These are lean times for investment bankers, especially those working in Latin America. It is years since business has been this bad. The volume of privatizations, initial public offerings, mergers and acquisitions, and bond issuance has dwindled. Competition for mandates has become more vicious than ever, especially in Brazil, the region’s most important market.
Fees have crumbled. Last year, rival bankers scorned Merrill Lynch for its 46 basis points underwriting fee for a $4.33 billion equity offering for Petrobras, the Brazilian national oil company. What looked paltry then looks princely today. In July, Salomon Smith Barney underwrote another Petrobras equity offering of $701.7 million for a fee of 19 basis points, probably earning barely enough to cover the cost of doing the deal.
One might have thought that consolidation in the investment banking industry would drive fees up. But that is not happening. There may be fewer banks around, but there is no noticeable reduction in competition, especially in Latin America’s key markets. Steven Cunningham, head of Latin American investment banking for Morgan Stanley, says, “There are opportunities in Mexico and Brazil and that has led to increased focus by the investment and commercial banks.”
These two countries have generated the bulk of investment banking transaction volumes this year, in spite of Argentina’s $29.5 billion swap in June, which generated about $140 million in fees for the 10 banks managing the deal – the largest fee payout in Argentina for eight years .
Latin American bond issuance in the first eight months of this year fell to $26.93 billion from $30.45 billion in the same period last year. Issuance for the whole of last year was down by a third from 1997, the last bull year for the Latin American bond market, when issuers placed $57.24 billion-worth of paper. The structure of the market has also changed. There are fewer bond deals, but they tend to be much larger than in the past. On average, the size of individual issues has increased by almost half to $342 million since 1997.
This trend only adds to the competitive pressures in the market. Issuers can demand smaller fees for larger issues, since they will pay a larger dollar amount. And banks are aware that losing a mandate is more of a problem these days than in the past, when there was more business to go around. In the boom days of the early- to mid-1990s, when big-ticket privatizations and Brady deals dominated the investment banking industry, banks could still make sound profits with small fees.
Now, the bulge bracket firms are being drawn into the bidding war for relatively small deals. According to Brazilian officials, Goldman Sachs offered a fee of 50 basis points for the July Petrobras secondary equity offering and Morgan Stanley’s fee was only slightly higher.
Wall Street firms are under pressure to keep deals flowing to cover their large overheads. As Rick Liebars, head of origination at Caboto says, “Some banks have very large teams – not just on the origination side, but in research, trading and back office as well. If we’re not seeing desperation now, give it a couple of months and we certainly will.” In the words of another banker, “the biggest players have a lot of mouths to feed and even a deal at half the price it was is better than none at all.”
Gargantuan banks like JP Morgan and Citigroup, which can combine investment banking services with a full range of corporate banking products have huge structures to maintain. Unlike the old-line investment banks such as Goldman Sachs, Morgan Stanley and Merrill Lynch, full-service banks use investment banking as a loss-leader to establish or cement relations and so win business for more stable and lucrative, if less glamorous sources of revenues, like treasury, cash management and lending. Peter Getsinger, Deutsche Bank’s head of Latin American investment banking, says, “Increasingly, we look at the overall profitability of the transaction rather than treating its elements in isolation.”
Issuers testify to the decline in fees. “Since the end of last year, we have seen competitors trying to win mandates through lowering fees,” says Adriana Ordóñez, head of the external capital markets team at Colombia’s Ministry of Finance. Sub-investment grade issuers have seen fees drop to a range of 60-65 basis points from 62-75 basis points on a dollar issue.
Brazil paid Nomura a fee of 60 basis points in August on its ¥200 billion, two-year issue. In January, JP Morgan earned 60 basis points for Mexico’s $1.5 billion 10-year bond. These were two of the most important sovereign bond deals this year, but the fees were a far cry from the levels seen in the boom years. In 1997, for instance, Chase Securities got a fee of 100 points on a $4 billion, 20-year Venezuelan bond issued as part of a Brady exchange. Brazil paid Goldman Sachs 112.5 basis points for a $3 billion 20-year bond also issued as part of a Brady exchange that year.
Francisco Pujol, managing director for Latin American fixed income at Morgan Stanley in New York, has seen competition sharpen in other ways. “Fees haven’t been the crazy thing this year,” says Pujol. “It’s on the commitment front that the lunatics have taken over the asylum.” Banks are winning business by making commitments to deliver deals at a certain size and a certain price. It is unusual to see commitments in the investment grade markets, let alone in emerging markets.
Peter Wallin, senior vice president with Standard New York Securities in Miami, part of the Standard Bank group, says, “The bigger the houses get, the more difficult it is for them to find profitable transactions.” This has created new opportunities for smaller houses, like Standard, that can make money with deals Wall Street banks don’t even look at.
Smaller houses like Bear Stearns and Lehman Brothers, with little more than 5% of the Latin American bond market, might be expected to cut fees more aggressively than their larger competitors. But Bear Stearns has shown that it is possible to earn better fees with smaller issuers. The Jamaicans paid Bear Stearns a fee of 85 basis points on a $275 million issue, compared with 45 basis points on the $1.5 billion Brazilian issue at the start of the year that Bear Stearns handled with Morgan Stanley. Still, it is obvious that bankers would prefer to share a tiny fee for a large Brazilian bond than keep a fat fee to themselves for placing bonds from a smaller issuer.
European banks are also bringing an extra twist to the competitive spiral. With traditional banking relationships fraying in their domestic markets, European banks are turning to Latin America. However, the Europeans are not as successful at clinching deals as their US competitors, and have drifted downward in the league tables as Wall Street firms tighten their grip on global capital markets by expanding distribution capacity in Europe. Deutsche and ABN AMRO had to drop out of the Argentine debt exchange after research was mistakenly distributed to US investors, which embarrassed both banks and cut them out of a lucrative deal.
Different types of business also tend to attract varying numbers of bidders. Sound Latin American corporates can raise short-term financing cheaply, but still need to pay stiffer fees for less appealing deals, such as in project financing where term lending is difficult to syndicate.
However low fees may have gone, borrowers want more than just a bargain basement deal. Colombia’s Ordóñez says, “You want people who will give you support in bad times and you work with those who have performed well in the past: those who have had good execution and have supported you with the effort they have made in selling the country. As well as research and execution, it’s a matter of how involved they are in the secondary markets.” Banks willing to support other deals – such as participating in syndicated loans or transactions for the central bank or other government bodies – also win points.
But officials in Brazil, where competition is particularly stiff, say in private that they worry that low fees will result in poor execution and indifferent support in the secondary market. However, public-sector issuers like the central bank and the BNDES national development bank are obliged to pick the lowest offer in open bidding.
Brazil’s central bank has adopted a scorecard for evaluating banks’ proposals. It will consider only those banks that are in the top 15 of the league tables and that have made regular visits to the bank. Typically, the bank prefers not to work with the same advisors on two consecutive deals and looks always for two banks to handle each deal. Until recently, that meant two European banks on any euro deals, but the central bank has now begun to accept the involvement of US banks in the euro market. Cost then comes into play as the “last, but not the least” criterion.
In evaluating costs, the central bank’s external debt and international relations department, headed by José Linaldo de Aguiar, no longer looks at all-in costs including spreads and yields, but focuses purely on the fee levels. “These tend to be very similar,” says Aguiar, “and we try to choose the bank with the lowest fees. But we also have to consider their performance in previous operations.” He feels that there is greater likelihood of a bank throwing in a noticeably lower bid when it “doesn’t have much opportunity on the basis of our criteria.”
It is sometimes unclear whether relationships in other areas lead to business on the sovereign and semi-sovereign issuer side, or whether the flow of business leads from sovereign transactions to other deals. Ordóñez believes Colombia and Venezuela are similar in that, “The core business is the government and other people are comfortable to go with a bank that has won business from the government.”
Treading Lightly
In that context, it may make sense for a bank to take a more aggressive approach to winning a sovereign mandate. But there is a limit: issuers are not comfortable with a bank they believe lacks credibility. Issuers are reluctant to give a mandate to a bank that lacks a solid track record, since clients know the secondary market is important.
League table position is the favored measure of credibility. Bankers accept that league tables have become more influential, with BNDES using Thomson data to help decide on mandates. The Brazilian central bank’s use of league tables in its criteria has reinforced this.
What matters most is how banks stand among comparable issuers rather than their positions in an overall table, which may include other, less relevant comparisons. Others see league tables as a fluctuating influence. Bulge bracket firms have tended, until recently anyway, to stay away from marginal deals that do not enhance their league table rankings. For institutions ranked lower, there is a greater incentive to bid strongly. And for those that want to assert their primacy in the primary market, they matter a lot.
Salomon felt it was worth undercutting its competition for the July Petrobras mandate, which was awarded by BNDES on behalf of the government, to gain credentials in the equities business. Last year it ranked fourth in Latin American equity with a 12% market share. In 1999, it did not even appear in the league tables. Thanks to the Petrobras deal, Salomon now tops the Latin American league table with a 50% share of a much-diminished market in this product.
Participation in the big debt exchanges wins banks prestige, headlines and league table recognition, and it generates a lot of fee income. The Argentine exchange provided banks with $140 million in fees. Fees on exchanges are small, at about 50 basis points, but the size of these transactions makes them tremendously profitable for Wall Street. In their early days, exchanges also allowed banks to drum up new business with creative structures, though Aguiar at the Brazilian central bank believes that structures used in exchanges are now well-known and fees have come down as a result.
To cope with diminishing business and falling fees, banks can always attack their cost base, and the mergers on Wall Street mean there is still a lot of fat to be cut. However, there is a cost to this. Dismantling teams to gain a temporary respite can demoralize staff, cause poor performance and lead to departures of key bankers. There can be savings in doing repeat business for an issuer, as this may allow a bank to duplicate parts of the documentation. But Latin American credits want banks to be in the market explaining their story to investors with people who can give a convincing account.
JP Morgan has been willing to let its M&A team dwindle by attrition after the merger with Chase, while Salomon is still fully staffed and, although ING Barings has been cutting back, Barclays continues to hire on the fixed income side by taking the likes of Grant Kvalheim, global head of debt origination from Deutsche Bank, and by hiring on the research side.
Downward fee pressures may at last be abating and an element of stability returning. “In the past fees were too compressed,” says Getsinger of Deutsche. “Now Latin America is becoming much more realistic.” Getsinger says this is because the rising cost of capital and enhanced perception of risk.
Ordóñez at Colombia’s Finance Ministry also expects prices to stabilize. “There is no more room for fees to go down,” she declares. “Fees are not just for arranging but for supporting issues and when volatility is so high, the cost of supporting issues is also high. Banks will be charging more for arranging and structuring and supporting the secondary market in these conditions.” Liebars at Caboto predicts a return to more normal fee structures and an end to the enthusiasm for commitments when the market reopens. “There will be no continuity with the way things are now,” he says, “and there will be a different fee structure to account for the greater risk.”
At an individual corporate level, the region’s unloved companies are probably going to find themselves facing higher fees, while banks will start to charge more if they can demonstrate the ability to execute a deal in current conditions. As Getsinger says, “Clients are more focused on accomplishing their goals and getting deals done.”
No doubt that was the case with Embraer’s June secondary offering in New York that raised $652 million. Bookrunner Morgan Stanley earned a healthy 238 basis point fee. LF