For investment bankers, 2011 started with a shout and ended with a whimper -- causing fees to shoot up in the first half, then fizzle at year’s end.
Early on, Dallas-based AT&T Inc. and Frankfurt-based Deutsche Boerse AG announced bold plans to acquire competitors across the Atlantic. Initial public offerings surged in the first half to levels not seen since before the near collapse of the U.S. financial system in 2008. Pipeline operator Kinder Morgan Inc. went public with a $3.3 billion IPO in February that raised $1 billion more than projected, Bloomberg Markets magazine reports in its April issue.
Investor appetite for IPOs was even hotter by May: Shares of social-networking website LinkedIn Corp. surged 109 percent to $94.25 in their first day of trading.
“Activity continued to build to a crescendo even after the tragedy in Japan,” says Paul J. Taubman, investment banking chief at Morgan Stanley, speaking of the 9.0 megathrust earthquake and tsunami that hit Japan in March.
The high point of the year came in mid-July, when London-based Apax Partners LLP launched the biggest leveraged buyout since late 2008 with a $5.7 billion bid for medical-device maker Kinetic Concepts Inc., in which Morgan Stanley advised Apax and designed the financing package.
And then investment-banking deals vaporized.
‘Tale of Two Years’
“No doubt, it was a tale of two years,” Taubman says. “The deal calendar dried up, and we limped into the end of the year.”
So far in 2012, the pattern is familiar. The year is starting strong, with Facebook Inc. announcing it will do an IPO -- probably in May -- that may value the company at as much as $100 billion. In February, commodities giant Glencore International Plc announced a friendly $37 billion bid to take over mining company Xstrata Plc. Those announcements were accompanied by strong gains for stock markets around the world, with the Standard & Poor’s 500 Index up more than 20 percent from its October low through March 6.
“Our clients feel better about 2012, but they’re still concerned about the macro risks,” says David Solomon, co-head of investment banking at Goldman Sachs Group Inc.
Goldman is No. 1 in the Bloomberg 20, Bloomberg Markets’ eighth annual ranking of the best-paid investment banks by the fees they earn.
In 2011, total fee revenue at the biggest investment banks was down, sometimes sharply. Eight of the top 10 banks made less money in fees in 2011 than in 2010, according to data compiled by Bloomberg. In the cases of New York-based JPMorgan Chase & Co. and Zurich-based UBS AG, it was about $1 billion less.
Total Fees Flat
Total investment banking fees for all financial institutions in 2011 were $49.1 billion, matching the $49.1 billion from 2010. Total deal volume also matched 2010, at $6.9 trillion.
Goldman took the top spot in the ranking even as its total fees fell in 2011 to $3.46 billion from $3.6 billion in 2010. Goldman is also No. 1 in M&A fees for the eighth consecutive year.
JPMorgan dropped to No. 3 from No. 1 in the overall ranking. Morgan Stanley held on to the No. 2 spot, with $3.26 billion in overall fees, down 11 percent from the prior 12 months.
The falling fees were part of a tumultuous year for the big banks. Trading revenue also plunged; it fell to $13 billion in the fourth quarter from $28 billion in the first for the top five banks in the Bloomberg 20. It was driven down by anxiety over Europe; by the Volcker rule, which will severely limit proprietary trading; and by new global capital regulations, known as Basel III, that limit the amount of leverage banks can take on by increasing the amount of equity capital they must hold against illiquid assets.
Job, Pay Cuts
The banks responded to the revenue shortfall by cutting both jobs and compensation. Globally, more than 230,000 bankers were let go in 2011. At Citigroup Inc., Credit Suisse AG and Morgan Stanley, those that survived were handed pay cuts, with total investment banking compensation falling as much as 30 percent. Bank of America Corp. cut pay by up to 40 percent in some of its investment-banking divisions and awarded more stock and less cash in bonuses.
Bankers say they are more cautious today when it comes to committing assets on their balance sheets to certain deals, including long-dated derivatives contracts.
“Balance sheet is a much scarcer commodity and a much dearer resource,” says Hugh “Skip” McGee, head of global investment banking at Barclays Plc’s Barclays Capital in New York, which is No. 8 in the Bloomberg 20.
M&A Fees Rise
Total merger and acquisition fees rose to $20.3 billion in 2011 from $17.9 billion in 2010. Those numbers, however, were offset by declines in fees from debt and stock deals. And they conceal the M&A freeze that took hold in the second half, when announced M&A volume plunged to $1.03 trillion, a drop of 18 percent from the first half. As a result, total volume was up just 4 percent from 2010, with $2.3 trillion in announced deals. That’s a 44 percent drop from the 2007 peak of $4.03 trillion.
The pullback from the deal market started in early July, when the International Monetary Fund authorized a 3.2 billion euro ($4.2 billion) loan to Greece to prevent it from defaulting on debt held by European banks. Euro-zone leaders approved another rescue package of 109 billion euros for the troubled nation on July 21.
U.S. lawmakers then stoked fears that America could miss its own debt payments by waiting until Aug. 2 -- when the U.S. Treasury said its borrowing power would be exhausted -- to adopt a plan to raise the country’s debt limit. Standard & Poor’s downgraded the debt of the U.S. to AA+ from AAA on Aug. 5.
“We had a cocktail of the U.S. deficit, the downgrade and a whole number of issues around the sovereign-debt crisis in Europe,” says James Amine, global co-head of investment banking at Zurich-based Credit Suisse, which is No. 6 in the Bloomberg 20, with $2.26 billion in fees. “That story just overwhelmed the positive start to the year.”
Economists revised growth projections down, and some predicted a double-dip recession for both the U.S. and Europe.
“It looked like the U.S. economy in the third quarter was grinding to a halt,” Amine says.
While concern about a new U.S. recession has diminished, bankers say 2012 is fraught with challenges.
“The U.S. feels slightly better, but Europe is still an issue,” Barclays’ McGee says. “You could see things surprise to the upside, but that means some of these uncertainties have to be eliminated.”
Europe Fees Plunge
The drama in Greece has hurt European banks. At Deutsche Bank AG, Germany’s biggest financial services firm, fourth-quarter profit fell 76 percent as its investment bank posted a 422 million euro loss. Fourth-quarter profit at UBS, Switzerland’s largest bank, also dropped 76 percent, as its investment bank recorded a pretax loss of 256 million Swiss francs ($280 million).
UBS is No. 9 in the Bloomberg 20, with $1.60 billion in fees, while Deutsche Bank is No. 5, with $2.29 billion.
Goldman Sachs emerged on top of the Bloomberg 20 partly by taking a bigger share of the M&A market. The bank acted as an adviser on 23.3 percent of the global M&A deals announced in 2011, up from 19.7 percent the year before. It surged ahead of the pack by acting as an adviser on a number of big deals completed in the fourth quarter, including Australian beer maker Foster’s Group Ltd.’s $13.1 billion sale to SABMiller Plc and Global Crossing Ltd.’s $3.2 billion sale to Level 3 Communications Inc.
Goldman Not Immune
Yet Goldman Chief Executive Officer Lloyd Blankfein and his crew were not immune from the first-half/second-half syndrome. From January to June, the bank took in $2.7 billion in net revenue from M&A advice and underwriting; that number dropped to $1.6 billion for the second half. Underwriting revenue at Goldman plunged 68 percent to $258 million in the third quarter from $811 million in the second as CEOs and corporations shelved plans to issue new debt and stock in volatile markets, Goldman Chief Financial Officer David Viniar said in an Oct. 18 analyst call.
“Some of the deals that you’ll see get announced in 2012 stem from discussions that started in 2011 but ended up falling away because the market environment wasn’t great,” says Solomon, who runs Goldman’s global investment bank with Richard Gnodde and John Weinberg.
Almost half of the banking industry’s M&A volume in 2011, about $1 trillion, came from cross-border transactions.
‘Scale is Critical’
“Scale is really critical for our clients to expand their physical and product reach,” says Jacques Brand, co-head of investment banking at Deutsche Bank. “A lot of M&A activity is going to be driven by a desire to diversify geographically. You’ll see cross-border activity continuing to increase dramatically.”
As they seek acquisitions abroad, companies are looking to their investment banks to navigate sharp swings in foreign-exchange rates and commodities prices, Brand says. For example, Bentonville, Arkansas-based Wal-Mart Stores Inc. needed to hedge its foreign currency and other risks when the world’s biggest retailer paid 16.5 billion South African rand ($2.1 billion) in June for a 51 percent stake in Massmart Holdings Ltd., South Africa’s biggest food and general-goods wholesaler, Brand says.
Wal-Mart used JPMorgan and Rothschild for advice, as Deutsche Bank guided Massmart in the transaction.
“We are in one of the most volatile markets with respect to foreign exchange, commodity prices and interest rates,” Brand says. “If you don’t integrate risk management into every dimension of your M&A strategy, that can undermine the strategic and economic rationale of the transaction.”
Deutsche Bank, among other firms, handled the biggest announced M&A deal of the year when AT&T proposed to pay $39 billion for T-Mobile USA, a unit of Deutsche Telekom AG. The deal fell apart after the U.S. Justice Department sued to block it on antitrust grounds.
M&A activity in Asia picked up last year, with the region involved in 40 percent of all cross-border deals versus 37 percent in 2010, even as China’s growth fell into single digits. Purna Saggurti, chairman of Bank of America’s global corporate investment bank, says his clients saw consumer demand in China decline toward the end of last year, and the softness has continued so far in 2012.
Bank of America Merrill Lynch is No. 4 in the Bloomberg 20, with $2.79 billion in fees.
About 63 percent of all cross-border deals and the biggest IPO in 2011 came out of Europe. Glencore launched the year’s biggest IPO, at $10.1 billion, when it listed itself in London and Hong Kong. Its proposed takeover of Xstrata this year came as no surprise, because it already owns 34 percent of that company.
As 2012 began, confidence was rising among investors that Europe would contain its debt woes. As of March 6, the Bloomberg European 500 Index of stocks was up 5.8 percent for the year.
“Our sense is that people are getting a bit more comfortable with Europe and the risks there,” Barclays’ McGee says.
“Europe is a challenge,” Deutsche Bank’s Brand says. “But, having said that, we just advised on a transaction involving the Polish mobile-operator Polkomtel SA. It was the largest European LBO transaction since 2007.”
Bank of America’s Saggurti expects the weakness in Europe to persist. “I don’t think anyone is waiting for deal activity in Europe to come back anytime soon,” he says. “The economy is hurting there and will continue to struggle.”
Still, as of mid-February, companies and investors had stopped worrying about an imminent euro-zone collapse. The European Central Bank averted a major banking crisis in December when it announced a plan to offer three-year loans at 1 percent to area banks, Taubman and other bankers say.
“Volatility has dropped demonstrably in the marketplace,” Taubman says. “The VIX has come down dramatically from its October highs, which I think is a necessary launch condition for the equity calendar.”
The Chicago Board Options Exchange Volatility Index, or VIX, measures swings in the price of the S&P 500 Index. The VIX hit a two and a half year high in August and remained elevated until the ECB plan was announced on Dec. 8.
Credit Suisse’s Amine says many investors and clients think the U.S. economy could decouple from the European system and grow by as much as 2.5 percent this year, even if there is a broad-based recession across the Atlantic. Only drastic change, such as a “messy” Greek default or the breakup of the euro zone, is likely to have a major impact, he says.
Decoupling from Europe
“Negative GDP growth in Europe alone shouldn’t be enough to derail the U.S.,” Amine says. “However, if there is a default in the financial system and it creates contagion, the U.S. market would stall.”
Nonfinancial corporations in the U.S. and Europe are on the whole healthy, bankers say. Valuations on potential acquisition targets are reasonable, and financing costs for highly rated corporations are at historically low rates, Barclays’ McGee says.
“There are reasons to be optimistic, but we’re not counting on a snapback to ‘06, ‘07 levels anytime soon,” he says.
What bankers do expect is a healthy debt market. Corporations issued $2.9 trillion in bonds and debt instruments last year, the second-highest volume on record, after $3.2 trillion in 2009. Corporations were awash in low-cost funding options as the Federal Reserve kept overnight borrowing rates close to zero and announced that it plans to keep them there through 2014.
JPMorgan No. 1 Debt Dealer
Many companies took the opportunity to refinance their debt at lower rates, says Jim Casey, who runs the debt capital markets desk for JPMorgan with Andy O’Brien. JPMorgan was No. 1 in debt underwriting for 2011.
About 65 percent of the companies that borrowed in the markets in the first six months used those funds to refinance other debt. That flipped in the second half of the year when 61 percent of leveraged loans were used to make acquisitions and finance buyouts, Casey and O’Brien say.
“There was a fair amount of capital that was committed to in the first half that didn’t get executed until the second half,” Casey says. “And in the second half, when markets were weaker, issuers that just wanted to refinance saw that the markets were really difficult and backed away.”
While bankers are mildly optimistic about 2012, they temper their predictions with warnings. If the European Union finds a way to save Greece from default -- and in the process stabilizes the national finances of Italy, Ireland, Portugal and Spain -- then Europe could start growing again and the markets could conceivably take off, they say.
No one, however, is counting on such a felicitous chain of events.
“We still live in an uncertain environment where investor confidence can turn on a dime, liquidity can dry up and markets, even if they’re open, can quickly shut down,” Morgan Stanley’s Taubman says. “And markets that are closed can open back up almost overnight. In what is still a volatile, uncertain environment, I think the right answer is to be cautious.”