerge
purpose investment vehicle and loading         was the glue that kept many economies               and it     positively and strongly out of this current
it up with complex and opaque structured       globally growing and it invited the global         invited     crisis:
products. He said 200 branches working         banking and financial sector to move                           1. more balanced growth profile;
for a full year would only then be able to     further up the risk curve into asset classes     the global    2. solid retail banking model;
generate those sorts of earnings.              such as sub-prime mortgage segments                            3. focus on deposit growth (funding
   However, investment banks and prime         and the financing of highly-leveraged          banking and        stability);
brokerage units have become victims of         structures.                                       financial    4. well-diversified commercial banking
their own excesses to the point where they        The only apparent remedy for banks,                            operations;
are unlikely to exist in the structure that    once the global credit shock hit, was to            sector     5. margin management to reflect the
existed pre-crisis.                            deleverage; that is, to shed assets and                           scarcer liquidity and rising spreads; and
   In Australia, the thirst for yield and      to embark on balance sheet shrinkage.             to move      6. conservative balance sheet and credit
yield-based products led to investment         As is now widely recognised, global              further up       management.
banks packaging highly-leveraged               financial markets have not been able                              We will continue to look closely at and
products to manufacture yield. Many            to accommodate the significant and                 the risk    monitor those banks that have these sorts
investors have been burnt by these             simultaneous shrinkage of multiple                             of priorities and those banks that look
structured products as the so-called           balance sheets without major damage                 curve.     attractive on a capital-adjusted basis.
yield was illusory and typically coming        being incurred to institutions and to the


                                                                                                  ”
                                                                                                              MATThew hegArTy IS A SenIor eqUITIeS
out of capital, rather than any cash           overall system.                                                AnAlyST AT GlobAl VAluE InVESTorS.



october 2008                                                                    23                                                I N V e S t o r w e e K Ly

				
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