Back to the Drawing Board

Burned by complex deals, investment banks show a new appreciation for simplicity.

As Lehman’s financial condition deteriorated, the bank peddled a majority stake in its asset-management division and considered unloading its fixed-income business to become an advisory boutique. Wachovia, whose new CEO is overhauling the bank after an ill-timed acquisition of mortgage giant Golden West, wrote down $6 billion in the second quarter and plans on asset sales, which may include its insurance and brokerage businesses, according to RBC Capital markets and Alliance Bernstein analysts.

“Some banks are not convinced that investment banking needs to be a core strategy,” says Eduardo Mestre, vice chairman of Evercore Partners. “The notion of being a ‘supermarket’ or a multiple-product provider with cross-selling synergies has proven to be less of a boon than people anticipated.” Banks, he adds, are therefore asking, “Do you really have to be all things to all people? Is that a competitive advantage?”

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While investment banks won’t rush to fund M&A deals, they will push advisory services. M&A advisory is one of the most profitable areas in investment banking. Fees are based on deal size and range anywhere from 2 percent on the high side to half a percent for multi-billion-dollar deals. The problem, though, is competition. A pure investment bank offering mostly advice and no financing has to differentiate itself in other ways, either by an excellent reputation for certain kinds of deals or with expertise in a given vertical market. Goldman Sachs has a reputation for defending companies from hostile bids, for example, while Lazard is well known for its restructuring prowess.

Another notable change in investment banking will be a migration away from a heavy reliance on revenue from fixed income businesses. Fixed-income revenue has declined 36 percent in the first half of 2008. In particular, CDO-related fees, which contributed $3.5 billion in revenue to the top five issuers in the first half of 2007, tumbled 90 percent in the first half of 2008, to $374 million, according to Freeman & Co., a financial services advisory firm.

Securitization, a dirty word since the collapse of the mortgage-backed securities market, will make a comeback, analysts say — but not in the complex, opaque form of CDOs. Simpler, more-transparent securitization that complies with tighter credit-rating standards and is backed by strong assets will draw investors — maybe even more than previously, now that more-exotic products are off the market.

Even as the credit crisis deepened, companies with strong credit ratings, such as Textainer Group Holdings Ltd., managed to structure receivables securitization deals. Bermuda-based Textainer, a large-container lessor, buys and leases containers and securitizes the receivables in a special-purpose vehicle. Last July, the company increased the size of its securitization facility with Wachovia to $475 million (from $300 million) at a favorable rate of 1.25 percent over LIBOR. The deal “will help to ensure that we have access to the financing necessary to position Textainer for future growth,” says John Maccarone, Textainer’s president and CEO.

CFOs will also benefit from investment banks’ renewed interest in equity research. Why? After years of erosion, equity-trading margins stabilized earlier this year, says Lionel Conacher, president and chief operating officer of Thomas Weisel Partners. More revenue devoted to equity-research groups will likely result in more companies getting more coverage. Some mutual-fund companies have been showing renewed interest in research, while hedge funds, which have always been willing to pay for research, manage a growing pool of assets, and therefore have more impact on trading, Conacher says. “The pendulum has probably swung too far and now people are realizing the need to pay for good ideas.”


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