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.