In today’s markets, the investment banker’s misery is the corporate banker’s delight. Up to a point, that is. There’s no arguing with the reality that M&A activity has plummeted by half this year, and, try as they may to talk up the market, people in corporate finance departments are spending a lot of time staring at the wall.
But Teather & Greenwood’s banking analyst Martin Cross argues that business at the investment banks has by no means come to a halt. “Investment banks are getting work in IPOs and equity raising as companies de-gear and restructure their balance sheets, he says. “But they are lumbered with a high cost-to-income ratio, so their capacity for weathering a downturn is limited.”
The investment banking crisis also highlights an interesting side question, concerning whether the integrated houses, such as Schroder Salomon Smith Barney and JP Morgan Chase, that have been put together in the past few years, can live happily under one roof. The conflicts between the amalgamated risk-prone investment bank and risk-adverse retail and corporate banks have been make starker in recent months. It has become unsustainable for investment bank analysts to remain bullish. They have had to acknowledge that many corporates under their coverage are in deep trouble, and this drags down business for the entire group. Clients are no longer prepared to tolerate equity research put out on false pretences.
Companies are finding it expensive to raise debt through the markets, with the appetite for corporate paper having all but dried up. A shrinking universe of investors means that corporate issuers have to price their paper accordingly to attract buyers.
Also, as Trevor Pitman, group MD at Fitch Ratings, points out, investor confidence has taken a nosedive in the past year: “It’s been particularly difficult since the second half of the year,” he says. “There were moments when it looked like the market was picking up, but it was a false dawn.” This has been reflected in the postponement of some high-profile issuance, such as a EUR1.5bn bond by Hong Kong’s Hutchinson Whampoa.
Some corporates have reportedly been looking into the US dollar private placement market, because it has not suffered nearly the same degree of turbulence as the public markets. But the number of inquiries is few and this alternative is mainly at the rumour stage.
“You can get rights issues away, as we’ve seen in the insurance sector, where companies are raising equity to plug their solvency ratios,” says John Hitchins, banking leader at PricewaterhouseCoopers. “Today, companies are looking at traditional bank finance. Bonds were a cheap option, but their pricing benefit has been eroded.”
Hitchins says that much depends on a corporate’s credit rating. “You have to look at which companies are doing best,” he says. “The more traditional sectors find it easier to raise finance, and corporates in counter-cyclical businesses are also doing well.”
A look at junk bonds also tells a story. Investors have become risk adverse. In Europe, issuance in the leveraged loan market for the first half of the year was EUR26.8bn – half the total for the same period in 2001.
The bottom line is that the bond market depends on agency ratings and investors, which are almost always insurers or pension funds with an in-house allocation for corporate bonds. When credit problems arise, the agencies issue downgrades and investors are handicapped by their in-house allocation mandates.
But banks still have plenty of capital, and a recent CBI report says there has been an upswing in corporate banking business. This is hardly surprising, given the close relationship European corporates have with their lenders. The debt-to-liabilities ratio for US corporates is roughly two-thirds capital markets and one-third bank borrowing. In Europe that ratio is reversed.
“There’s less disintermediation and longer-standing bank relationships in Europe,” says Pitman. But even here, Pitman warns, there may be trouble. Bad loans tend to lag the cycle – so their effects are yet to be felt.
“With rates this low one would expect the economy to be buoyant and to find companies making five to ten-year investment decisions and funding them with long-term bonds,” says Norman Bernard, director of First Consulting. “But this is like a phoney war, in that nobody quite knows where things are going.”
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