Investment banking: How to make money in 2009

The Future of Capital

The world is running out of capital just as companies realize they urgently need to raise equity, like the banks before them, to strengthen their finances as recession bites. The desperate search is on for wealthy investors willing and able to take strategic stakes to anchor big equity deals. Peter Lee reports.

AN ENGLISH INVESTMENT banker recounts the most troubling moment of a recent business trip abroad. "I was going through passport control and they asked me the purpose of my visit and what I did. For the first time in my career, I thought ‘I can’t say I’m a banker, I’ve got to say something else... maybe I can tell them that I’m a doctor’". Amused at this confession of shame and embarrassment at his own profession, the banker’s colleague chips in helpfully: "He told them he was a masseur."

He shouldn’t feel so bad. The irony is that, while they have been cast, probably rightly, as the villains of the piece, investment bankers and their core skills – the ability to marry up the capital needs of financially stretched issuers and the investment objectives of those lucky few still with cash to put to work – have never been more acutely needed than they are today. Those skills have never been more valuable.

Another investment banker recounts a recent visit to a corporate client in the truck-making business. He had been to see the company in the autumn of 2008, at a time when the survival of his own employers hung in the balance. The banker had wanted to talk about how the truck company was prepared to face the difficult times ahead. "They told me, ‘look these are your problems in the financial industry, don’t come and project them on to us’. At the time, they were sitting on an order book for 20,000 units." He went back to the company at the end of 2008. "I’m always interested in trucking because it tells you so much about the economy and other industries, obviously construction and other sectors as well. Do you know how many cancellations they had had?" Euromoney can’t even begin to guess. "They had had 20,000 cancellations."

As a piece of anecdotal evidence, it’s at the extreme. But corporate executives are quickly coming to terms with the need for urgent action: cutting expenditure, paying down debt, reducing costs, husbanding cash and wrestling with how to maintain access to credit while bolstering their capital structures.

As one head of capital markets puts it: "Since last October, we went from peacetime to wartime in a matter of weeks."

So 2009 promises not only to be one of the most challenging and fascinating years ever to be working in capital markets, it also promises to be hugely rewarding financially. As investment banking divisions within many universal banks have been cut back if not shuttered and several big independent firms have failed or disappeared into mergers, competition is diminishing just as margins start to rise and volumes, too, look set to recover.

The primary debt markets will be much busier this year than last. And even though much of that will be government and government-guaranteed issues, fees are going one way: up (see story on predicted volumes of debt capital markets issuance). As the countdown to Christmas quickened, one banker confided to Euromoney that for 2008, his bank’s debt capital markets business enjoyed record profitability. "In revenues, we are 25% ahead of 2007, which was previously our record year, and we’ve done that after taking out 30% of the overhead costs."

Secondary markets are broken, volumes are down but don’t underestimate the impact of wide bid-offer spreads on banks’ capacity to make money from relatively risk-free customer business.

Equity is the new debt

The volume of new issuance in the equity capital market is hard to predict. One that can be made with confidence is that there will be more of it. In 2008, the primary equity market was largely the preserve of banks rebuilding their capital through large rights issues, with a handful of consumer companies following suit. The banks will continue to issue this year and more companies will follow where the banks have led.

A debt capital markets banker tells Euromoney: "Companies are fearful not just about what happens this year. We already have companies coming to us and talking about debt maturities falling due in 2010 and 2011 and asking what they can do to meet those."

At a rival bank, an equity capital markets banker poses an intriguing question for corporates. "With CDS indices now pricing in thousands of corporate defaults at low recovery rates and the debt markets only open to the best issuers at coupons close to double digits and spreads way over 500bp, companies should ask whether the present cost of debt is close to their long-term cost of equity," he says.

There is no easy definition for what is now the appropriate capital structure with which companies in any sector should face the economic downturn. One simple rule of thumb for companies is to do whatever it takes to maintain investment-grade status. Without that, they are likely to be shut out of the debt capital markets at a time when banks have severely limited appetite for lending. That’s a life-threatening position to be in. How do you stay investment grade? You raise equity by whatever means: selling assets, or selling shares.

Selling non-core assets sounds great: but at what price and who to? Debt-financed acquisitions will be very tough to do in 2009, although theoretically they make sense, as prices have come down. "The good news is that assets are cheap," says an M&A banker. "The bad news is that no one has any money."