On top of Bear’s subprime losses, hedge fund woes, and pending lawsuits and investigations, what else could go wrong? Answer: one of its big earnings engines seizes up.
The Financial Times reports that Bear Stearns will announce that it has lost market share in prime brokerage. Prime brokerage is something of a misnomer; hedge funds and money managers once gave all (or at least most of) their brokerage business to a so-called prime broker in return for having them also take responsibility for certain operational tasks. Effectively, smaller money managers outsourced their back office to the brokerage firm in return for near-exclusivity. That model has evolved considerably. Hedge funds are now the target customers; the vast majority have more than one prime broker, and the big money is in providing leverage (which can be margin lending or via derivatives), not brokerage.
It wouldn’t be surprising to see all firms post lower prime brokerage revenues; hedge funds may be exercising more caution and similarly, Wall Street firms could be expected to take a more stringent posture on credit risk. But the loss of position in a core business may be a sign that Bear’s franchise has taken a hit. Remarkably, DeutscheBank has displaced Bear as the number three player in prime brokerage, behind Goldman and Morgan Stanley.
From the Financial Times:
Bear Stearns’ market share in the lucrative prime brokerage business has fallen sharply during the credit squeeze, an issue the bank is likely to address on Thursday as it announces what is expected to be its first ever quarterly loss.
Prime brokerage – which entails providing trading, lending and other services to high-paying hedge fund clients – is a critical business for Bear, which had long been a top three-player in the industry behind Goldman Sachs and Morgan Stanley.
Bear’s decline in prime brokerage began about three years ago and has been accelerated by its recent mortgage-related troubles, including the collapse of two hedge funds run by the bank’s asset management division.
The troubles have raised questions about its financial stability.
Goldman Sachs and Morgan Stanley remain the market leaders in prime brokerage and Deutsche Bank has pushed into the number three spot. According to one industry analysis, Goldman and Morgan Stanley each now generate about $2bn a year in revenue from prime brokerage, or 40 per cent of the industry total. Bear has about 5 per cent of annual prime brokerage revenue, according to this analysis.
Deutsche is believed in recent months to have picked up several Bear hedge fund clients in the US. In the past Deutsche has tied with UBS in third place, but UBS has fallen away after troubles in its Dillon Read hedge fund arm.
In the third quarter, customer balances in Bear’s prime brokerage business dropped 13 per cent to $284bn. In many cases, funds have continued to use Bear as a prime broker but have shifted significant amounts of their money elsewhere.