Eat-What-You-Kill Brokers Starved After Bank Bailout

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Bond-trading boutiques are being squeezed out of the market as Wall Street’s biggest banks recover from the financial crisis that caused almost $2 trillion in losses worldwide.

BTIG LLC, an equities broker that hired 75 debt traders and salespeople in 2009, has lost at least 42 fixed-income staff in the past year, regulatory records show. Chapdelaine & Co. is seeking a buyer to stem a staff exodus after a deal announced in April to raise capital broke down, said people familiar with the matter. LaBranche & Co. in New York shut its debt-trading operations in July, informing clients in an 11-word e-mail.

Banks that dominated debt trading before the credit crisis have recovered their market share after $12.8 trillion of government bailouts healed credit markets and cut profit margins by more than 80 percent. Traders who joined smaller firms are abandoning so-called eat-what-you-kill, or commission-based, pay in search of guaranteed compensation.

“People who went into this expected that the banks would take two to three years to come back; they turned that around in six to nine months,” said John Purcell, who left BTIG in June, 17 months after joining the firm in New York to help lead its expansion into fixed income. “The practical realities of competing in an environment where the banks not only are applying capital again, but are also aggressively hiring and writing some good contracts, just made it more difficult.”

Purcell, who ran global fixed-income syndicate for New York-based Citigroup Inc. before going to BTIG, hasn’t joined another firm.

Relying on Relationships

An estimated three out of four brokers have left the boutiques to return to bigger banks, according to Simon Lewis, a managing director at Michael Page International, the London-based recruitment firm.

BTIG, Chapdelaine and LaBranche were among about 70 firms that entered the market in 2009 when larger competitors reduced trading as they suffered losses and had to preserve capital, said Roger Freeman, an analyst at Barclays Capital in New York.

The boutiques, some of which consisted of two or three people, didn’t have capital for trading. Instead, they used relationships with institutional investors to match buyers and sellers of assets frozen in the credit crisis. High-yield, high-risk bond values plunged to as low as 55 cents on the dollar in December 2008, three months after the collapse of Lehman Brothers Holdings Inc.

‘Made Hay’

The firms lured Wall Street veterans with promises of 40 percent commissions, double the rate they made at the banks, according to Lewis at Michael Page in New York. The commissions were being offered at a time when the fees brokers make from trading soared more than five-fold to records.

The average difference to buy and sell the 10 most actively-traded U.S. corporate credit-default swaps contracts ballooned to 24.2 basis points in the nine months after Lehman’s bankruptcy, from an average 4.5 basis points in the two years before the collapse, according to data compiled by Bloomberg and London-based CMA. That means a trader after the crisis could have earned an extra $19,700 on a $10 million trade.

“They made hay while the sun shined,” Lewis said. “The total compensation was great at the boutiques when the larger banks couldn’t compete.”

Those margins collapsed as the U.S. government and the Federal Reserve spent, lent or committed $12.8 trillion to unlock capital markets and bail out banks. The average gap between prices to buy and sell credit-default swaps narrowed to an average 7 basis points in 2010, CMA data show.

‘It’s About Security’

“We tried to provide liquidity in a niche market where balance sheet was not readily available at the time,” said Alex May, a 15-year veteran of Citigroup hired by BTIG in May 2009 to run a team of brokers that matched buyers and sellers of emerging-market debt. “Liquidity came back into the market quicker than we expected,” he said.

May and most of his team left the firm in the past three months, according to records from the Financial Industry Regulatory Authority. May isn’t currently registered as a broker, Finra records show.

Larger banks were offering salespeople and traders at boutiques between $1 million and $2 million a year in 2010, with guaranteed contracts of as long as two years, said Jeanne Branthover, a managing director at Boyden Global Executive Search in New York.

While those sums are comparable to the amounts earned at boutiques in 2009, traders and salespeople now want the promise of term employment as profit margins have fallen, she said.

“It’s not just about the money for these guys,” Branthover said. “It’s about security.”

Dealer Control

Banks have increased their share even after Congress passed the biggest overhaul of financial regulations since the Great Depression. Firms must hold greater amounts of capital and are restricted by the amount of risk they can take with their own money.

The percentage of trading controlled by the top 10 dealers climbed to 92.5 percent from 87.5 percent in 2008, according to a survey published in August by Greenwich Associates, a research and advisory firm in Greenwich, Connecticut, specializing in financial services. The share for smaller dealers outside the top 10 increased to 7.2 percent from 4.9 percent.

Banks are using their own assets to make markets and to build bond inventories their smaller rivals lack. They’re also winning share by using debt underwriting operations to compete for trading business, said Peter Santry, who left Chapdelaine last year to become head of distressed trading at New York-based Jefferies Group Inc.

Raising Capital

Companies issued a record $286.7 billion of U.S. high-yield, high-risk corporate bonds in 2010, up from $162.7 billion in 2009 and $65.9 billion in 2008, Bloomberg data show. The two largest U.S. banks, JPMorgan Chase & Co. and Bank of America Corp., and Credit Suisse Group AG, Switzerland’s second-biggest bank, had a combined 38 percent of the share last year.

“Firms that could deploy more capital and had new issuance became more significant to buyside accounts,” said Santry, who joined Jefferies in September and worked for 14 years at Bank of America as a managing director and head of special situations.

Many boutique firms have had to resort to raising capital to compete, he said. “It’s been hard for those guys to attract any new capital and that’s been a problem,” he said.

‘Melting Away’

The 18 primary U.S. government debt dealers that trade directly with the central bank held $88.2 billion of corporate debt with maturities greater than one year as of Jan. 12, up from $59.8 billion on April 29, 2009, the least since 2003, Fed data show.

Goldman Sachs Group Inc., JPMorgan, Citigroup and Morgan Stanley in New York along with Bank of America of Charlotte, North Carolina, have generated the most revenue in their history during the past two years. They produced a total of $93.7 billion in the first nine months of 2010 from advisory, debt and equity underwriting, and from trading stocks and bonds, after a record $127.8 billion in 2009.

“The boutique business model of finding trading opportunities to liquefy frozen assets is melting away,” said Sanford C. Bernstein & Co.’s Brad Hintz in New York, ranked by Institutional Investor as the top analyst covering brokerage firms. “Fixed income is going back to its older model.”

Boutiques Pull Back

One of the first casualties was LaBranche, the broker-dealer founded in 1924 that hired traders from Deutsche Bank AG as it was starting a credit-markets business in March 2009.

“Thank you for your business,” Christian Reddy, a senior managing director, wrote in the e-mail to clients 16 months later. “We have exited the debt markets.” Reddy declined to comment.

BTIG, which started with five employees in 2002 and grew to more than 400 last year after an investment of an undisclosed amount from Goldman Sachs, lost at least 42 fixed-income staff in the past year, Finra records show.

Six months after Purcell’s departure, Jon Bass joined MF Global Holdings Ltd., the New York-based futures broker run by Jon Corzine, the former head of Goldman Sachs who also was a U.S. senator and governor of New Jersey. Bass, BTIG’s former co-head of fixed income, spent 14 years at Citigroup and Salomon Brothers Inc. and nine years at UBS AG.

Kelsea Michael, an outside spokeswoman for BTIG in New York, declined to comment. Co-founder Steven Starker said in a November statement announcing new hires that the firm continues “to see opportunity for BTIG in high yield, distressed and convertibles and we are aggressively looking to add talented professionals in those areas.”

Chapdelaine Departures

As fees for brokering trades diminished, a 2009 agreement by Hong Kong-based Primus Financial Holdings Ltd. to buy 70 percent of New York-based Chapdelaine soured, according to three people with direct knowledge of the matter who declined to be identified because they weren’t authorized to speak publicly.

Senior management at New York-based Chapdelaine informed employees at a meeting this month that the Primus deal was in jeopardy, the people said. A team of four that traded structured debt at the firm left this month, and rival firms are being contacted by other Chapdelaine employees seeking jobs, according to executives from six brokerage companies.

Primus founder Robert Morse, a former Asia investment banking chief for Citigroup, said in a Jan. 14 interview that his transaction is a “live deal at this point.” He declined to comment further.

The brokerage arm of Ken Griffin’s Citadel LLC and CRT Capital Group LLC, the broker-dealer backed by private-equity firm Aquiline Capital Partners LLC, are among firms considering a bid for Chapdelaine, the people said. Devon Spurgeon, a spokeswoman for Chicago-based Citadel, declined to comment.

“There are several opportunities in this market as the smaller firms without capital struggle to survive,” Ron Kripalani, the chief executive officer of Stamford, Connecticut-based CRT, said in an e-mail Jan. 14. “I suspect there will be considerable consolidation” in the first quarter of 2011.