Back to the Drawing Board

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

Even in the midst of the credit crunch, several banks beefed up research departments, although much of the action focused on non-U.S. companies, a major growth area. For example, Citigroup, a top player in Asian investment-banking, hired a dozen new analysts last August even as it trimmed other areas.

One product line that will continue to enrich investment bank revenue streams is derivatives. Derivatives have been one of the fastest-growing areas for Wall Street banks, which will still be able to write them and buy credit default swaps to hedge lending exposure. That’s assuming that movements to reform the over-the-counter market’s practices — such as a standard auction settlement mechanism and guidance on collateral management — won’t dissolve margins.

The continued existence of the derivatives market is important to companies as well, because it provides a way to hedge interest rates and limit foreign-currency exposure. But given the current instability in investment banking, finance chiefs will have to exercise extra caution when choosing a counterparty for derivatives contracts, says Alliance Bernstein’s Hintz.

A CFO looking to enter interest-rate swaps, for example, would be wise to choose a bank with superior credit ratings for the longer-term trades and relegate short-term swaps to those with less-than-stellar credentials. “The weakening of the ratings of the brokerage firms means that many corporate counterparties are going to be passing on the brokerage names in the future and will do only short-dated derivatives,” says Hintz. “The longer-dated trades will go to the commercial banks because of their ratings.”

Betting long on investment banks in any area of financing is inadvisable, at least for now. Crowley recalls that he “sweated bullets” as the Lehman deal went through a revise even as Bear Stearns collapsed. Many CFOs may find themselves in similar straits as the number of investment banks shrinks and large commercial banks further expand their already sizable range of offerings. These days, everyone would welcome a return to simpler times.

Avital Louria Hahn is a senior editor at CFO.

Pretax profits (losses) of U.S. broker-dealer holding companies

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