It's been eight years since the Gramm-Leach-Bliley Act lifted the restrictions keeping commercial banks from directly engaging in investment banking. But other than an initial flurry of activity after the passage of the act by the largest global money center banks (and before passage in the case of Citicorp), the mid-tier and regional banks have mostly shied away from capital markets.
In a September speech at the Financial Services Roundtable Leadership Lunch, Securities and Exchange Commission Chairman Christopher Cox told attendees, "All in all, the seven year stretch from enact merit of Gramm-Leach-Bliley until today is a disappointing record of indecision and inaction. We've made several efforts to cross home plate, but all our runners have been left stranded on base."
"Banks haven't been getting into capital markets and understandably so: it's a very different beast in terms of culture, compensation, and fundamental business economics," explains Alenka Grealish, managing director of the Banking Group at Celent, Boston. "It's a volatile business that won't necessarily improve their total shareholder return."
There are exceptions, of course, and some banks, such as $1.4 trillion JPMorgan Chase and Citigroup ($1.8 trillion) have a thriving capital markets business. Others that entered investment banking have exited: $6.4 billion BankAtlantic Bancorp, Fort Lauderdale, Fla., recently announced completion of its sale of Ryan Beck Holdings, Inc., to Stifel Financial Corp., St. Louis. Minneapolis-based US Bancorp spun off Piper Jaffray & Company in 2003.
Lack of synergies
Investment banking can be a hugely profitable endeavor (think Goldman Sachs). In addition, the synergies between commercial banking and investment banking seem obvious: a bank's loan customer is doing very well and decides to take the company public. Because it already has a relationship with the company and knows its credit worthiness, a bank should be able to manage the process more easily than an outside firm.
So are banks missing an opportunity by not entering investment banking? Not necessarily, says Tim Yeager, associate professor of finance and the Arkansas Bankers Association Chair in the Sam M. Walton College of Business in Fayetteville, Ark.
Yeager, a former economist with the Federal Reserve Bank of St. Louis, studied the financial performance of financial holding companies for two periods: the four years preceding the Gramm-Leach-Bliley Act and four years after. He found only minor performance differences between the time periods. "Banks became financial holding companies in spirit but not in practice, deriving most of their earnings from standard bank offerings such as deposits and loans," he notes.
Cream of the crop
Minus a few exceptions, those that are in, are in. Those that are not in seem content to stay that way.
"The banks that are getting into investment banking have already gotten in to it," says James M. Schutz, director of the Financial Institutions Group at Sterne, Agee & Leach, Birmingham, Ala.
Part of the difficulties in entering investment banking is that the market is extremely competitive and reputation is important. There are the firms that are the cream of the crop: the Goldman Sachs and Morgan Stanley's of the investment banking world--and companies wanting to go public naturally want to be associated with a big-name to maximize their offering price. The second-tier investment banks can still make high profits, but "let's face it, no one wants to go with a third-tier firm," explains Yeager. Some third-tier firms (however that may be defined) may dispute that, but the consensus clearly is that getting and staying at the top is difficult and too expensive for most banks except the very largest. Even some of the biggest banks acknowledge this, at least in part.
In talking about being in the investment banking business, Ken Thompson, chairman and CEO of Charlotte, N. …