Record earnings as sector recovers
By Peter Thal Larsen and David Wighton
Published: January 27 2005 08:34 | Last updated: January 27 2005 08:35
Investment banks have bounced back. After three years of retrenchment and upheaval
caused by the deflating of the stock market bubble and a string of scandals and regulatory
battles, the investment banking sector enjoyed a broad-based revival in 2004, fuelling
record earnings for most of its leading lights.
As they look into 2005, most senior investment banking executives remain relatively
upbeat. The boom in fixed income that helped to keep several groups afloat during the
lean years may be tailing off, but traditional sources of revenue, such as equity
underwriting and mergers and acquisitions, are coming back.
At the same time, many banks have diversified by developing businesses such as
proprietary trading, servicing hedge funds or making private equity investments.
Guy Moszkowski, analyst at Merrill Lynch in New York, says the past cycle has been
much shallower for the leading investment banks than in the past. “If you look back over
the last 20 years, at the bottom of several cycles the banks have seen return on equity fall
to 5 or 6 per cent. This time it bottomed at 10 to 11 per cent.”
One important factor is that the banks have got better at cost management so that
expenses, particularly compensation, are much more variable than in the past. Risk
management has also improved. “We have not seen the massive blowouts as certain parts
of the market have performed poorly,” he says.
Bill Winters, co-head of JPMorgan Chase’s investment bank, says the appearance that
this latest cycle had been shallower than in the past was somewhat deceptive. “Cycles
that used to play out over a number of years are now playing out over a number of
months. On an annual basis, it looked less cyclical but there were some horrific quarters
for the industry along the way,” he says.
What is more, the fruits of the rebound have not been evenly distributed. Banks with
strong positions on Wall Street benefited most as activity in Europe lagged behind that of
the US. Some, such as Deutsche Bank, have launched restructuring plans to tackle
traditionally high cost bases.
Meanwhile, Credit Suisse announced plans to integrate CSFB, its investment bank, more
closely with its private banking and asset management operations. Marginal players, such
as Commerzbank, decided to scale back.
One consequence of the shallower cycle is that most of the large banks have continued to
perform well and, despite confident predictions of consolidation four years ago, there
have been no significant mergers.
Perhaps the best example is Lehman Brothers, which was widely seen as too small to
survive in late 2000 but has enjoyed stellar returns since.
Chuck Prince, chief executive of Citigroup, which looked at a takeover of Deutsche
Bank, said recently that he thought deals between securities houses were unlikely in the
short term. The fallout from such mergers, in terms of the loss of top fee-earners and of
clients, had proved so costly in the past that it was very difficult to make them pay.
It has become a commonplace to say that the future shape of the investment banking
industry will be a few giant, global firms at one end and small specialists at the other,
with little in between.
Many believe this is still the case. “This is still fundamentally a business where you are
either globally important or you have a boutique model,” says Simon Robey, UK head
and co-chairman of global M&A at Morgan Stanley. “It is very problematic to be caught
between the two stools.”
That said, the experience of the past few years has shown that it is possible to be
successful without offering the complete range of products everywhere in the world.
European banks, such as Barclays, BNP Paribas and Société Générale, have built up
profitable investment banking businesses by concentrating on strengths in areas such as
fixed income and equity derivatives.
“If you are dealing with large corporates, then you had better be good at what you do,
you’d better make sure you have an integrated offering, and you’d better make sure you
do it everywhere they operate,” says Bob Diamond, chief
executive of Barclays Capital. “But if you are not top-tier in
"The demand for
something, do not bother.”
capital, in particular for
credit, has helped the
Even so, there are limits to the extent to which banks can
universal banks to pick
specialise. For example, some investment banks have
up more investment
deliberately pursued a strategy of concentrating their resources
on certain industry sectors. But this approach can cut off other
“To have a good relationship with financial sponsors, we think it is important to focus
also on the industries they are looking at,” says Andrea Orcel, head of European
investment banking at Merrill Lynch.
There is no doubt that there is significant overcapacity in some areas of the business,
notably in cash equities, where the relentless squeeze on commission rates continues. But
none of the leading banks with large equities businesses seem prepared to get out.
That is partly because it is seen as vital for a bank to be in cash equities to get business in
other, more lucrative, areas, such as advising on deals. The banks have been able to keep
investing in difficult areas such as cash equities partly because they have been so
successful growing their earnings from trading.
Mr Moszkowski is relaxed about the increased proportion of profits the large banks
generate from trading. The diversity of trading profits and the improved risk management
make them less volatile than in the past. And he plays down concerns that the banks are
taking outsized risks.
By the widely used measure of “value at risk”, the amount of risk taken on has not grown
faster than the banks’ balance sheets in recent years.
However, others think that the banks are underestimating the risks they are running. “I
cannot see how it is possible to generate such high proprietary trading results without
running much higher value at risk than reported. I believe banks have been taking bigger
and bigger bets and sooner or later it is likely to come home to roost,” says one senior
Some argue that the pure investment banks, such as Goldman Sachs and Morgan Stanley,
have been forced to take bigger risks to offset the inroads being made by universal banks,
such as Citigroup and JPMorgan Chase.
The increasing tendency of some banks to take proprietary positions is also raising
questions about whether they will eventually clash with their corporate clients.
Michael Klein, head of banking at Citigroup, says: “The market strength of the last few
years has in some ways delayed the real test of models in the business. Some firms are
leaning more on proprietary trading, and as they do this, clients realise that they may not
be a firm’s top priority or may even have contrary interests.”
Meanwhile, the growth of hedge funds has made prime brokerage a large and lucrative
business, particularly for market leaders such as Goldman Sachs and Morgan Stanley.
But regulators have increased their scrutiny of hedge funds and the banks that service
them – and it remains unclear whether the market will continue to expand. One constraint
on smaller banks is the increasing pressure on investment banks to commit capital on
behalf of their clients.
Hedge funds want banks to invest in them and provide liquidity. Europe has seen the
growth of block trades where investors sell a large stake in a company to a bank which, it
hopes, will be able to place the stock in the market at a slight profit.
As one senior investment banker says, this is a dangerous game involving “a touch of
skill and a lot of luck”.
He believes that institutional investors are becoming increasingly concerned about the
practice because of the number of occasions where a bank underprices the deal and is left
with stock which overhangs the market.
The demand for capital, in particular for credit, has helped the universal banks to pick up
more investment banking business in the last few years.
The universal banks insist that their market share gains in investment banking are built on
the long-term relationships of their corporate banking business and the quality of their
service, not their ability to offer cheap credit.
However, the pure investment banks accuse the universal banks of buying market share
by using the muscle of their balance sheets. While the universal banks have continued to
move up the investment banking league tables, their rivals point to an apparent decline in
their share of fees last year.
“In 2001 and 2002, when credit was in short supply, the universal banks used the
leverage of their balance sheets to sell other investment banking services. Now that
companies did not have the same need for credit, they are returning to their traditional
investment banking suppliers,” says a senior executive at a leading pure investment bank.
However, the very strong fourth quarter investment banking revenues reported by
Citigroup last week suggest the pure investment banks have no room for complacency.
Growth of trading: Will investment banks sustain their explosive advance?
By David Wells
Published: January 27 2005 08:44 | Last updated: January 27 2005 08:45
Investment banks have delivered explosive growth in trading revenue during the last five
years, a performance that has helped them to weather a downturn arranging stock sales
Frank Fernandez, chief economist for the Securities Industry Association, a lobbying
group, summed up the situation saying: “People are getting better at trading.”
The numbers show it. Three of the four largest US investment banks with November
year-ends – Goldman Sachs, Lehman Brothers, and Bear Stearns – generated record
earnings in 2004 thanks, mainly, to their trading prowess.
Consider Goldman Sachs. It generated $20.55bn in total net revenue last year. Trading-
related revenue made up 65 per cent of the total. In 2000, trading-related revenue
accounted for 40 per cent of the $16.6bn total.
The bank’s biggest contributor in 2004 was the fixed income, currencies and
commodities department, known as FICC. It had record net revenue last year of $7.32bn,
a gain of 31 per cent from 2003, the previous record year, and about 2.5 times the $3bn
reported in 2000.
Rivals have reported similar gains. The figures have impressed investors but also have
generated fear that Wall Street’s trading departments, especially those involved with
fixed income, currencies and commodities, are due for an inevitable cyclical downturn in
2005 or beyond.
The investment banks do not deny that trading is a cyclical business and do not pretend
that their trading departments are immune from downturns. They do, however, argue that
improvements in technology are allowing them to open new markets and manage risk
more efficiently, increasing their chances of weathering downturns better than in the past.
They also say another factor helping them is the rise in sophisticated clients, especially
hedge funds, which adopt their new products quickly and find uses for them that go
beyond that for which they were intended.
Lloyd Blankfein, president and chief operating officer of Goldman Sachs, says: “I think
that concern over the growing percentage of trading revenues at investment banks is
Mr Blankfein has been instrumental in keeping Goldman Sachs’ traders adept at
managing risk and shifting resources to meet the needs of clients. Goldman Sachs
reported $9.29bn in net revenue from all trading last year. If equities commissions and
principal investments are included that total rises to $13.33bn, an increase of 28 per cent
To understand further how explosive trading growth has been at Goldman Sachs, it helps
to know that, in 2000, it generated net revenue from trading of $6.49bn. FICC revenue
was $3bn. Lehman Brothers and Bear Stearns have also at least doubled the amount of
fixed income trading revenue they generated in the five years from 2000 to 2004.
Mr Blankfein says he thinks concern over the growing percentage of trading revenues at
investment banks is misplaced for several reasons. “First, client activity is the key driver
of trading – it is our role and valuable franchise to be asked to price and assume risks that
our clients want to shed,” he says. “And trading opportunities come from increasingly
diverse businesses and sources, involving broad and often uncorrelated markets.”
Competitors echo Mr Blankfein’s opinion. Morgan Stanley did not achieve record profits
in 2004, but its trading divisions have generated explosive revenue growth as well,
especially in fixed income.
Jim O’Brien, co-head of Morgan Stanley’s corporate credit group which trades
investment grade and high-yield bonds, says: “What has characterised the improved
performance is bigger risk taking and bets in macro markets.”
Investment banks, he adds, have benefited from managing risk more dynamically and
from trading more often with clients. Morgan Stanley and others, says Mr O’Brien, were
taking steps to make it even easier to trade and manage risk.
This includes finding ways to improve liquidity, developing more index products and
promoting the development of electronic trading. “Our view is that as the market gets
bigger, we will benefit,” says Mr O’Brien.
Morgan Stanley boosted its fixed income trading revenue last year to $5.56bn, up from
$2.7bn in 2000.
Technology has played an enormous role in the growth of trading profits and will
continue to do so this year, say traders. Advances in software have allowed investment
banks to identify more efficiently the trading opportunities and to analyse the
Take Credit Suisse First Boston, which has an advanced execution services (AES)
division that develops algorithms to help clients trade electronically. The product helps
clients to protect their anonymity, provides split-second forecasts and trades throughout
Manny Santayana, a managing director in AES, says the program “helps traders simplify
their life with complex algorithms”. He adds: “You can bundle all the intellectual capital
at one keystroke and help people to make money.”
Mr Santayana says that for products such as his, acceptance is the key. He says that once
he can get clients over what he calls the Fuds – fears, uncertainties, doubts and suspicions
– then he can create a “fully empowered trader”.
Since the inception of AES in 2002, volume has almost tripled each year, says Mr
Santayana. However, he declines to offer a specific number.
Investment banks argue that if they can keep getting clients over the “Fuds” issue, then
trading will continue to have a prominent place in the percentage of revenue generated by
As Mr Blankfein of Goldman Sachs says: “I am not suggesting that revenue from trading
is like an annuity, but the franchise value and recurring nature of this part of the business
Private equity: Conflict of interest on Wall Street?
By James Politi
Published: January 27 2005 08:52 | Last updated: January 27 2005 08:52
The Bankers Trust building at 280 Park Avenue, New York, will soon have a new tenant.
In the past few weeks Larry Schloss, the former head of Credit Suisse First Boston’s
private equity unit, has been preparing to move Diamond Castle Holdings, the buy-out
group he recently founded, from temporary offices into the building.
The move means yet another private equity group will be setting up shop along Park
Avenue, where many medium-sized funds, as well as Blackstone and Warburg Pincus,
the industry giants, are already based. But its significance extends well beyond that.
During the past year, many of Wall Street's top investment banks have been searching
their souls to decide whether it is worth their while to maintain a significant private
equity arm as a core part of their business.
Last month, CSFB, which had one of the largest and most successful operations in the
business, came to the conclusion that it would be better to let go. As part of its wide-
ranging “strategic review” CSFB decided to spin off its DLJ Merchant Banking Partners
IV, which is expected to raise about $3bn.
Mr Schloss had already left the Swiss banking giant when the decision was made. Yet,
his departure remains one of the most glaring symbols of CSFB’s move away from the
CSFB is not the only bank to have parted ways with its private equity arm recently. In
July Morgan Stanley sold its private equity unit to a team of bankers led by Howard
Hoffen, one of the top executives at Morgan Stanley Capital Partners, and renamed it
Metalmark Capital. That move came on the heels of a similar one by Deutsche Bank in
Industry observers say the main reason for the string of spin-offs is that banking
executives are worried that their in-house private equity arms will end up competing on
deals with the largest buy-out groups, which have developed into crucial clients.
Blackstone, for example, doles out about $700m in fees to Wall Street firms every year
for mergers and acquisitions advice, debt financing, and equity financing. “Some of our
funds have grown to the point where they are now competing with major clients of the
firm, or would otherwise benefit from an independent platform,” says Brady Dougan, the
new chief executive of CSFB, explaining the move last month.
“It would not surprise me if private equity groups get a bigger voice as they get more and
more muscle,” says Joshua Leuchtenberg, a lawyer who specialises in the private equity
industry at Ropes & Gray in New York.
This would involve being more vocal about asking an investment bank to back off
seeking a deal for itself in favour of working for another buy-out group as a mergers and
acquisitions or financing adviser.
Many bankers within private equity divisions are often happy to accept a spin-off that
would offer them more freedom to choose their investments. In some cases, such as
CSFB’s, it is difficult to see what the negative side to such a move might be. People close
to the bank say the spun off unit will continue to benefit from the deal flow and the
contacts its bankers had while the business was fully integrated with the mother ship.
However, while the belief that investment banking and private equity are incompatible
appears to be gathering pace, other banks, such as Goldman Sachs, JPMorgan Chase and
Bear Stearns, all of which have significant private equity arms, do not appear to be
rethinking their strategy. Moreover, Merrill Lynch is said to be bolstering its small
private equity division.
“We are separate from the investment bank but we can draw on it in many helpful ways,”
says Jeff Walker, managing partner at JPMorgan Partners, hailing the benefits of his
firm’s model, which usually involves seeking smaller investments that do not pit it
directly against the likes of Kohlberg Kravis Roberts, Thomas H Lee Partners, or Bain
“If we are looking to make a technology investment, we can benefit from advice and deal
flow by meeting with our global technology team, and so on with other sectors. That is a
real advantage,” says Mr Walker.
The private equity arm of Goldman Sachs is generally regarded as the most integrated
with its mother ship because its bankers report to the investment banking unit and are
paid on the basis of the performance of the entire firm. This means Goldman’s unit, in a
similar way to CSFB, often co-invests on deals that have come through the investment
“You can tell the client, ‘we will not just finance the deal with debt and advise you on the
M&A strategy, we will also add some of our own equity’,” says a banking executive
familiar with the model.
Risk management: Keeping pace with effective results
By David Wighton
Published: January 27 2005 08:05 | Last updated: January 27 2005 08:05
If you are looking for the hot new jobs in investment banking, forget fixed-income,
eliminate equities and do not bother with derivatives. Risk management...that’s where the
growth is. Banks have been ramping up their risk management operations in recent years,
increasing headcount, technology investment and status.
According to the 2004 Global Risk Management Survey by Deloitte & Touche, 81 per
cent of global financial services companies now have a chief risk officer. Two years ago,
it was only 65 per cent.
Most industry insiders believe this has resulted in a big improvement in the effectiveness
of banks’ risk management – in spite of the perceived increase in risk the banks are
taking on, the growth of hedge funds and the ever increasing complexity of financial
However, some regulators question whether risk management has improved quite as
much as the banks like to believe. It could be they have just been lucky.
Edward Hida, head of banking risk management at Deloitte & Touche, says that, while it
is difficult to prove that risk management has improved, all the evidence points that way.
“The fact that there have been fewer disasters in many of the larger markets suggests that
risk management has improved.”
He says there have been advances in all the main areas of risk management – credit risk,
market risk and operational risk – and, in particular, in the way these all interact to create
financial risk for the firm.
Guy Moszkowski, investment banking analyst at Merrill Lynch in New York, agrees that
the lack of “massive blowouts” is persuasive. His analysis of the top Wall Street banks
shows that the “efficiency” of risk taking has improved, measured by the ratio of trading
revenue to “value at risk” (VAR).
Value at risk is a measure of the potential loss in value of trading positions due to adverse
market movements over a defined period.
Mr Moszkowski disputes the widespread belief that banks have been taking on
proportionately more risk. The amount of risk measured by VAR taken on by the top
Wall Street investment banks as a group has not increased in relation to their growing
capital in recent years, he says.
Among the European banks, Deutsche is widely seen as having question whether risk
been aggressive on risk recently and it recorded a sharp rise in management has
VAR in the third quarter of last year. However, bankers say improved quite as
this was inflated by a statistical blip and that its risk-taking is much as the banks like
not out of line with its US peers. to believe"
The ever growing complexity of the products investment banks trade makes some outside
observers nervous and risk management experts agree that they do present new
Don McCree, deputy head of risk management at JP Morgan Chase, which has a huge
derivatives business, says it is critical that the risk management process keeps pace with
product innovation. “We routinely move people from the business into the risk
management function to ensure that we remain in step with developments,” he says.
However, Mr McCree says it is important to remember that, in many ways, the growth of
derivatives has made risk management easier, not more difficult. In particular, the growth
in credit derivatives has allowed banks, such as JPMorgan, to manage their big credit risk
exposures much more efficiently. “When we weigh credit derivatives as a risk or a
benefit, we come down significantly into the benefit category.”
The other development that makes some outside observers jumpy is the growth in hedge
funds. This nervousness is understandable given that the collapse of Long-Term Capital
Management is still a recent memory. When the hedge fund imploded in 1998, prompting
the Federal Reserve to organise a $3.6bn bail-out, its bankers had an estimated exposure
Tim Geithner, president of the New York Federal Reserve, one of the US bank
regulators, said in a recent speech that the quality of risk management of counterparties
of hedge funds had “improved substantially since 1998”, but that progress had been
“uneven across the major dealers”.
He also drew attention to “signs of some erosion in standards in response to competitive
pressures” as banks fought to attract increasingly lucrative hedge fund fees.
Mr Geithner said that improving the overall discipline of the stress testing regime was
critical. Because potential future exposure measures are based on VAR calculations, they
can produce misleadingly low overall measures of counterparty credit risk, he said. This
is because VAR calculations reflect recent market conditions and correlations, so do not
necessarily provide an effective measure of vulnerability to loss under more severe
conditions of market stress and illiquidity.
Thanks partly to the relatively benign market conditions in recent years, the biggest risks
to leading investment banks, particularly in the US, have come from a completely
different quarter: the wave of corporate scandals. Citigroup and JPMorgan alone have set
aside billions of dollars to cover potential settlements of lawsuits related to their alleged
role in scandals, such as WorldCom and Enron. Mr McCree says JPMorgan is spending
an “enormous amount of time” analysing new risks such as “reputation risk and litigation
risk created by parties we do business with”.
At the same time, banks are also facing new demands on risk management as part of their
implementation of the Basel II capital adequacy rules. All of which suggests those risk
management departments will keep growing for some time to come.
Jamie Dimon: Obsessed with cutting costs
By David Wighton
Published: January 27 2005 08:09 | Last updated: January 27 2005 08:09
Jamie Dimon is so focused on costs that, shortly after he became chief operating officer
of JPMorgan Chase, he ordered the meat portions in staff cafeteria in its New York
headquarters be cut by 25 per cent.
That story, along with many others told about Mr Dimon during the last year, is
completely false. But it does illustrate two truths. One, Mr Dimon is indeed obsessed
with costs; two, Wall Street is obsessed with Mr Dimon.
Mr Dimon returned to New York last year when JPMorgan paid $58bn for Bank One, the
Chicago group he headed. Ever since, he has been a favourite subject of Wall Street
debate, rumour and gossip.
The interest is not new. Almost as soon as he left New York to go to Bank One four years
ago, the speculation started about when and how he would return to Wall Street. That he
would return never seemed in doubt.
The Bank One deal brought him back as number two at JPMorgan with the agreement
that he would succeed Bill Harrison as chief executive in 2006.
The Wall Street gossip is that Mr Dimon has already taken control, an impression
heightened by the large number of former Bank One executives that have moved into
Insiders insist that he and Mr Harrison are working very well together. In a recent
interview, Mr Dimon said that the two agree on most things but that he had been
overruled by Mr Harrison a couple of times.
Wall Street is in Mr Dimon’s blood. Not the glamour of investment banking, or the high
stakes of trading, but the more down to earth world of retail broking.
His Greek-American grandfather was a stockbroker and his father still works as a broker
at Citigroup’s Smith Barney. It was through his father that Mr Dimon met the man who
was to become his mentor, Sandy Weill.
After graduating from Harvard Business School, Mr Dimon became Mr Weill’s personal
assistant and was his right hand man for much of the next 16 years, during which Mr
Weill put together the world’s largest financial services company, Citigroup.
Colleagues say Mr Weill’s success owes a good deal to Mr Dimon’s energy, intelligence,
eye for detail and ruthless approach to costs. “He is a very smart guy, and he knows it,
with an unbelievable memory for detail. He is great at deals but also at running
businesses,” says one senior executive who worked with him at Citigroup.
Mr Dimon was president of Citigroup and Mr Weill’s likely heir when the pair fell out
and he was sacked in 1998. In some ways, the timing was fortunate for Mr Dimon. His
move to Chicago 18 months later meant he was far from Wall Street during the aftermath
of the corporate scandals which cost many of the banks a fortune. Both Citigroup and
JPMorgan have put aside billions of dollars to cover lawsuits related to their alleged roles
in scandals, such as Enron and WorldCom.
While many Wall Street reputations were severely damaged in that period, Mr Dimon’s
was enhanced by his tenure at Bank One. He slashed the loan book, cut back costs, sorted
out its tangled computer systems and generally dressed it up for a deal.
The deal with JPMorgan has created a smaller version of Citigroup, though with a less
international spread, no retail broking and a much less strong investment bank.
Mr Dimon has made clear he would like the group to have a retail broking business.
Analysts speculate that he will also try to fill out the group with more US retail banking
and greater international exposure. They think deals are unlikely on the investment
banking side and Mr Harrison recently ruled out buying a securities firm.
For the moment, Mr Dimon is focused on the integration of the two groups and cutting
waste across the board. One area where his influence has already been clearly felt is in
information technology, where he persuaded Mr Harrison to scrap a huge outsourcing
contract with IBM. This reflected Mr Dimon’s, unfashionable, belief that systems are so
strategically important to banks that they should be managed in-house.
Mr Dimon inspires great loyalty and many people now in senior positions in JPMorgan
have worked with him for years, not only at Bank One but also at Citigroup.
Colleagues insist that this is not because he likes to surround himself with “yes men”. On
the contrary, they say he creates an informal and open culture in which people are
encouraged to speak their minds.
True up to a point, says one admirer who recalls Mr Dimon’s tendency to “think he’s
right and everyone else is wrong”. His self-confidence, combined with his energy,
sometimes left him accused of micromanagement. “It could be infuriating when he
seemed to want to make all your decisions for you,” says one fan.
But even his critics agree he is one of the most able executives in the financial services
industry and the expectations of his leadership at JPMorgan are extremely high. To meet
them he will have to do more than revolutionise the cafeteria portion control.
Hedge funds: The attraction is still there
By James Drummond
Published: January 27 2005 08:13 | Last updated: January 27 2005 08:13
Hedge funds are sometimes described as unregulated banks. Banks, so the analogy goes,
take short-term liabilities like sight deposits and invest them in longer-term instruments
Hedge funds do the same type of thing or they may do it the other way round – taking
longer-term liabilities and trading rapidly in short-term, liquid instruments.
Either way, both hedge funds and banks are in the business of earning money from
supplying liquidity and bridging a mis-match between assets and liabilities.
The similarities do not end there. Investment banks, and in particular their proprietary
trading desks, also play in the same spaces: bonds, equities and derivatives trading.
The difference is that hedge funds shun the limelight while banks are, whether they like it
or not, in the public eye, highly regulated and have to meet capital requirements.
Such speculations point to the symbiotic, some would say incestuous, relationship
between investment banks and hedge funds.
Investment banks act as so-called prime brokers for hedge funds, settling trades and
providing a range of back-office services. In the US, prime brokerage is dominated by
Goldman Sachs, Morgan Stanley and Bear Stearns.
The banks also extend credit to hedge funds and may also supply investors through their
capital introduction departments.
The banks’ brokerage teams may well come up with suggestions for hedge fund traders
on individual trades and market specifically designed securities.
However, the hedge-funds-as-unregulated-banks conundrum begs a question: if hedge
funds are so profitable and populated by people who used to work in banks, why do
investment houses not do more to retain hedge fund traders within their own ranks?
The answer is that they do – up to a point. But hedge fund trading is a volatile and risky
business and credit rating agencies already take a dim enough view of the proportion of
revenues earned by investment banks from proprietary trading.
The charge is denied by investment bankers. “Contrary to what you may think, we are not
a hedge fund with some investment banking tacked on the side,” says one prime broker.
“The vast majority of our business is executing trades on behalf of our clients. We have a
range of fund management businesses, including hedge funds. If we wanted to have more
hedge fund business (in-house) we could do, but we choose not to,” he says.
The scale of business that a hedge fund can execute with its prime brokers – there can be
more than one – is staggering. Hedge funds are usually active managers and that means
that they trade a lot.
Marshall Wace, a large, London-based long-short equity hedge fund with about $5bn
under management, has between 400 and 500 stocks on its books at any one time and
turns over its book more than 30 to 40 times a year.
A study last year by Andrew McCaffrey, chief executive officer of Attica LJH
Investment Management, indicated that investment banks may derive about one-fifth of
their revenues from prime broking with hedge funds.
The attraction of hedge funds to investment banks was seen by JPMorgan Chase’s
acquisition last year of Highbridge Capital and Lehman’s on-again, off-again pursuit of
GLG. Lehman already has 20 per cent of GLG and an immediate acquisition now appears
For the hedge fund managers, their relationship with their former employers who may
now be acting as nursemaid is critical.
A large relatively well-established hedge fund will be able to put the squeeze on its prime
brokers when it comes to fees, while a start-up will be grateful for all the help it can get.
“When you start, you are very reliant on someone big and powerful taking an interest in
you. That is very important. The type of relationship will alter over time,” says Michael
Alen-Buckley, one of the founders of AIM-listed RAB Capital in London.
“The fact is that the universe is well defined now. I would say that price and service are
The scale and complexity of hedge funds’ relationship with their prime brokers,
combined with memories of the collapse of Long Term Capital Management, a hedge
fund, in 1998, has repeatedly caught the attention of regulators.
In November, Tim Geithner, president of the New York Fed, warned that investment
banks may be low-balling in an effort to attract hedge fund business. There was evidence,
Mr Geithner said, of “some erosion in standards in response to competitive pressures” in
banks’ risk management of relationships with hedge funds.
Nick Roe, head of European prime brokerage at Deutsche Bank in London, is unruffled
by the charge that investment banks might be unduly reliant on hedge fund business.
He points to the institutionalisation of big European hedge funds such as GLG, Vega and
CQS, which want to be seen more as money-managers.
These funds are moving into conventional, long-only management, says Mr Roe. “I do
not think that people will distinguish between institutional flows as more institutions are
looking more like hedge funds (and) as more of these (conventional) institutions are
beginning to take on risk, I do not see people distinguishing hedge fund flow.”
Regulators: Learning to cope with a blizzard of reform
By Andrew Parker
Published: January 27 2005 08:20 | Last updated: January 27 2005 08:20
Investment banks are still learning to cope with the regulatory blitzkrieg that was
unleashed by Eliot Spitzer, New York state attorney-general.
Mr Spitzer rocked Wall Street to its foundations in April 2002 by revealing how some
research analysts were privately disparaging companies that they were publicly
recommending investors to buy.
In one notorious e-mail to his colleagues, Henry Blodget, a senior research analyst at
Merrill Lynch, described an internet company’s stock as a “piece of shit”.
Merrill Lynch is among 10 of the world’s biggest investment banks that were fined and
forced to embark on sweeping reforms under a “global settlement” with regulators led by
Mr Spitzer and the Securities and Exchange Commission (SEC) in April 2003.
The central objective of the settlement is to bolster confidence in the integrity of equity
research. Banks have had to sever links between their research and investment banking
businesses after evidence that the latter was compromising the former’s independence.
But the global settlement crystallised concerns about conflicts of interests at the banks
that continue to preoccupy regulators today. “It has been a regulatory blizzard for almost
three years now,” says an executive at a bank that is party to the settlement.
As well as dealing with conflicts of interests between research and investment banking,
the global settlement also banned the practice of “spinning” by banks.
Some had sought investment banking business from companies by spinning or allocating
of stocks from initial public offerings to their directors.
Hard on the heels of the global settlement, Mr Spitzer turned his attention to abuses in the
mutual funds industry.
The enforcement actions and reforms that have followed are affecting the investment
banks because many have asset management arms as well as brokerage operations.
Some executives at the banks still feel a sense of injustice at how state and federal
regulators have competed for the title of Wall Street’s toughest supervisor, and thereby
engendered a climate of fear.
But initial anger among executives about the scale and complexity of the reforms in the
global settlement, given they insisted the abuses were strictly limited, has subsided.
“Initially, there was a lot of hand wringing and hair pulling,” says an executive at another
bank that is party to the settlement. He says the banks then realised that, although the
settlement is far reaching, the reforms applied to most of their peers, and so no one would
be left at a competitive disadvantage.
“It affects all the major Wall Street firms, so we have not really felt any negative impact
because everybody plays on the same field,” says the executive.
Under the global settlement, the banks have been required to separate physically their
research and investment banking businesses.
Research reports now include opening statements that warn of possible conflicts of
interests. The banks must also offer independent research to their customers.
Tom Hill, global head of equity research at UBS, which is party to the settlement, says its
impact had been positive. “The settlement has achieved what it set out to achieve, which
is to improve the truthfulness of Wall Street research, and that
is a good thing,” he says.
"The number of
analysts at the big
Mr Spitzer admitted last month that the settlement had also
investment banks has
provoked some unintended consequences, such as reduced
declined, together with
coverage of stocks by the big investment banks. However,
executives at the banks appear divided as to whether the settlement has caused the
reduced coverage or the economic downturn that preceded it.
The number of analysts at the big investment banks has declined, together with their pay,
compared with the time of the internet boom years. Prior to the global settlement, their
pay could include large bonuses that were linked to their help in generating investment
Some of the senior and most experienced analysts have therefore left the banks to work
for hedge funds offering higher salaries. One executive expressed fears about the
potential for a deterioration in the quality of research at the big investment banks
because, he said, they had fewer and less experienced analysts.
Another executive argued that the banks would focus their research on certain industry
sectors rather than opt for the blanket coverage that was attempted in the past.
The other glaring result of the settlement has been multiple initiatives by regulators in the
European Union and Asia to buttress the integrity of research.
The investment banks, given their global presences, are having to contend with national
rules that are not necessarily complementary, although most borrow heavily from the US.
Tim Plews, a partner at Clifford Chance in London, says: “One of the unintended
consequences of the global settlement has been a plethora of regulatory initiatives outside
the US by regulators who have not ensured that those initiatives always fit together.”
Moreover, the investment banks are unlikely to get any let up from the regulators.
Stephen Cutler, head of enforcement at the SEC, used a speech in September 2003 to
invite the banks to review further possible conflicts of interests inside their multi-
The banks are still busy sharing the information with SEC staff, and they suspect it could
result in new enforcement actions. Investors, meanwhile, are still waiting for their
compensation. Under the global settlement, banks paid $430m that is to be given to
investors who suffered losses. But the plan for how to distribute the money, which has
been drawn up by an academic, has yet to be approved by the courts.
Harvey Pitt, a former chairman of the SEC, who oversaw some of the negotiations on the
global settlement, says it was important that investors got their compensation as soon as
possible, partly so as to maintain faith in the regulatory system.
“Anyone who cares about investors would say it would be much better if investors are
going to receive a benefit from the settlement sooner rather than later,” he says.
Private banking: Top bankers are back on the trail of the super-rich
By Peter Thal Larsen
Published: January 27 2005 08:29 | Last updated: January 27 2005 08:29
Once again, the world’s largest banks are keen on private banking. For decades, the
business of managing money for the world’s rich was seen as a niche business best left to
secretive institutions in Switzerland and Luxembourg.
Attitudes changed during the 1990s, when large financial institutions were seduced by the
prospect of luring millions of newly wealthy investors. But when paper riches shrivelled
in the bear market, most of the new ventures were scaled back.
Now the world’s investment banks are, once again, showing an interest in private
banking. UBS, the investment bank which has probably most successfully aligned its
brand with managing money for the world’s super-rich, is on an acquisition trail,
snapping up smaller operators around Europe.
However, others are pursuing similar strategies. Late last year Credit Suisse paid its
Zurich-based rival the ultimate compliment when it announced plans to integrate more
closely its investment bank, Credit Suisse First Boston, with its private banking
Several trends are fuelling the vogue. To begin with, executives at UBS and elsewhere
have simply spotted a growth opportunity: private banking is still a relatively fragmented
business where scale can bring improved returns.
The largest players can afford to invest more in information technology and other
services. As clients demand access to ever more sophisticated financial products, the
private banks with the largest pools of capital can also negotiate preferred access to
alternative investments, such as private equity and hedge funds.
What is more, as regulators and tax authorities crack down on offshore financial centres,
much of this activity is taking place in onshore accounts. The promise of discretion and
absolute secrecy – the traditional selling point for the smaller Swiss banks – no longer
has the same appeal.
These factors mean the largest private banks are at an advantage. According to Goldman
Sachs, the flow of capital to private banking will increase by about 7 per cent a year until
However, the private banking arms of UBS, Credit Suisse and other industry leaders
should grow faster: in 2003, Goldman estimates, UBS captured 7 per cent of the industry
inflows even though its market share is just 3.5 per cent.
Several large groups now argue private banking is not just a good growth opportunity,
but also a business that offers substantial synergies with their investment banking arms.
The benefits fall into two categories. First, there is the ability to cross-sell. Entrepreneurs
who hire an investment bank to sell or float their business will also need some advice on
managing their new found wealth, creating an immediate opportunity for the private
Similarly, a businessman who has developed a trusted relationship with his private
banker may be willing to hire the same institution when he needs wholesale banking
Clearly, there will be cases where these benefits exist, though it is uncertain that the two
arms will always work well together, particularly as the organisations grow larger and
more complex. It may also be hard to mesh the eat-what-you-kill culture of an investment
bank with a private bank’s longer-term approach.
A striking example is Citigroup’s recent setback in Japan, where regulators shut down the
group’s private bank.
A more ambitious claim is that investment banks can offer wealthy private clients to a
range of complex products that have been developed for institutional customers.
“The cost of specialised products, such as tax and inheritance planning, can be provided
in-house and amortised over a larger revenue pool, making them more accessible to
clients from a cost standpoint,” analysts at Goldman Sachs wrote last September.
Yet, at the same time, private bankers must also convince their clients they are not being
used as a captive distribution base for whatever new-fangled products the investment
bank is churning out.
That is why, while pointing to synergies, most private banking arms of investment banks
also publicly embrace a so-called “open architecture” business model, meaning they will
offer the best products regardless of where they come from.
“There are some clients who warm to the intellectual innovation of these banks, but there
are others who see the whole culture as too aggressive for them and would prefer to deal
with people who stand back and don’t get overexcited by every new development,” says
Michael Maslinski, director of Maslinski & Co, the wealth management consultancy.
Moreover, the crossover between investment banking and private banking works best
when clients are rich enough to start behaving like institutional money managers. So the
synergies may work for wealthy “family offices” with full-time professional staffs. They
are less likely to apply to clients who have just scraped together their first million.
“The model we have pairs investment banking with ultra high net worth investors. It
would be much harder to pair retail banking with private banking,” says Marianne Hay,
head of private wealth management for Europe and the Middle East at Morgan Stanley.
A more compelling case for the combination of private and investment banking may be
that the former is relatively stable, neatly balancing the growing risks that investment
banks are taking on their own account.
Under new capital adequacy rules, private banking assets can provide a stable asset base
and source of steady revenues.
That is a development investment banks – and their shareholders – are likely to welcome.
Asia: Market is firing on all cylinders
By Francesco Guerrera
Published: January 27 2005 08:41 | Last updated: January 27 2005 08:41
End-of-year trips to headquarters in New York and London tend to be painful
pilgrimages for Asia-based senior investment bankers. Explaining why a region with the
world’s fastest economic growth, one-third of the earth’s population and some of the
nascent stars of global capitalism delivers only tiny profits is, undoubtedly, a tough task.
It is true that, in Asia, competition among securities houses is fiercer than in the US or
Europe, and the region’s companies are less active than their western counterparts on
both capital markets and the merger and acquisition arena.
But for those looking at Asia from the corner offices of a skyscraper in Manhattan or
London’s Canary Wharf, dazzled by the constant talk of China’s rocketing economic
expansion, it is difficult not to interpret these reasons as excuses.
In the past few months, though, the pilgrimages have turned into triumphant
homecomings. Last year, for the first time in recent memory, Asia fired on all cylinders
for investment banks. Equity issuance in Asia Pacific, excluding Japan, was the highest
on record, with total volume reaching more than $100bn last year, according to Dealogic,
the research firm.
Debt issuance was also at a record, with volumes rising more than 30 per cent to
$254.3bn, helped by large bond issues by governments, such as China and Hong Kong.
2004 mergers and acquisitions in Asia
Excluding Japan (Jan 1 2004 - Dec 31 2004)
Rank Market Number of
Value ($m) share (%) deals
1 Morgan Stanley 17,370.8 16.7 41
2 Citigroup 11,396.7 11.0 47
3 Goldman Sachs 9,666.5 9.3 22
4 JP Morgan 8,704.8 8.4 38
5 Credit Suisse First Boston 8,474.0 8.2 33
6 UBS 7,725.4 7.4 18
7 Deutsche Bank 7,619.0 7.3 16
8 Rothschild 4,676.5 4.5 26
9 Merrill Lynch 4,623.5 4.5 31
10 HSBC Holdings 3,725.0 3.6 10
11 Black River Capital 3,720.0 3.6 1
12 ABN AMRO 3,615.2 3.5 18
13 ING 3,440.3 3.3 24
14 Somerley 2,833.9 2.7 37
Australia & New Zealand
15 2,618.0 2.6 8
Source: Thomson Financial
Mergers and acquisitions, traditionally the Cinderella of Asian investment banking,
recorded its best year since 2000 as transactions such as Lenovo’s $1.75bn purchase of
IBM’s personal computer business pushed the total value of deals to $224bn. The sharp
rise in activity translated into higher earnings for investment banks in the region.
Dealogic estimates securities firms shared more than $2.5bn from debt and equity deals
“We had our best year in Asia in 2004,” says Paul Calello, chairman and chief executive
of Credit Suisse First Boston Asia Pacific. “What is most encouraging is that we have
seen an increase in activity spanning a broad range of products across the entire region.”
The problem for investment bankers looking forward to fat bonuses and further
investment from New York and London is that Asia has been here before. The boom
times of 2000, for example, were followed by a couple of lean years that prompted
several firms to cut staff and reduce their presence across the region.
In this respect, this year will be crucial. If investment banks can extend the good showing
that began in the second half of 2003 into 2005, they will be able to show that Asia is
outgrowing short boom-and-bust cycles and becoming a consistent contributor to global
The region’s bankers are typically bullish about the near-term outlook. “Asia is coming
off a very strong year for investment banking, but the backlog is very healthy across all
products,” says Todd Marin, co-head of investment banking for Asia Pacific at
The pipeline of new equity issuances is bulging. CSFB estimates that initial public
offerings alone could raise more than $70bn this year, 17 per cent higher than 2004.
Part of the reason for the expected rise is that 2005 is forecast
"Markets are showing
to witness a wave of IPOs by small privately-owned Chinese
minimal risk aversion,
companies, especially in the technology and manufacturing
so capital is available at
sector. And if two giant state-owned lenders, China
historically tight rates"
Construction Bank and Bank of China, succeed in raising a
combined $15bn, Asia will witness another record year for
The question is whether stock markets, which have begun the year on a negative note,
and foreign investors, the key driver of the recent IPO boom, will be able to absorb such
a large amount of new shares.
“We are very negative on the likelihood that foreign investors will mop up such large
volumes unless there are sharp falls in valuations,” according to an equity strategist.
There are similar doubts about the strength of investor demand and companies’ appetite
for debt, as US interest rates are expected to keep rising, lowering the attraction of
corporate and sovereign bonds.
As for M&A, bankers believe the strength of the market will be driven by the ability of
companies to raise relatively cheap funds to pay for acquisitions.
“Markets are showing minimal risk aversion, so capital is available at historically tight
rates,” says Matt Hanning, head of regional M&A at Morgan Stanley. “M&A activity
will be fuelled by market confidence and access to this capital.”
However, a sharp fall in share prices would damp Asian companies’ desire to acquire,
triggering a downturn in takeover activity.
The real unknown of the year, however, is the extent of outbound M&A by Chinese
companies. Recent developments, such as the Lenovo/IBM deal, and news of interest by
the state-controlled group CNOOC in a $13bn bid for its US rival, Unocal, have raised
hopes of a flood of overseas takeovers by Chinese groups.
But failed deals, such as the $5bn offer by the Chinese state group Minmetals for the
Canadian company Noranda, are a reminder of the inexperience and lack of financial
sophistication of would-be Chinese acquirers.
With the region poised between an extended bull run and a return of the bad years, Asia-
based investment bankers will have to work harder than ever in 2005 to make that end-of-
year trip back to headquarters all the more pleasurable.
Putting more value on credit facilities
By Jane Croft
Published: January 27 2005 08:49 | Last updated: January 27 2005 08:50
There is a long running debate among the investment banking community about how
important capital and balance sheet size are to winning M&A mandates.
In these days of mega-mergers and global deals, an investment bank is seen to have a
huge advantage over rivals if it can offer clients vast loans or complex financial deals
together with its M&A services.
To do this, an investment bank needs a big balance sheet which only large commercial
banks, such as Citigroup and JPMorgan Chase, command.
These giant banks have an edge over rivals such as Goldman Sachs and Lehman, whose
balance sheets do not always allow them the luxury of lending billions of their own
money to clients.
In fact, to help increase its balance sheet, Goldman Sachs did a deal with Japan’s
Sumitomo Mitsui Financial in 2003. Sumitomo provides credit loss protection to
Goldman and takes most of the initial losses suffered in providing such facilities,
allowing Goldman to make loan commitments.
Russell Collins, head of financial services practice at Deloitte, says: “Banks with large
balance sheets have the advantage of being able to take on risks and, as a result, can price
aggressively, which also helps them to win M&A mandates.”
He adds: “The investment-only banks have responded aggressively by stressing their
traditional advisory and distribution capabilities. But they are sometimes taking on more
risks. Although they have large balance sheets, these are not as large as the global
For Citigroup and JPMorgan Chase, both banks that have added investment banking to
their repertoire in recent years, it is only to be expected that they should make big loans.
Lending is their main business, while investment banking is a more recent addition.
Banks with large balance sheets also have an advantage in the current growth of
structured products and derivatives which can be capital-intensive.
The big banks may be using their balance sheet weight effectively, but they still face
fierce competition from those who claim that advice, not cash, is the real requirement.
However, banks with large balance sheets have also recognised they need to bolster their
M&A capabilities by hiring experienced staff. “Clients are looking for three areas in
M&A advisory work: relationship trust, content and execution capabilities,” says Ted
Moynihan, director of Mercer Oliver Wyman.
“We have seen banks with large balance sheets beginning to build up their M&A
capabilities and add to them because having a balance sheet is not enough. However,
credit is still important and the balance sheet is increasingly part of the discussion with
corporate clients,” he says.
Another senior investment banker acknowledges that a large "There is no shortage of
balance sheet is helpful in winning mandates as many clients capital in the
prefer a one stop shop. However, he cautions that the power world...only a shortage
and scale of these banks can, potentially, make clients feel of good ideas"
intimidated if they rely on the bank for both lending and M&A.
He says: “Where a company is in difficulty, they may feel pressure to accept an advisory
mandate from a bank which is also their lender; otherwise, the bank could become an
A bank can ask a company for an investment-banking mandate but, if that bank is also
the company’s biggest lender, a company can feel compelled to accept.
The investment banker says: “It depends on the size of the company. But if you are a
business halfway down the FTSE 100, you are not on an equal footing to argue with
some of these huge banks.”
He also believes that with the availability of credit, capital has become a commodity and
balance sheets are less important.
“There is no shortage of capital in the world but there is a shortage of good ideas – and if
you have a good idea, finding the capital to support it is not a problem,” he says.
“Capital is a commodity but I do not think M&A skills are a commodity as every deal is
Mr Moynihan adds that a bank seeking an M&A mandate could have a big advantage
over rivals if it is also the lender.
“In theory, of course, the killer punch can be if two banks have exactly the same
execution and M&A capability and one is a long term lender to the company. That might
swing the mandate,” he says.
“In the US, advisory businesses often have in-house teams for idea generation, but in
Europe they often have a main advisory and usually a secondary advisory team which can
often be the credit lender.”
One risk for a large commercial bank seeking M&A work is that ruthless investment
bankers might advance their own careers in winning M&A mandates while dispensing
their bank’s cash unwisely.
At Smith Barney, bankers may have been thrilled about winning the Enron M&A
business but it was parent company Citigroup which lost hundreds of millions of pounds
in bad debts when the energy group collapsed.
An investment-banking arm could still clock up big profits from advisory work while the
bad-loan loss would be attributed to a different department.
Brady Dougan: Plotting a course to the top
By David Wells
Published: January 27 2005 08:54 | Last updated: January 27 2005 08:54
Brady Dougan spent his first six months as chief executive of Credit Suisse First Boston
under the radar of investors. During that time he completed a six-month review of the
investment bank’s operations. His goal: devising a plan to help the bank to catch up with
rivals. He said Goldman Sachs and others had been more adept at shifting capital and
people to exploit market opportunities, such as commodities trading, and he wants to
In December, CSFB unveiled its plan. The investment bank will revamp its business lines
and merge with the banking operations of Credit Suisse, its parent company, over the
next two years.
Mr Dougan said in an interview at the time that the task would be a challenge akin to
piloting a tall ship in rough waters, a reference to a painting that hangs behind his desk in
During the review, critics had offered routes the new captain of CSFB could take to safer
waters. One was to exit cash equities. But this turned out to be wishful thinking on the
part of rivals.
Mr Dougan said last month that he was not searching for calmer waters. He just wanted
to make sure his ship had the right crew and sails – people and capital – and that these
resources were used appropriately.
He said CSFB had considered exiting cash equities, but decided that doing so would not
save enough money to justify the pain. More importantly, Mr Dougan did not want to
become a niche player. “We will continue to be a full-service investment bank,” he said.
This desire comes, in part, from his experience. Mr Dougan has worked in most of the
businesses CSFB operates and has ideas for improving them.
He joined CSFB in 1990. Prior to being named CEO, he was co-president of institutional
securities with responsibility for the oversight of day-to-day management and strategy of
CSFB’s equity, fixed income, investment banking and private equity businesses.
From 2001 to 2002, he was global head of CSFB’s securities division and before that was
in charge of equities for five years. Mr Dougan had also been co-head of the CSFB global
debt capital markets group and co-head of Credit Suisse Financial Products’ marketing
effort in the Americas.
Analysts said that CSFB’s rivals had already implemented many of the steps Mr Dougan
outlined in December. But Mr Dougan is betting CSFB can still outperform rivals
because improvements will mean more at CSFB.
“Goldman and Morgan Stanley generate $1.2bn a year from their commodities
businesses,” he said in December. “If we can do a third of that, it would have a big
In addition to commodities, Mr Dougan also has plans to expand in derivatives, a
longtime interest of his. He joined CSFB from Bankers Trust where he began his career
in the derivatives group.
Mr Dougan’s plan for improvement also involves changing how it covers clients and
manages its top talent. CSFB, he has said, often sent too much firepower when it met
with corporate clients who might use the bank to buy a rival or raise capital. So it is
dividing bankers into teams of “generalists” and “specialists”.
CSFB was getting 60 per cent of its investment banking revenue from companies,
typically small to medium-sized operators, which required just one product from the
investment bank. But CSFB was courting them, with star bankers eager to sell them a
host of services rather than the one they needed. This occupied the time that a generalist
could have spent serving clients who desired more than two products.
Brian Finn, the CSFB president, who oversees the division, said the move would increase
accountability and profitability. He also said he is willing to risk being wrong sometimes.
“There is no doubt that a percentage of our coverage decisions will prove to be wrong
and we will lose out,” said Mr Finn. “But we have no interest in wasting resources.”
Now a bright spot on the radar, Mr Dougan is putting the right “bums on seats” and
getting these people to implement his plan. He expects to lose staff unhappy with the
changes forced on them but thinks he will find good replacements who think he’s steering
the ship well.
Boutiques: Still not quite the obvious choice for loans
By James Politi
Published: January 27 2005 08:56 | Last updated: January 27 2005 08:56
As the US market for initial public offerings heated up last May one of the new listings
on the New York Stock Exchange stood out. Greenhill, a private investment bank
specialising in mergers and acquisitions advisory work, as well as restructuring, was
valued at about $600m, significantly higher than the target set by the IPO’s underwriters.
Throughout the year, its shares kept rising, and, earlier this month, were trading 50 per
cent above the offer price. The success of the deal, however, has been more than a boon
for the company’s investors.
To many on Wall Street, the success of the Greenhill deal provided a crucial sign that so-
called “boutique” banking, where small private partnerships offer only strategic advice to
companies rather than lending them money or offering them other products and services,
which most large investment banks do, is an attractive and growing, business.
“When I started, only two people thought it was a good idea to have an independent
investment bank: my mother and I,” says Peter Solomon, a former Lehman Brothers
banker who founded a boutique bank, called Peter J. Solomon, in 1989.
However, the belief that size is the only factor driving success in investment banking,
which was pervasive in the late 1980s and much of the 1990s, has since taken a hit, as the
largest investment banks, particularly in the wake of the corporate scandals of 2001 and
2002, have been severely criticised for being riddled with conflicts of interest.
Mr Solomon, whose firm advised 45 clients last year, including retailers Barney’s and
Fortunoff, says the “new morality” on Wall Street is a key element driving business for
smaller, private investment banks.
“Public boards receive firm instructions from their lawyers to obtain independent
financial advice on important strategic transactions,” says Alan Colner, a partner at
Compass Advisers, a boutique investment bank in New York founded slightly more than
three years ago. “This type of counsel generally cannot be obtained from an investment
bank that has been hired to arrange the related M&A financing.”
Since its birth, at a time when financial advisory work was experiencing a sharp
downturn, Compass has expanded its offices in New York, London and Tel Aviv. It has
also advised on a number of high-profile transactions, such as Lukoil’s alliance with
ConocoPhillips, one of the most significant international oil deals of 2004, the
restructuring of ATA Holdings, the US regional airline, and the purchase of Sunny
Delight, the fruit juice producer, by JW Childs, a US private equity firm.
“In advising a client on a recent acquisition, we succeeded in soliciting more than 20
proposals for funding the transaction. The company would not have had the benefit of
these choices if it had initially sourced both strategic advice and capital from a single
bank,” says Mr Colner.
Other boutiques have also been busy. Rohatyn Associates and the Quadrangle Group, set
up by former Lazard bankers Felix Rohatyn and Steve Rattner respectively, advised
Comcast on its ultimately unsuccessful $66bn offer for Walt Disney, the largest hostile
takeover bid in the US last year.
Furthermore, Allen & Company, a boutique established by Paul Allen, the co-founder of
Microsoft, is currently working on all cylinders as it flanks UBS in weighing bids for
Adelphia Communications, the fifth-largest US cable operator that could be sold for as
much as $20bn in an auction.
For all their inroads, however, boutiques are still not the preferred choice for companies
seeking advice on M&A and other advisory services. In recent years, the so-called
“league tables”, or rankings of number and volume of deals, have shown that large
investment banks, such as Goldman Sachs and Morgan Stanley, still rake in most of the
business in this highly lucrative sub-sector of investment banking.
Another encouraging piece of news was that Rothschild, a private investment bank, was
the top ranking M&A adviser in Europe last year, according to Thomson Financial.
However, that position was controversial in that it was partly obtained thanks to
Rothschild’s work on the restructuring of Royal Dutch/Shell, which did not involve a
deal but was still awarded $80bn in credit for the rankings.
However, the success of boutique investment banking this year is unlikely to be measured
only in their league table performance. Industry insiders say many will be watching to see
how easily boutiques will be able to attract talent at the peak of their careers from the
largest investment banks, which they have traditionally had trouble doing.
Mr Solomon suggests that the success of the Greenhill IPO, and the prospect of an IPO of
Lazard, which also offers independent M&A advice but whose size and breadth means it
is rarely labelled a boutique, may boost the attractiveness of working at a boutique.
Referring to the Greenhill listing, Mr Solomon says: “All of a sudden, people who owned
stock in Peter J. Solomon could figure out how much it was worth.”