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Opinion

ECM outlook dims as volatility returns

Banks enjoyed a good end to the first quarter in equity capital markets, but the benign conditions that prompted deals might have come to an end.

As wholesale and investment banks continue their struggle to restore earnings and returns, the outlook for their various business lines remains highly uncertain. The first quarter of this year was good, especially for FICC revenues and debt capital markets, in large part thanks to central bank liquidity boosting risk assets and reducing volatility. But lingering macro fears make corporate decision-makers hesitant to consider M&A and the syndicated loan market is in near shut-down.

So equities and ECM look like the swing factor.

ECM bankers will tell you that, like their DCM peers, they had a great first quarter. In fact it only looked great compared with the dire second half of 2011. First-quarter ECM volumes and fees were down around 25% compared with the first quarter of last year. The most encouraging sign, after a quiet January, was the speed with which the business recovered, culminating in the launch of successful IPOs for such companies as Dutch cable-telecoms business Ziggo, whose $1.2 billion debut was successfully completed in March shortly after Swiss trade and services company DKSH found its IPO heavily oversubscribed in part because of its promise of Asian-related growth. With markets finally rallying after months of depression, private equity vendors looked ready to put attractive valuations on good-quality assets for sale.

This reopening of the highly remunerative IPO market after eight months of closure exceeded bankers’ earlier expectations. Sustaining it will be tough however. In April activity slowed once again as companies geared up for the reporting season against a backdrop of fears resurfacing around European sovereign debt, the damage inflicted on economic growth by government austerity measures and political instability even at the solvent core of the eurozone. When the Dutch government resigned amid disputes over EU-mandated spending cuts, stock markets in the core of Europe suffered 3% one-day falls. Confidence evaporated.

Jim Reid, market strategist at Deutsche Bank, suggests that financial market participants need to see positive economic news before the end of the first half of this year if they are not to lose faith in the capacity of austerity measures to lead to a brighter future. The sharp declines in eurozone and German purchasing manager indices in late April saw hopes dimming.

The second quarter has historically been the busiest for equity raising. ECM bankers say they have a substantial pipeline of deals set for pricing in May and June. Decisions on whether to proceed or not are now imminent. Equity traders suggest that investors are still defensively positioned and equities still look cheap. The worry is that they have little capacity to cope with short-term volatility. Even when markets were rallying in the first quarter, volumes were low. Now, with stocks well off their recent highs and volatility increasing again, investors’ appetite to pick up apparent bargains is in doubt.

On the supply side, the likelihood of large-scale transformative M&A deals requiring companies to raise equity to restore credit ratings looks remote. Banks, traditionally the most active issuers, don’t want to sell at depressed valuations. ECM bankers say no more than 10% to 15% at most of the €115 billion capital raise required by the European Banking Authority will come through new issues. UniCredit has already done the biggest slug of that and only then attracting support when valuations fell to around 30% of book value.

ECM bankers say it will be a very bad sign if a slew of deals don’t price this month and next. It might be wise for bank shareholders to brace themselves for disappointment.

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