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C ONDITIONS A ND T RENDS I N T HE I NVESTMENT B ANKING I NDUSTRY

C ONDITIONS A ND T RENDS I N T HE I NVESTMENT B ANKING I NDUSTRY. Presentation to the World Services Group, Inc. May 7, 2004. William T. Sherman, President SunTrust Robinson Humphrey. Agenda. Topics for Discussion. Industry Consolidation Entrance / Build-up of Universal Banks

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C ONDITIONS A ND T RENDS I N T HE I NVESTMENT B ANKING I NDUSTRY

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  1. CONDITIONS AND TRENDS IN THE INVESTMENT BANKING INDUSTRY Presentation to the World Services Group, Inc. May 7, 2004 William T. Sherman, President SunTrust Robinson Humphrey

  2. Agenda Topics for Discussion • Industry Consolidation • Entrance / Build-up of Universal Banks • Increased Market Volatility / Increased Capital Requirements • Institutionalization of Markets / Growth and Impact of Program Trading • Regulatory Changes and Requirements

  3. Industry Consolidation A Decade of Consolidation • Recent trend of consolidation in financial services industry • New landscape is fiercely competitive with fewer, larger competitors • Cultural clashes have resulted in many professionals starting boutiques • Victims of consolidation in investment banking: • Alex Brown • Dain Rauscher Inc. • Dean Witter Reynolds, Inc. • Dillon, Read & Co. • Donaldson Lufken and Jenrette • E. F. Hutton & Co. Inc. • Equitable Securities Corp. • Hambrecht & Quist • Interstate Johnson Lane Corporation • J.C. Bradford & Co. • Kidder, Peabody, & Co. • Montgomery Securities • Oppenheimer • Paine Webber • Prudential Securities • Robertson, Stephens & Co. • Salomon Brothers • Shearson • Smith Barney, Harris Upham • Soundview • Tucker Anthony • Volpe, Brown, Whelan • Wertheim Schroder • Wheat First Butcher & Singer

  4. Industry Consolidation A Decade of Consolidation 1987 United States Offering 2,500,000 Shares The First Boston Corporation Bear Stearns & Co., Inc. Alex, Brown & Sons Dillon, Read & Co., Inc. Donaldson, Lufkin & Jenrette Goldman, Sachs & Co. Hambrecht & Quist E.F. Hutton & Co., Inc. Lazard Freres & Co. Montgomery Securities Morgan Stanley & Co. Paine Webber Incorporated Prudential Bache Robertson, Colman & Stephens L.F. Rothschild, Unterberg, Towbin Salomon Brothers Shearson Lehman Brothers Smith Barney, Harris Upham S.G. Warburg Securities Wertheim Schroder & Co., Inc. Dean Witter Reynolds, Inc. Wood Gundy Corp. Allen & Company Oppenheimer & Co., Inc. Thomas McKinnon Securities, Inc. Advest, Inc. Arnhold and S. Bleichroder, Inc. Butcher & Singer, Inc. Cowen & Co. Jefferies & Company Cyrus J. Lawrence Legg Mason Wood Walker Mabon, Nugent & Co. Morgan Keegan & Co., Inc. Moseley Securities Corp. Neuberger & Berman The Robinson-Humphrey Company Tucker Anthony & R. L. Day, Inc. Wheat, First Securities, Inc.

  5. Industry Consolidation A Decade of Consolidation • Why consolidate? • Scalability of financial services offerings • Capital requirements have increased • Regulatory environment is more complex and expensive • Driven by market share mentality • Volatile market performance has “forced” sellers and “encouraged” buyers The repeal of the Glass Steagall Act in November 1999 spurred more merger activity 1997 1999 2000 Commercial banks became viable competitors in 1997 immediately after the Federal Reserve increased allowable Section 20 (investment banking) revenue from 10% to 25% of total revenue The merger mania peaked in 2000 with such mega-mergers as CSFB/DLJ, JP Morgan/Chase and PaineWebber/UBS

  6. Industry Consolidation A Decade of Consolidation • The largest investment banks have greatly increased their global market share… “Top Three” Percentage of Global Fees 1991 2000 1991 2000 1991 2000 Source: Thompson Financial Securities Data * Top Three – Goldman Sachs, Morgan Stanley, Merrill Lynch

  7. Industry Consolidation A Decade of Consolidation • Industry Segmentation: • Global Players • Large Industry and Product Specialists • Boutiques and Regionals

  8. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • Since the repeal of Glass Steagall in late 1999, commercial banks have aggressively pursued highly profitable investment banking operations • Commercial banks cited the following reasons for pursuing additional “fee based” businesses: • Compelled to offer one-stop shopping for existing clientele • A necessary step to compete with European banks not restrained by regulations • Cross selling platform appeared attractive • Apparent cost savings available through leveraging existing client and industry knowledge base • As competition intensified – commercial banks could provide credit to win capital markets business

  9. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • The recent trend to combine commercial and investment banks has been widespread; however, some industry leaders remain solely focused on investment banking Selected Commercial & Investment Banks Selected Pure Investment Banks

  10. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • The impact on market share has varied depending on the platforms of the companies involved in the combination Source: Freeman & Co. * Pro forma market share based on average of 2 years prior to merger versus 2 years following the merger

  11. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • The following table demonstrates the impact of the Section 20 amendment and the repeal of Glass Steagall • Are we back where we started? Section 20 Restriction EasedPost-Repeal of Glass Steagall 1996 2000 2002

  12. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking U.S. Fee Market Share of Equity Underwriting 1996 2002 Source: Freeman & Co., June 2003

  13. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • Three common considerations for an issuer in selecting an underwriter: • Banker relationships • Equity sales and trading prowess • Research support • Although universal banks would appear to be better positioned given their size and access to capital, pure investment banks have maintained market share since 1996 for the following reasons: • Difficulty for universal banks of integrating and aligning banking / sales & trading / research • Pure investment banks are also well capitalized and are not “handicapped” for lack of capital (i.e. block trades) • Credit relationships can both help and hurt

  14. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking U.S. Fee Market Share of M&A Advisory 1996 2002 Source: Freeman & Co., June 2003

  15. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • Despite significant historical activity in the M&A advisory arena, universal banks have lost M&A fee market share since 1996 • M&A fees generated from deals involving lending have not been significant • Stock swaps were favored in the late 1990’s • However, if equity markets deteriorate once again and interest rates remain low, debt financed acquisitions may return to the spotlight favoring the universal banks • Financial Sponsor related M&A deals are another story • Financial Sponsor related M&A deals now account for approximately 10% of total M&A fees • Pure investment bank market share of financial sponsor related deals has decreased from 33% in 1996 to 20% in 2002

  16. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking U.S. Fee Market Share of Debt Underwriting 1996 2002 Source: Freeman & Co., June 2003

  17. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • Commercial banks that acquired investment banks immediately leveraged their credit expertise, balance sheet and lending relationships to increase share in fixed income underwriting • Despite increases in share, however, the increased competition has also contributed to the “commoditization” of debt products, thereby pushing down the overall margins • Many “pure investment banks” are willing to let market share go given the profitability proposition • Capital can be conserved for more profitable businesses such as equity, securitized products, structured products and proprietary trading

  18. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking • What does this mean for the service providers? • Collaboration required between corporate and investment bankers (culture) • The best “service” may not prevail • Pressure on pricing when “full suite” of products are offered • What does this mean for the client? • Managers must be sophisticated about range of financial products and the pricing implications of various relationships • Relationships must be carefully managed (how will one decision impact the other?)

  19. Entrance / Build-up of Universal Banks The Impact of “Full Service” Investment Banking MARGINS Ideal Characteristic of an Investment Banking Client Ideal Characteristic of a Commercial Banking Client High Capital Deficient Acquisitive Growth, No Credit History Growth, Credit Worthy RISKS Low High Stable Cash Flow, Transaction-Oriented Stable, Cash Flow, Non-Transaction-Oriented Low Source: Freeman & Co., June 2003

  20. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market • Investment banking requires significantly more capital today than in the past • Market making • Surviving volatile markets • Lending capital for corporate clients and to support transactions • Underwriting • Increased fixed costs (technology, regulation, etc.) • Pricing pressure on trades (same capital requirement, less margin)

  21. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market • From 1994 to 2003, we have seen a dramatic increase in the amount of capital required to participate in sophisticated markets: • Universal banks (C, WB, BAC) – Book equity average increase of 616.7% ($25 billion to $178 billion) • Pure Investment Banks (MWD, GS, MER, LEH, BSC) – Book equity average increase of 316.6% ($23 billion to $95 billion) • Regionals (AGE, RJF, LM) – Book equity average increase of 303.2% ($1.2 billion to $3.9 billion)

  22. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market • Average daily trading volumes have increased dramatically… Average Daily Trading Volume – CAGR: 26.5% Source: NYSE, AMEX, NASDAQ

  23. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market • At the same time, institutional trading commissions have dropped steadily… Average Institutional Commissions – Cents Per Share Source: Freeman & Co.

  24. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market Equity Underwriting Spreads Fixed Income Underwriting Spreads

  25. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market Domestic Institutional Equities – Fixed Expense Base (dollars in millions) Source: SIA Large Investment Bank Database and Bernstein Research

  26. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market Institutional Equity Margins Source: SIA Large Investment Bank Database and Bernstein Research

  27. Increased Market Volatility / Increased Capital Requirements Financial Flexibility in Today’s Market Institutional Equity – Domestic Return on Equity Source: SIA Large Investment Bank Database and Bernstein Research

  28. Institutionalization of Markets / Program Trading Technology’s Role in Today’s Markets • The emergence and continued growth of institutionally controlled assets have impacted capital markets • U.S. institutional investor assets nearly tripled between 1990 and 1999 from $6.3 trillion in 1990 to $18.6 trillion in 1999 • Hedge funds continue to grow in popularity and contribute to the sophistication of capital markets • “Smart money” is changing the ways that investment vehicles are traded (i.e. program trading) U.S. Institutional Assets Trillion Trillion

  29. Institutionalization of Markets / Program Trading Technology’s Role in Today’s Markets Hedge Fund Assets (billions of U.S. dollars) Source: TASS Research

  30. Institutionalization of Markets / Program Trading Technology’s Role in Today’s Markets • What is Program Trading? • Program trading usually involves arbitrage between the futures market and the stock exchanges and is a strategy employed by large investors or institutions where orders are placed to buy or sell large quantities of securities and are triggered by prices rising or falling to a pre-determined level as determined by computer programs that are monitoring price changes on certain equities • Large mutual fund complexes having multiple portfolio managers can reduce execution charges by trading securities as a basket (increasingly complex software is available to help institutions bundle trades) • According to the NYSE, program trading accounts for approximately 50% of the trading volume every day

  31. Institutionalization of Markets / Program Trading Technology’s Role in Today’s Markets • What is the impact of Program Trading? • Reduction in commission dollars for the same number of shares traded • Commissions per share have dropped 34% since 1999 and continue to trend downward • May draw business away from traditional commission business and reduce revenues available to support the core research, sales and trading platform Program Trading as a % of NYSE Volume

  32. Institutionalization of Markets / Program Trading Technology’s Role in Today’s Markets • The traditional reasons for trading with full service broker dealers are: • Equity research / access to company managements • Access to deal flow – IPO’s and follow-ons • Liquidity provider • Market intelligence • Each reason is under attack • Equity research: Perceived objectivity has been compromised, buy-side investing in internal research capabilities • Access to deal flow: Enhanced regulatory restrictions and scrutiny • Liquidity provider: Competition has driven cost of risk adjusted capital above compensation opportunities; alternative trading mechanisms exist • Market intelligence: Information technology and sophisticated internal trading desks provide access to market data

  33. Regulatory Changes and Requirements Changing the Way Business is Done • “Global Settlement” with purpose of separating investment banking from “independent” research departments • Physically separate research from investment banking • Research analyst compensation can not be tied to or dependent on banking revenue • Research analysts are prohibited from soliciting banking business • Sarbanes-Oxley Act of 2002 with purpose of governing corporate compliance in wake of corporate scandals • Audit committees and internal controls • Outside auditing firms and audit independence • Outside directors • Analyst conflict of interests • SEC review and additional financial disclosures

  34. Regulatory Changes and Requirements Changing the Way Business is Done • How have these measures changed the way we do business? • Compliance officers present at meetings between bankers and research analysts • Bankers do not influence “drops” and “adds” to a research analysts’ coverage universe • Limitations on research analysts participating in marketing trips with potential clients • Will investors pay for research?

  35. Regulatory Changes and Requirements Changing the Way Business is Done Declining investment banking and sales & trading revenues High compensation and overall departmental costs Equity Research Disgruntled retail groups Increased costs due to regulatory scrutiny

  36. Regulatory Changes and Requirements Changing the Way Business is Done • Research budgets increased 93% from 1997 to 2001 • Currently, research departments are being restructured and in many cases – reduced Source: Bernstein Research

  37. Regulatory Changes and Requirements Changing the Way Business is Done Investment Bank Products and Margins High Margin M&A Advisory Equity IPO High Yield Underwrite Equity Derivatives Equity Follow-on Fixed Inc. Derivatives Equity Arbitrage Emerging Markets Mortgage Backed Low Margin Comm Paper Investment Grade Govts & Munis Clearing Trading

  38. Questions and Contact Information Questions Questions? William T. Sherman, President SunTrust Robinson Humphrey Atlanta Financial Center 3333 Peachtree Road, N.E. 10th Floor Atlanta, GA 30326 (404) 926-5798

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