banking new realities, new challenges eng v3

Banking: New Realities, New Challenges

Impact on Emerging Markets

Alejandro Dillon

October, 2009

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Agenda

I The Financial Crisis

II New Scenarios

III The Future of Banking

IV Looking Ahead


II New Scenarios


IV Looking Ahead

4

Overview of the US Financial CrisisThe US house hold price bubble was the main cause of the problem

The combination of both delinquency and the erosion of lending standards was a disaster – The latter eased when they should have tightened

Ample liquidity and low interest rates fueled housing price inflation. The FED has great responsibility for these monetary excesses through interest rate relief and also the US Treasury by taking wrong decisions at crucial moments (e.g: Lehman case)

Increased securitization channeled funds into the subprime mortgage market and masked the risks faced by investors. Credit rating agencies and the US SEC failed to warn buyers and investors of real dangers & rewards (e.g: Madoff case)

Lenders moved into riskier lending – “reaching for yield” – at very easy borrowing parameters

Banker were very eager to originate high yield “complex products” using “very cheap money”

Credit default swaps (“CDS”), originally used to provide insurance against default on mortgage-backed securities (“MBS”) and Collateral Debt Obligations(“CDO’s”), became trading instruments for hedge funds and I-Banks. Most of sellers of CDS did not have the capital to cover a broad market downturn (e.g.: AIG)

There was a “Spill over” effect from US to world markets, and the US crisis became global

“We are at the end of an era”George Soros March-2008

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The Vicious CycleWhen the defaults started, financial institutions became reluctant to lend to each other around the globe. Intermediaries could not roll over their short-term borrowing. Markets started to freeze up world-wide achieving its peak in last quarter 2008. There was a vicious cycle, which drove further illiquidity.

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The Big Problem: Global Savings Imbalance

-1,004-1,073-465-31-9,860TOTAL

-73-51-1-17-263Italy

1,4431,315237588,899TOTAL

-16-8-18-10-264Mexico

-43-57-7-5-529Australia

-45-81-304-695United Kingdom

-154-145-24-5-773Spain

-673-731-3852-7,336United States

In deficit

8462281444Norway

3847100523Netherlands

4543200597Switzerland

10276340614Russia

2352500-141,047Germany

34225440821,404Middle East

4403721701,522China

15721188-112,748Japan

In Surplus

2008200720011980Accumulated 1980-2008(US$ Bn)

Source: Ricardo Arriazu & Asociados

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Equity Markets – Comparative Performance

Volatility, Uncertainty and Risk are not any more an intrinsic Emerging Markets problem, but now they are also present in OECD and in the rest of the World

FTSE: -30%

NYSE: -36%

Nikkei: -35%

Bovespa: -30%

IPC: -20%

Merval: -30%

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The Great Dilemma

Largest Exporter in the current recessionVs.US Citizen as the

World’s consumer of last resort

World biggest Investor in US TreasuriesVs.World largest Debtor

China

Vs.

USA

“Geitner’s tough times with China”Washington Post – June 14th, 2009


II New Scenarios


IV Looking Ahead

-Your credit card is ok, I’m just checking if your bank isn’t expired-

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Market Realities

Market Cap as of second quarter 2007 (US$ bn) Market Cap as of first quarter 2009 (US$ bn)

-87.9%

91

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Barclays

As of first quarter of 2009, American banks lost approximately US$ 1 trillion and received over US$ 800 bn in new capital

-92.5%

253

19

Citigroup

Aa3*-90.0%

120

12

RBS

Aa3*-45.0%

165

91

JP Morgan

Aa1*-57.2%

215

92

HSBC

Aa1*-70.7%

116

34

UBS

Aa2*

-63.8%

116

42

Santander

Aa1*-61.0%

100

39

GoldmanSachs

A1* Aa3*-62.1%

77

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RBC

Aa3*-75.8%

62

15

Deutsche Bank

Aa1*

* Credit ratings of long-term bank deposits (Moody’s, as of fourth quarter 2008)

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Government Intervention in the Industry: Nationalizations and Bailouts

6 (Merrill Lynch, Citigroup, Bank of

America, Wells Fargo, JP Morgan, Goldman Sachs)

8 (Bear Stearns, Citigroup, Bank of

America, Wells Fargo, Merrill Lynch, Morgan Stanley, JP Morgan,

Goldman Sachs)

-Federal government launched the

Troubled Asset Relief Program (TARP)

-2 (Allied Irish, Bank of Ireland)

1 (Anglo Irish)Top 3 banks bailed out or nationalized

-1 (ING)1 (Fortis Netherlands)Government fund available to boost bank capital

1 (Swedbank)1 (Nordea)-Swedish government announced scheme to strengthen banks’ capital

1 (UniCredit)--First bank applied for government capital rescue (UniCredit)

-2 (Dexia, KBC)1 (Fortis Belgium)Further government capital unlikely given Fortis and Dexia rescue

1 (Postbank)1 (Commerzbank)1 (Hypo Real Estate)Government ready for intervention to nationalize Banks

1 (Credit Suisse)1 (UBS)-Bad bank rescue system for toxic assets

-4 (Credit Agricole, BNP, SocGen, Dexia)

-State capital plan launched

2 (Barclays, HSBC)-5 (Northern Rock, B&B, RBS, HBOS, Lloyds)

Most Banks already nationalized

Capital RaisingBailouts (loans or <50% stake)

Effectively nationalized (>50% stake)

Current Capital Situation

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New Players are challenging the leadersJP Morgan (JPM) vs. ICBC -China

Price variation: 19 Sept 2008 – 19 May 2009

- JP Morgan: -23.9%

- ICBC: 3.9%

Market Cap (US$):

- JP Morgan: 91 Bn

- ICBC: 40 Bn

Credit Rating

- JP Morgan: Aa1

- ICBC: A1

Source: finance.yahoo


Citigroup (C) vs. Santander (STD)


- Citigroup: -81.1%

- Santander: -38.3%

Market Cap (US$):

- Citigroup: 19 Bn

- Santander: 42 Bn

Credit Rating

- Citigroup: Aa3

- Santander: Aa1

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New Players

Bank of America (BAC) vs. Itaú


- Bank of America : -68.3%

- Itaú: -20.3%

Market Cap (US$):

- Bank of America : 34 Bn

- Itaú: 43 Bn

Credit Rating

- Bank of America: A1

- Itaú: Ba2



Deutsche Bank (DB) vs. ICICI Bank Ltd -India


- Deutsche Bank: -27.2%

- ICICI Bank Ltd: 4.6%

Market Cap (US$):

- Deutsche Bank: 15 Bn

- ICICI Bank Ltd: 16 Bn

Credit Rating

- Deutsche Bank: Aa1

- ICICI Bank Ltd: Baa2

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Structural Transformation in Financial Intermediation*

65%32%8%Subtotal

35%68%92%Subtotal

100%100%100%Total

3%0%0%Finance corporations

4%1%2%Stock exchange houses

1%0%0%Mortgage trusts

3%5%1%Financial companies

7%0%0%Asset baked securities issuers

7%2%0%Mortgages pool

5%4%1%Government supported companies

19%3%1%Mutual & other funds

16%17%3%Pension funds

10%14%17%Insurance companies

1%1%0%Credit institutions

3%17%9%Savings institutions

19%32%49%Commercial Banks

2%4%17%Monetary authority

200819801945

*Percentage over total assets - USASource: Ricardo Arriazu & Asociados

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Lessons LearnedSophisticated Financial Instruments (CDS, CDO, MBS, etc): Clearinghouse and proper regulation needed

Banking leverage: Asset value support by capital requirements

Regulation: Reform and supervision has to include changing market conditions in different regions

Hedge Funds: Leverage, exposure and disclosure have to be monitored by third parties

Madoff Case: No more safe heavens for investor confidence

False decoupling: The world is totally interconnected

Compensation: Bonuses based on the past year’s financial performance must give way to one that better aligns compensation to a longer timescale

Rating Agencies: Limit conflict of interest by regulatory adjustment.

Transparency: needed for products, players and markets

Good and Bad Bailouts?: OECD 08 vs. EM ’90s

Exchanges vs. Banks: new battle?

Open debate: Insurance instruments ( USA) vs. Counter-cyclical regulation (Europe)

“A full-blown financial crisis can exact an enormous toll in both human and economic terms. Financial disruptions do not respect borders. The crisis has been global, with no major country having been immune. The strong and unprecedented international policy response proved broadly effective; it

averted the imminent collapse of the global financial system”

by Ben Bernanke – Chairman, US Federal Reserve Board,August - 2009


II New Scenarios


IV Looking Ahead

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The Rules of the Game within the Banking Sector Have Changed

Pre-Crisis decisions made on overall value

Growth

Cost efficiency

Credit risk

Liquidity

Solvency

During-Crisis decisions made on cash

Solvency

Liquidity

Credit risk

Cost efficiency

Growth

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New Expectations and Needs have emerged in the Sector

New Shareholder/Regulatorexpectations

Focus on the core business

Contribution to the domestic economy

Long-term orientation

Lower financial rewards

More accurately risk evaluation across the cycle

New Customer needs

Lower volatility

Simpler products

Increased transparency

Multi-bank relationships

Stronger balance sheets

Multi-currency risk management

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Bankers: Back to Basics5 C’s

Credit

Cash Flow

Collateral

Counterparty

Credentials

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New Commercial Banking Models

Dispose of high risk / international portfolio

Aggressively manage costs down

Define boundaries of government direction

Plan for return to private ownership

Define the “public service” mission

Redefine incentives to motivate organization and retain talent

Restructure portfolio and business model

Build scale in home country and selectively in other key markets

Manage default and credit risk in high growth segments

Tightly manage cash / liquidity to maintain independence from government

Define the future sustainable core

Divest non-core assets

Upgrade risk management

Acquire / retain top talent as others restructure

Global specialists Global universals

“Back to basics” universalLocal Banks

Policy Banks

LowLow

High

High

Size / depth of business and geography

Level of independence

from government

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Wealth Management (Ex-Private Banking) Evolution

Service model adapted to the needs of each segment

One fits all service model

More consolidated Industry (economies of scale)Fragmented Industry

Clear country focusStock in mature countries but higher net inflows from emerging countries

Provide IB AdvisoryNo IB deals

Annuity pricingTransactional pricing

Research driving investment insights Research as generic service

Open architectureProprietary products

Personalizing the portfolio advisory role Product sales force

Full client balance sheet (asset allocation as a key driver of success, advice adapted to broadened product range)

Investment focus (alternative & structured products, stocks, “beating the market”)

On-shore driven growthOff-shore “dominant” culture

Value added solution and servicesSecrecy and asset preservation

Tomorrow’s PracticesTraditional Practices

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New generation Investment Banks

Focus on advisory & value added servicesSeller of commoditized products

Operations through horizontal integration across businessesOperating in vertical product silos

More rational and stable payroll structuresExcessively generous and volatile compensations

Risk management as a competitive differentiatorRisk management as a support function

New deals originated + executed by experienced teamsDeal flow based on credentials

Specialization (“Boutique approach to profitable business, products and clients”)

Supermarket offering (“Be all things to all people”)

Driven by risk-adjusted profitabilityFocus on aggressive revenue growth

Government will demand cooperation from Private Sector

Non government intervention

Higher cost of capital & reduced leverageLow cost of capital & high leverage

Emerging local & regional competition with the disappearance of US Investment Banks Global dominance of US Investment Banks

New ModelOld Model

But more importantly concentrate on the“Relationship Concept with Client”

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Different Institutional Goals among major participants

Regulators GovernmentsBanks

De-leverage balance sheet

Provide credit to sustain the economy

Price risk correctly Increase credit margins on mass clients

Preserve access to credit to mass clients

Constitute reserves in high cycles

Limit high-risk activities

Increase profitability on core activities

Adapt cost base through FTE reductions

Keep prices for retail and corporate clients stable

Sector to remain strong employer

Capitalize net worth

Will these issues create new tensions?

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Challenges for Banking SectorStrengthening of capital adequacy in line with more stringent regulations.

Global banks aim to reach a higher capitalization, focusing mainly on domestic markets and less on foreign markets

Emergence of powerful regional banks with a strong local potential and global reach

Systemic shocks accelerate process of consolidation, primarily in the USA

Withdrawal of monetary stimulus/credit easing in the US and de-nationalization in the UK

Tighter lending standards restore industry focus on traditional financial instruments

Intensifying participation of the State and Monetary Institutions to manage systemic risk

Higher participation of multilateral agencies in the corporate and government financing

Re-launching of the “Relationship” and “Advisory” role in the banking industry

“Several things were achieved, but there is still much to do”

“The recovery will come sooner or later, depending on the cleaning of the banking sector balance sheets”

Dominique Strauss-Kahn – Director, FMI April-2009


II New Scenarios


IV Looking Ahead

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New M&A Trends in Emerging MarketsCREDIT CYCLE Strategic (not speculative) buyers pave the way for an emerging buyer’s market

MONETARY CONTEXT Low-interest rate environment favours corporate investing

OWNERSHIP TRANSFER Sellers will be more willing to negotiate on an exclusive basis

INTENSIFYING REGULATION Derivatives instruments in M &A deals subject to rigorous scrutiny

EMERGING INVESTORS Sovereign Wealth Funds will act as key strategic investors

ASSET QUALITY IMPROVEMENT Distressed-debt transactions will increase

PURSUIT OF SIMPLICITY LBO-type transactions will be significantly reduced

BRIC(+) PROMINENCE Increasing transactional flow lead by BRIC(+) countries

There will be more investment banks acting regionally and locally than globally in the near future, due to the changing path of financial intermediation and to the

implementation of the new models created

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35%

52%

47%

23%

60%

33%

39%

48%

72%

36%

32%

9%

5%

5%

4%

0% 20% 40% 60% 80% 100%

Argentina

Brazil

Chile

Colombia

Mexico

Local Foreign Cross Border Regional Cross Border

Latam Cross Border M&A Deals 2006-2008

North America

Europe

Asia

M&A by Acquiror Nationality

% of Total M&A Deal Value

Source: Thomson Financial

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ConclusionsBanking Industry needs “Our Mea Culpa”.

Stronger and better capitalized financial institutions are needed.

One World + Different Markets = New risks & opportunities.

New Rules for a New Era: Still to be defined.

Top credit names will capture the market available financing, with BRIC (+)issuers being a key relevant player.

Emerging Markets will receive more foreign direct investments in strategic assets than investments in financial securities.

Latam is a clear leading Player in this new scenario with new assets classes (e.g: Agribusiness).

Latam should use the new Strategic M&A and the more Solid Capital Markets to consolidate corporate growth.

“The crisis was created and extended around the world by the irrational behavior of white people with blue eyes who, before the crisis, seemed to know everything and now have proved to know nothing.

The G8 has no longer a reason to exist now. Developing countries must have higher decision power in this new era”

Lula da Silva-Brazilian President

March 2009

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Final Remark

“Capitalism, with all its market mechanisms, has to survive…”“ No doubt about it. What I excoriate is that today there is only one incentive for doing business, and that is the maximization of profits…But the incentive

of doing social good must be included…”

Muhammad Yunus - Nobel Peace Prize 2006May-2009

banking new realities, new challenges eng v3

Economy & Finance