Wall Street’s Bulge Bracket May Shrink to 5 Firms, McKinsey Says

Investment banks must take further actions to improve returns and more will follow firms like UBS AG and Royal Bank of Scotland Plc that have exited businesses, McKinsey & Co. said.

Only five or six companies will remain “bulge bracket” firms that offer all investment banking and trading products worldwide, the consulting firm said today in a report titled “After the Reckoning.” Others will step back from some businesses to focus on areas where they have a competitive advantage, according to the report.

“There are more aspiring flow monsters than projected levels of flow can support,” McKinsey analysts said in the report. “We have already seen a few early movers exit capital-intensive fixed-income businesses or scale-intensive cash equities businesses to focus on areas where they were better able to compete; we will see more such moves in the future.”

UBS, which has been the most aggressive in reducing costs and risk-weighted assets according to the report, said last year it was trimming 10,000 jobs and exiting many fixed-income businesses. RBS plans to close or sell its unprofitable cash equities, mergers advisory and equity capital markets divisions, the Edinburgh-based firm said last year.

The 13 largest investment banks have announced plans to cut $15 billion in expenses, including compensation, and $1.03 trillion in risk-weighted assets, McKinsey said. Still, the investment bank divisions of those firms produced an average return on equity of 7 percent in 2011. ROE will probably be 6 percent to 9 percent in 2017 without “significant actions.”

Boosting ROE

If banks can boost their ROEs to the industy’s cost of equity, which will probably be an estimated 11.7 percent in 2017, they can restore $160 billion of shareholder value, according to the report.

The top three firms in each asset class account for about two-thirds of trading volume in that product, according to the report. Banks that lack such scale or face higher funding costs will probably focus on businesses such as foreign exchange or structured rates and credit, McKinsey said.

The 13 firms addressed in the report were Bank of America Corp., Barclays Plc, BNP Paribas SA, Citigroup Inc., Credit Suisse Group AG, Deutsche Bank AG, Goldman Sachs Group Inc., HSBC Holdings Plc, JPMorgan Chase & Co., Morgan Stanley, RBS, Societe Generale SA and UBS. Those firms accounted for about 60 percent of the $292 billion of investment banking and trading revenue in 2011, according to the report.

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