TEXT-Fitch: consolidation benefits growing for some smaller investment banks
Nov 15 - The two recent mergers involving independent investment banks Jefferies Group and KBW highlight changing competitive realities for smaller and midtier securities firms at a time when rising regulatory costs and more revenue volatility underscore the importance of scale and balance sheet strength. Further consolidation activity among smaller players is likely to persist, in Fitch Ratings' view. Both of the recent acquirers, Leucadia National and Stifel Financial, were willing to pay a premium over tangible book value, which bodes well for other securities firms' valuations, potentially supporting more M&A. Small and midtier firms not considered globally systemically important financial institutions (G-SIFIs) may experience more business challenges relative to larger firms that benefit from that designation. We believe that institutional customers and counterparties may gravitate toward large firms, which are still widely considered to be too big to fail. In addition, compensation at many midtier firms has remained competitive with global trading banks, putting pressure on earnings. The Leucadia transaction adds merchant banking capabilities to the Jefferies franchise and builds on an existing relationship between the two firms. Jefferies may also be less exposed to the type of stress it experienced in November 2011 as part of a diversified investment company. The drivers behind the Stifel/KBW combination are reflective of the overall environment. KBW's willingness to sell primarily resulted from a lack of capital markets and M&A activity among financial institutions, which is the firm's niche. Therefore, cost synergies are likely to play a meaningful role. Even though smaller firms are not subject to many of the Dodd-Frank regulations affecting their larger competitors, the regulatory burden is still increasing significantly. New regulation in commodity dealing and commodity derivatives operations, as well as potential new SEC rules on automated trading, are likely to add to regulatory costs. Furthermore, weaker trading volumes and a lack of M&A activity are both hurting core earnings across the industry. Smaller firms not regulated as banks could see expanding business and hiring opportunities, either organically or through acquisitions, as new regulations such as the Volcker Rule and Basel III constrain larger institutions. To the extent securities firms not regulated as banks move towards riskier activities as a result, there could be negative credit implications. For additional insights into the state of the U.S. securities industry and the credit outlook for investment banks and trading firms, see "2013 Outlook: U.S. Securities Firms," dated Nov. 9, 2012, at www.fitchratings.com.
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