Jones Lang LaSalle
Investor's Business Daily
Investment Banks Stay Busy
Friday February 17, 7:00 pm ET
Laura Mandaro
When Mittal Steel announced a $23 billion hostile bid for rival Arcelor late last month, it wasn't the only company setting its sights on a big prize.
The four investment banks advising Mittal (NYSE:MT - News) -- Citigroup (NYSE:C - News), Credit Suisse (NYSE:CSR - News), Goldman Sachs (NYSE:GS - News) and HSBC (NYSE:HBC - News) -- stand to take home healthy fees on the deal, the largest one ever for the steel sector.
Merger plans such as Mittal's, plus a host of smaller deals, helped lift investment banks' sales and profits to new highs last year. Global announced mergers jumped 38% to $2.7 trillion, the highest level since 2000, according to Thomson Financial.
Investment banks' extensive sales and trading divisions also reeled in profits. Global bond issuance jumped 17%, boosting the industry's underwriting fees to $18 billion. Plus, surging prices in commodities such as oil and metals provided opportunities for traders to make leveraged bets on price moves and sell derivatives.
"It was a very good year," said Richard Peterson, a senior analyst at Thomson Financial. "While the capital markets were going sideways, the business of capital raising was robust."
As a result, Wall Street's biggest investment banks and smaller niche firms again outperformed the stock market. IBD's investment banking group climbed 34% in 2005 vs. 3% for the S&P 500. The group gained another 9% in January.
1. Business
Investment banks make money in much the same way they always have: advising on mergers, arranging bond and stock issues and selling them to investors, and trading for their own account.
What changes with every cycle are the hot products -- and who's positioned to win the most deals. In the late 1990s, firms touted the number of technology initial public offerings they led.
Then the nearly three-year bear market dried up IPO issuance. Deals have picked up since, but they're still far from 2000 levels.
In their place, offerings of bonds and complicated financial instruments like derivatives have increased.
The hot housing market helped. During another year of higher sales, prices and mortgage originations, Wall Street was busy arranging pools of mortgage and home-equity loans.
U.S. mortgage-backed securities volume rose 27% to a record $956 billion last year, representing 29% of all U.S. debt offerings, says Thomson Financial.
"We've had an absolute boom in housing and mortgage sectors, and rapid pickup in issuance and volume in the mortgage area," said Steve Davidson, director of research for the Bond Market Association.
And as state and local governments refinanced their debt into lower rates, municipal bond issuance also shot up to a record level.
Name Of The Game: Investment bankers have to seek out lucrative transactions in a range of fields. Successful firms shift quickly to the hottest areas.
2. Market
Years of mergers have erased many of the storied names from Wall Street's phone book -- from Salomon Bros. to E.F. Hutton to First Boston. These firms are now part of powerhouses like Citigroup, Lehman and Credit Suisse.
"Most of the activities (investment banks) do are quasi-commoditive and have gotten more competitive," said Richard Earnest, co-portfolio manager of Union Bank of California's HighMark Value Momentum Fund, which owns shares in Goldman Sachs and Morgan Stanley.
Competition for standard investment banking work -- like big stock trades and secondary market stock offerings -- have pushed down margins in these services. So investment banks have created and marketed more complicated, and lucrative, financial instruments that fill very specific needs.
Derivatives, for instance, have exploded in the past few years as corporations seek to hedge swings in the value of other financial assets like currencies, commodities and loans. Banks also have launched units that provide special services to hedge funds.
And investment banks have expanded overseas, where recoveries in markets like Japan and Germany have led to more mergers and stock deals.
Goldman Sachs, for instance, is reportedly planning to apply for a license to trade securities in Russia.
3. Climate
Investment banks have enjoyed a great run, and no one knows that better than their employees.
Total Wall Street bonuses shot up 15.5% to $21.5 billion last year, topping the 2000 record, said New York City's financial comptroller last month.
Per person, that came out to an average $125,000 in extra pay.
The surge in bonuses came on the heels of double-digit gains in mergers and trading revenue. Goldman Sachs last year reported a 23% gain in revenue from trading and principal investments to $16.36 billion.
The recent success of market-driven firms may seem odd, given the equities market lackluster performance last year. The Nasdaq eked out just a 1.4% gain, down from 8.6% in 2004.
But while a bear market is generally bad for business, a thriving bull market isn't a prerequisite for strong investment bank returns. That's because the banks benefit from volatility in markets, including commodities and bonds.
The merger environment also has been a big help. Just in January, U.S. firms announced over $80 billion worth of deals, says Thomson Financial. Helping lift volumes, private-equity or leveraged buyout firms have had plenty of cash to invest.
In March, Silver Lake Partners and other buyout firms agreed to take over SunGard Data Systems for $11.3 billion. It was the largest such deal since 1989.
In total, leveraged buyouts accounted for 13% of the $1.1 trillion in U.S. merger deals last year -- far more than buyout firms' 4% to 5% portion of mergers in the mid-1990s.
Energy and power deals, such as ConocoPhillips' (NYSE:COP - News) $37 billion takeover of Burlington Resources (NYSE:BR - News), made up 15% of deal volume.
A record year for bond market issuance also boosted profits in fixed-income sales, trading and underwriting.
The outlook for the bond market, at least as far as issuance goes, isn't as rosy this year. A December survey by the Bond Market Association found respondents expect overall issuance to drop 13% this year.
"Corporate issuance should grow, but because of the view that mortgage rates should be edging up ... mortgage issuance will be lower," said the association's Davidson.
Mergers could save the day. Analysts expect that as corporations struggle to grow organically, they'll look to do more acquisitions. That will provide more work to investments banks.
Plus, after over a year of strong stock prices and earnings, investment banks have the cash to expand in other areas that have a more predictable earnings stream like asset management.
"In the last year or so, investment banks with strong sales and trading divisions performed the best," said William Fitzpatrick, an equity analyst at Johnson Asset Management in Racine, Wis.
"At this juncture, we're looking at less investment banking and whether they've reallocated funds to more predictable earnings streams," Fitzpatrick said.
Merrill Lynch's huge retail brokerage, for instance, should offset the ups and downs of its trading income and other markets-driven revenue, he says.
4. Technology
All of the big investment banks are heavily reliant on their ability to execute trades in a fast and cost-efficient manner. Better servers and networking technology have helped them do that.
Plus, a number of smaller firms such as Investment Technology Group (NYSE:ITG - News) and GFI Group (NasdaqNM:GFIG - News) have carved out niches executing trades that give clients more anonymity than if they were to place an order directly through an exchange.
ITG's systems also let customers estimate how different order strategies will impact their returns.
"Traders on the buy side can take a moderately illiquid stock and model the costs if they sell it in one day vs. five days," said ITG Chief Executive Ray Killian.
5. Outlook
In good times, investment banks can top analysts' earnings expectations by wide margins. But they'll miss by double digits when business falls flat.
For this volatility, the market awards them lower price-to-earnings multiples than other financial service firms.
"A tremendous amount of income comes from trading income, and there's no visibility," said HighMark's Earnest. "You could watch a day, week, month -- you don't know what trading profitability will be."
The good news for investors is that earnings among similar investment banks tend to follow the same trend. If one reports earnings that beat views by 20 cents a share, its rivals often blow through views as well.
Upside: Investment banks feed off economic growth, which encourages companies to raise debt and equity to expand. With many economists expecting the economy to expand about 3% this year, banks should continue to find lucrative work -- particularly by advising on mergers.
Risks: With bond issuance expected to decline and IPO numbers still lagging earlier highs, other areas -- mergers, specialized financial instruments and overseas markets -- are expected to prop up profits.
But that's always a gamble.
"If the merger-and-acquisition environment doesn't pan out as expected, they'll take a hit," said Fitzpatrick.
Investor's Business Daily
Investment Banks Stay Busy
Friday February 17, 7:00 pm ET
Laura Mandaro
When Mittal Steel announced a $23 billion hostile bid for rival Arcelor late last month, it wasn't the only company setting its sights on a big prize.
The four investment banks advising Mittal (NYSE:MT - News) -- Citigroup (NYSE:C - News), Credit Suisse (NYSE:CSR - News), Goldman Sachs (NYSE:GS - News) and HSBC (NYSE:HBC - News) -- stand to take home healthy fees on the deal, the largest one ever for the steel sector.
Merger plans such as Mittal's, plus a host of smaller deals, helped lift investment banks' sales and profits to new highs last year. Global announced mergers jumped 38% to $2.7 trillion, the highest level since 2000, according to Thomson Financial.
Investment banks' extensive sales and trading divisions also reeled in profits. Global bond issuance jumped 17%, boosting the industry's underwriting fees to $18 billion. Plus, surging prices in commodities such as oil and metals provided opportunities for traders to make leveraged bets on price moves and sell derivatives.
"It was a very good year," said Richard Peterson, a senior analyst at Thomson Financial. "While the capital markets were going sideways, the business of capital raising was robust."
As a result, Wall Street's biggest investment banks and smaller niche firms again outperformed the stock market. IBD's investment banking group climbed 34% in 2005 vs. 3% for the S&P 500. The group gained another 9% in January.
1. Business
Investment banks make money in much the same way they always have: advising on mergers, arranging bond and stock issues and selling them to investors, and trading for their own account.
What changes with every cycle are the hot products -- and who's positioned to win the most deals. In the late 1990s, firms touted the number of technology initial public offerings they led.
Then the nearly three-year bear market dried up IPO issuance. Deals have picked up since, but they're still far from 2000 levels.
In their place, offerings of bonds and complicated financial instruments like derivatives have increased.
The hot housing market helped. During another year of higher sales, prices and mortgage originations, Wall Street was busy arranging pools of mortgage and home-equity loans.
U.S. mortgage-backed securities volume rose 27% to a record $956 billion last year, representing 29% of all U.S. debt offerings, says Thomson Financial.
"We've had an absolute boom in housing and mortgage sectors, and rapid pickup in issuance and volume in the mortgage area," said Steve Davidson, director of research for the Bond Market Association.
And as state and local governments refinanced their debt into lower rates, municipal bond issuance also shot up to a record level.
Name Of The Game: Investment bankers have to seek out lucrative transactions in a range of fields. Successful firms shift quickly to the hottest areas.
2. Market
Years of mergers have erased many of the storied names from Wall Street's phone book -- from Salomon Bros. to E.F. Hutton to First Boston. These firms are now part of powerhouses like Citigroup, Lehman and Credit Suisse.
"Most of the activities (investment banks) do are quasi-commoditive and have gotten more competitive," said Richard Earnest, co-portfolio manager of Union Bank of California's HighMark Value Momentum Fund, which owns shares in Goldman Sachs and Morgan Stanley.
Competition for standard investment banking work -- like big stock trades and secondary market stock offerings -- have pushed down margins in these services. So investment banks have created and marketed more complicated, and lucrative, financial instruments that fill very specific needs.
Derivatives, for instance, have exploded in the past few years as corporations seek to hedge swings in the value of other financial assets like currencies, commodities and loans. Banks also have launched units that provide special services to hedge funds.
And investment banks have expanded overseas, where recoveries in markets like Japan and Germany have led to more mergers and stock deals.
Goldman Sachs, for instance, is reportedly planning to apply for a license to trade securities in Russia.
3. Climate
Investment banks have enjoyed a great run, and no one knows that better than their employees.
Total Wall Street bonuses shot up 15.5% to $21.5 billion last year, topping the 2000 record, said New York City's financial comptroller last month.
Per person, that came out to an average $125,000 in extra pay.
The surge in bonuses came on the heels of double-digit gains in mergers and trading revenue. Goldman Sachs last year reported a 23% gain in revenue from trading and principal investments to $16.36 billion.
The recent success of market-driven firms may seem odd, given the equities market lackluster performance last year. The Nasdaq eked out just a 1.4% gain, down from 8.6% in 2004.
But while a bear market is generally bad for business, a thriving bull market isn't a prerequisite for strong investment bank returns. That's because the banks benefit from volatility in markets, including commodities and bonds.
The merger environment also has been a big help. Just in January, U.S. firms announced over $80 billion worth of deals, says Thomson Financial. Helping lift volumes, private-equity or leveraged buyout firms have had plenty of cash to invest.
In March, Silver Lake Partners and other buyout firms agreed to take over SunGard Data Systems for $11.3 billion. It was the largest such deal since 1989.
In total, leveraged buyouts accounted for 13% of the $1.1 trillion in U.S. merger deals last year -- far more than buyout firms' 4% to 5% portion of mergers in the mid-1990s.
Energy and power deals, such as ConocoPhillips' (NYSE:COP - News) $37 billion takeover of Burlington Resources (NYSE:BR - News), made up 15% of deal volume.
A record year for bond market issuance also boosted profits in fixed-income sales, trading and underwriting.
The outlook for the bond market, at least as far as issuance goes, isn't as rosy this year. A December survey by the Bond Market Association found respondents expect overall issuance to drop 13% this year.
"Corporate issuance should grow, but because of the view that mortgage rates should be edging up ... mortgage issuance will be lower," said the association's Davidson.
Mergers could save the day. Analysts expect that as corporations struggle to grow organically, they'll look to do more acquisitions. That will provide more work to investments banks.
Plus, after over a year of strong stock prices and earnings, investment banks have the cash to expand in other areas that have a more predictable earnings stream like asset management.
"In the last year or so, investment banks with strong sales and trading divisions performed the best," said William Fitzpatrick, an equity analyst at Johnson Asset Management in Racine, Wis.
"At this juncture, we're looking at less investment banking and whether they've reallocated funds to more predictable earnings streams," Fitzpatrick said.
Merrill Lynch's huge retail brokerage, for instance, should offset the ups and downs of its trading income and other markets-driven revenue, he says.
4. Technology
All of the big investment banks are heavily reliant on their ability to execute trades in a fast and cost-efficient manner. Better servers and networking technology have helped them do that.
Plus, a number of smaller firms such as Investment Technology Group (NYSE:ITG - News) and GFI Group (NasdaqNM:GFIG - News) have carved out niches executing trades that give clients more anonymity than if they were to place an order directly through an exchange.
ITG's systems also let customers estimate how different order strategies will impact their returns.
"Traders on the buy side can take a moderately illiquid stock and model the costs if they sell it in one day vs. five days," said ITG Chief Executive Ray Killian.
5. Outlook
In good times, investment banks can top analysts' earnings expectations by wide margins. But they'll miss by double digits when business falls flat.
For this volatility, the market awards them lower price-to-earnings multiples than other financial service firms.
"A tremendous amount of income comes from trading income, and there's no visibility," said HighMark's Earnest. "You could watch a day, week, month -- you don't know what trading profitability will be."
The good news for investors is that earnings among similar investment banks tend to follow the same trend. If one reports earnings that beat views by 20 cents a share, its rivals often blow through views as well.
Upside: Investment banks feed off economic growth, which encourages companies to raise debt and equity to expand. With many economists expecting the economy to expand about 3% this year, banks should continue to find lucrative work -- particularly by advising on mergers.
Risks: With bond issuance expected to decline and IPO numbers still lagging earlier highs, other areas -- mergers, specialized financial instruments and overseas markets -- are expected to prop up profits.
But that's always a gamble.
"If the merger-and-acquisition environment doesn't pan out as expected, they'll take a hit," said Fitzpatrick.
posted by Jones Lang LaSalle NJ News Blog at 4:55 PM
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