Without ambition, Wall Street would be nothing. Many people are fighting their way up the ranks of the large investment banks; quite a few more have left them entirely to set up small boutiques, in the hope of making a lot of money by providing specialist services. Roberto Mendoza and Peter Hancock, however, both highly successful executives at the pre-merger JP Morgan, have decided to go further, to set up a fully fledged investment bank called Integrated Finance Ltd (IFL). The idea, according to a friend of the pair, is to create a new player in the banking industry, a shop roughly the size of Lazard.
In fact, IFL has ambitions even beyond this. It’s looking to go public in as little as three years. Within five or six years, it hopes to have a stand-alone single-A credit rating, which it can leverage to take on substantial risk. So IFL is not your standard advisory boutique: its founders are going to compete head to head with the big guys.
IFL is actually plan B for Mendoza, Hancock and their partner Robert Merton, the Nobel Prize-winning economist who came famously unstuck at Long Term Capital Management. Plan A was to hit the ground running with a large institution that had already been built up over many years – General Re Financial Products, a firm that its owner, Warren Buffett, was quite happy to see go to rocket-scientists such as Hancock and Merton. Talks started in January 2001, but the deal fell apart after September 11. IFL’s story is that after doing due diligence, they determined that Buffett wanted too much money. Others in the market say that they had difficulty raising the nine-figure sum required. Certainly, there was a difference of opinion on the value of Gen Re’s derivatives portfolio.
IFL, by contrast, is a much smaller operation. The three partners put in $5 million capital each. Another $30 million was provided jointly by ACE insurance in Bermuda and NIB Capital.
NIB, a Dutch merchant bank owned by ABP and PGGM, two of the world’s largest pension funds, is providing more than just $15 million: it also has a double-A credit rating. When necessary, NIB has promised to guarantee IFL’s ventures, allowing the new firm to take on a risk book of its own.
The connection with ACE is easier to see. Both Mendoza and another ex-JP Morgan man, Scott Levine, were involved in founding it. Levine, after an ill-fated stint at imploded Latin American advisory boutique Violy Byorum & Partners, has now moved to IFL as its COO.
Big firms lose best talent IFL is by no means the only shop to be set up by executives who have left a major investment bank and think they can provide better service in a smaller setting. One investment-bank CEO says that “there’s more talent outside the industry than there is inside it”.
Gene Ludwig, the founder of advisory boutique Promontory Financial, agrees: “The constant churning in the banking system has left a lot of talented people on the street,” he says. “It’s also changed the view of a lot of people as to where they want to work. JPMorgan and Goldman Sachs sounded safe, but people’s view of job security is different today. Assuming the enterprise will always be around is asking for trouble.”
The growing number of small investment-banking shops, then, is a function of both supply and demand. A lot of 40- and 50-something executives are leaving the likes of Morgan Stanley and JPMorgan convinced they have one last big job left in them. And many clients are dissatisfied with precisely the same large banks, which might lack highly specialized skills, might not have seamless coordination between product groups, might not put their brightest stars or top executives onto the job, might have nasty conflicts of interest, and might well charge obscenely high fees.
Most of the enterprises that spring from this situation, however, are high-value-added propositions that are narrowly focused and aim to do one thing extremely well. Merton and Hancock’s former colleague, Nick Rohatyn, for instance, has decided that his aim is to set up the world’s best emerging-market hedge fund. Promontory specializes in giving financial institutions advice on risk management.
“Our secret has been that we try to do one thing, and do it well,” says Promontory’s Ludwig, who has found a gap in the market which he’s well qualified to fill, he says. “There aren’t many people who’ve been regulators, heads of risk management departments and bankers.”
One corollary of Ludwig’s approach can be seen in the art of not doing deals. IFL is quite proud of its impartial advice. While many big banks will peddle all manner of complex operations because they do wonders for the P&L, IFL takes a different approach. It, too, will specialize in constructing such deals, but the difference is it will usually then tell its client to go elsewhere for the actual execution. Only in the most abstruse cases, where it might be constructing instruments that have never been seen before, will it fill the gap in the market and write the tickets itself.
Even so, IFL intends to do much more than structure highly complex derivatives transactions, and will happily take on bread-and-butter M&A advisory mandates, for example, as well. In this, it stands in contrast to Promontory where, says Ludwig, “we’ve turned away just about as much business as we’ve accepted”.
IFL, on the other hand, wants to do just about anything that its clients might want it to do. One source high up in the company says that it’s trying to do “what John Pierpont Morgan himself would do, espying the wasted landscape” – providing “highly ethical, transparent, conflict-free advice driven by the client’s best interests”. They hope to grow fast – from 30 professionals by the end of this year to more than 200 in a couple of years’ time, before an initial public stock offering shortly thereafter. “The main risk is that we can’t penetrate the market in an important way over a two-to-four-year period,” says the source.
IFL even has plans to enter asset management, a business line that, while not providing big fees, does add stability to a small firm’s income stream. The idea is that many would-be investors in hedge funds want or need to know the risk profile of what they’re investing in. Hedge funds, on the other hand, are secretive, and don’t want to disseminate information anywhere that their competitors might ever see it.
IFL has plans to break the impasse. It could set up a fund of funds that would invest in hedge funds. These would give real-time information on their investments to IFL – and IFL only. In turn, IFL could aggregate that data and pass on a detailed overall risk analysis to its own investors, with no one fund’s position discernible.
The big questions, of course, are why these men have set up this bank, and whether they will be able to make it a success. The stated aim, since an IPO is very much a goal of IFL, is to create a strong franchise that will last long after the founders retire. Yet at the same time, a lot of IFL’s structure seems to be built around the individual and idiosyncratic strengths and preferences of the three partners.
Merton has the most obvious motivation in setting up a new company. He, like his former partner John Meriwether, does not want to end his career on an LTCM low.
Hancock is probably about as smart and successful as derivatives wizards come: one rival calls him “world-class on risk management”. And Mendoza is fully his equal in M&A. Both can provide valuable services. But why set up their own shop to do it?
“Roberto’s decided to do what he likes best,” says one friend, “which is a combination of advisory and risk-taking.” To more than one outside observer, IFL looks more like a vanity organization than a recipe for long-term success: a vehicle to give its founders the opportunity to redeem themselves from the Gen Re debacle and to do what they love, rather than an organization that is likely to grow into a major new player in the banking industry.
“Roberto never managed anything, and Peter is a dreamer,” says an ex-colleague of theirs from JP Morgan. “They’re doing this because there’s nothing else to do.”
They’re both smart men, and certainly made an intelligent hiring decision when they brought Levine on board, since he’s someone who can stand up to Mendoza, especially, when he flies into a temper. But, says the head of a rival bank, “to be successful as a boutique, you have to be more than just smart. You need to be driven to do it – it’s an entrepreneurial job. The question is do they have that fire in the belly?”
What’s more, there seems a very real risk that IFL is overreaching itself. The company is already hiring top-tier talent aggressively, and its expenses – especially payroll – will soon skyrocket.
“There’s certainly a lot of people no longer with JPMorgan who would be prepared to give rebuilding it a try,” says an investment bank CEO, “but it would need multi-billions of dollars in capital. IFL can recreate the intellectual firepower, but not the franchise, the confidence in the bank doing the right thing over an extended period of time. Morgan was about scale – it entered into 10-year-plus trades. The brand name had a lot to do with that.”
IFL also runs the risk of being sold out by its investors. Even if the three founders envision a long-standing franchise, the other investors are likely, if the bank has reasonable success in its initial years, to be sorely tempted to cash out by accepting rivals’ offers. One story doing the rounds is that Mendoza has already turned down Goldman Sachs, his employer after he left JP Morgan, which offered to fund the whole shop if Mendoza would set it up as an entity within Goldman.
Mendoza told a friend: “I haven’t done this to turn around in five years and sell it to somebody else,” but that is often what happens with boutiques: James Wolfensohn sold his to Bankers Trust, for instance, and Bruce Wasserstein his to Dresdner.
Nevertheless, Mendoza and Hancock, especially, are the kinds of people that any company would want giving it advice, and all those involved have reputations for being ethical and wholly transparent. The problem, one of their former colleagues says, is that they “are asking people to pay for things that they are used to getting for free”. Advice from IFL won’t come cheap, largely because it won’t be subsidized by sales and trading operations.
The partners, though, are optimistic: one of them has been telling friends that the worst part of building the franchise is already past. Maybe all that’s needed now is a little bit of luck.
