| Investment grade debt issuance market share |
| Source: Thomson Financial |
Source: www.breakingviews.com is Europe’s leading financial commentary service
Date: August 2003
By Christopher Hughes
The commercial banks’ assault on the US debt underwriting market is among the less visible shake-ups caused by the bear market. Some of them are even said to have offered loss-making loans to companies in a bid to win mandates. Yet for all the excitement surrounding bond issuance, underwriting it is a commodity business characterized by poor returns.
At first glance, it looks as if these banks are just taking share for the sake of it.
Three integrated banks – Citigroup, JPMorgan and Deutsche Bank – have made the biggest push into US debt underwriting. Between 1998 and 2002, their collective share of the market rose by 11 percentage points, according to Thomson Financial.
Citigroup made the biggest inroad, lifting its share by six points. The top traditional brokers – Merrill Lynch, Goldman Sachs and Morgan Stanley – have been the main losers. Their collective market share shrank by 10 points. Merrill’s alone dropped 5.4 points.
The only broker that significantly improved its position over the period was Lehman Brothers. It ended 2002 in fourth position, just behind the big three integrated banks.
Happenstance becomes skill The brokers’ loss of market share is partly a result of Citigroup and JPMorgan flexing the balance sheets enlarged by their founding mergers and Deutsche exploiting its acquisition of Bankers Trust. But it also shows that commercial banks had little choice but to look to the debt markets for opportunities at a time when the brokerages had equity underwriting sewn up at the peak of the boom.
When the bubble burst, that happen stance strategy began to look rather clever. The brokers’ focus shifted to cutting costs; there was less emphasis on investing in their debt capital markets businesses. Meanwhile, the commercial banks also enjoyed a natural advantage in winning mandates for debt issuance: their bulging balance sheets enabled them to advance cheap credit. Although it is illegal for them actively to package the two services together, there is nothing to stop chief financial officers requesting this.
People familiar with these deals say that it is not uncommon for banks to offer lending on generous terms when invited to do so as part of a debt mandate. But why, when the returns from investment-grade debt underwriting are slender?
Loss-leaders The only plausible answer is that the banks in question are taking a holistic approach to their corporate relationships. Debt issuance is the bread and milk that draws the chief financial officer or treasurer into the investment banking supermarket. The trick is then to sell them higher-margin products, such as instruments to hedge foreign exchange or credit risks. Over time, a loss-making loan and debt underwriting service could turn into a loss-leader.
It is too soon to know whether targeting chief financial officers rather than chief executives, which is what the strategy amounts to, is really working. Rating agency Standard & Poor’s has argued that it is. It notes that overall profit margins of the commercial banks that have gained share in US debt underwriting have overtaken those of the pure brokers.
But it would be wrong to draw too strong a conclusion from this. After all, S&P’s analysis looks at overall margins, not just investment banking margins. Part of the reason for the good performance of the integrated banks is their booming retail and private-banking franchises.
The integrated banks may, of course, suffer losses from providing loans too cheaply. Citigroup and JPMorgan have the blow-up of Enron fresh in their memories. But their charge into the debt underwriting business seems undiminished. The pressure on the traditional brokers isn’t going to ease.
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