One word recurs with almost monotonous regularity in the announcement of 1999 results at the major US investment banks. That word is 'record', with the explosion in mergers and acquisitions activity and strong equity issuance being the major driving forces behind performance. These factors combined with M&A-related financing and the rapid development of a corporate credit market in Europe following the introduction of the euro to produce a year of almost undiluted good news for the industry.
At Goldman Sachs, for instance, where annual net revenues increased 57% to a record $13.3 billion, there were several talking points. Goldman Sachs modestly points out that it ranked first in worldwide mergers and acquisitions for the calendar year, having advised on announced transactions valued at more than $1 trillion. It achieved record results in equity underwriting, ranking first in both worldwide and U.S. public stock offerings for the year. Its trading and principal investments business continued to produce favourable results, although strong performances in equities and merchant banking were partially offset, it says, by lower net revenues in the fixed income, currency and commodities business. Assets under supervision increased 18% to $485 billion and assets under management grew 17% to $258 billion.
Goldman Sachs reports that investment banking generated net revenues of $4.4 billion for the full year, a 29% increase over 1998. Equity underwriting benefited from favourable global economic conditions, which led major equity market indices higher and took new issue activity to record levels. The firm maintained its leading position in the advisory business and benefited from an increase in global merger and acquisition activity. Net revenue growth was driven by strong performances in the United States and Europe, particularly in the communications, media and entertainment, high technology, energy and power, and healthcare sectors.
Morgan Stanley Dean Witter also reported record net income for the full fiscal year, being 57% up on a year earlier, to $4.79bn. This included record results in investment banking, equities, fixed income and commodities. In global mergers and acquisitions, transaction dollar volumesurged by 72% to above the $1 trillion level.
Earnings at Merrill Lynch for 1999 were a record $2.6bn, up 69% from the figure reported in 1998. A highlight was the record investment banking revenues in the fourth quarter, led by continued strong equity underwriting activity and M&A advisory fees. During that fourth quarter, Merrill Lynch was lead manager for the largest US telecoms IPO to date (for Infonet Services Group) and the largest US Internet financing so far (for Internet Capital Group). The firm points out that according to Thomson Financial Securities Data it has retained its position as the leading underwriter of total debt and equity securities, both in the US and globally. It also retained its position as leading global debt underwriter. In the world's two fastest regions for investment banking growth, Merrill Lynch ranked number one in European IPOs and number two in announced Japanese M&A transactions.
Elsewhere, Chase Manhattan reported investment banking fees up 26% to $1.89bn for the year, reflecting strong syndicated finance activity, ongoing momentum in its merger and acquisitions and bond practices, and strong performance from Chase Hambrecht & Quist [the high technology investment banking specialist] during the period following its $1.46bn acquisition on December 9.
JP Morgan, which has arguably undersold its investment banking credentials, posted a 19% increase in full-year investment banking revenues, to a fraction under $1.2bn. The increase was driven primarily by growth in advisory revenues. The bank advised on more than $500bn of announced transactions globally. Equities revenues for the year more than doubled to $1.417bn. Equity derivatives saw higher client revenues and significant gains in portfolio management. Equity underwriting revenues increased and asset management services revenues increased by 16% for the full year, largely reflecting higher investment management fees, asset growth, a shift in asset mix towards higher-fee alternative investment disciplines and increased performance fees. "JP Morgan has spent years in transition," says Joe MacHale, chief executive of JP Morgan Europe, Middle East and Africa. "Over the past two years, we have moved from transition to performance."
If the year just completed was without doubt an annus mirabilis, there is talk already of an even better year in 2000 and more beyond. 'This time it really is different' is an observation that most experienced market-watchers have heard again and again, just before a market collapses. If one allows oneself to be swept along by the wave of excitement flowing through the international houses, one just might begin to believe it and the predictions that there are deals in the pipeline that will transform not just companies but the very industries in which they operate.
Europe has an important part to play in future growth given the growing appetite for equities across the continent. As Salomon Smith Barney pointed out at the beginning of February, December 1999 was a record month for flows into equity mutual funds, bringing the total for the year to more than $85bn. Its original estimate of almost $100bn for this year is already looking conservative, say its European Strategy analysts Niall MacLeod and Mark Howdle.
The enthusiasm surrounding the future is indeed infectious. "There is a secular change taking place in Europe," observes Huston McCollough, co-head of investment banking at Merrill Lynch in London. "The sale of Mannesmann to Vodafone is a watershed transaction and capital markets will enjoy increasing influence in corporate behaviour. Shareholder power will continue to grow in continental Europe. It's a more powerful force than any company or any investment bank." In addition, Germany's proposed changes to capital gains tax laws are widely expected to be a catalyst for a takeover wave there.
"I find it difficult not to see a very active year in Europe," adds Joe MacHale. "Europe is at an early stage in restructuring its industry and slightly behind the US in technology. The realisation that pensions are underfunded is creating a new demand for equities, and the vacuum left by the retreat of banks from large scale commercial lending will have to be filed by the capital markets. we are enormously excited by the opportunities arising."
In the midst of this heady optimism, are there any danger signs? However bright the sunshine, there is always a risk from exogenous variables. Disaster can appear on the horizon without warning and bring investment banking activity grinding to a halt with much crashing of gears.
Standard & Poor's analyst Tanya Azarchs touches upon this in her own recent assessment of a rise in trading risks for the major US banks. Trading, she observes, has become more volatile in the past few years. "Underlying this pattern has been the fact that the market shock of August-October 1998 was measurably worse than the market shock of February-March 1994 or any of the mini-shocks in between." In response, the agency has raised its estimate of the riskiness of trading activities generally, and now considers a smaller proportion of total trading income as recurrent core earnings.
The Internet too presents new challenges, as well as the opportunities that a number of institutions have begun to tap, such as in online bond or equity distribution. If nothing else, the Internet simplifies the mechanics of a transaction, improving communication between issuers, underwriters and investors during the course of a deal. But much more is currently expected of it than that."E-commerce is of course a big issue," says Joe MacHale. "It's crucially important to think it through. Advantages built up over the years risk being dissipated overnight. It would be possible for a bank to change from a market leader to an also-ran, or vice versa, very quickly. Competition could come from a wholly unexpected quarter."
Back in positive mood, new opportunities are likely to arise from the impact on international securities markets of the 'risk revolution' highlighted by a recent major survey carried out among its members by the International Securities Marketing Association. Andrew Freeman, author of the accompanying report, identifies three stages of a case for how securities markets might evolve in future. Stage one is the intense competitive pressure arising from technology and the concomitant impact upon margins. Stage two shows how bundling and unbundling made possible by financial engineering will continue to add new dimensions to risk management. Stage three shows how insurance and securitisation will come together to reshape the choices available to corporations and investors.
"Most of the major insurance companies are European," observes Freeman. "But the big US investment banking houses will inevitably play a leading role in this sector. They have the financial muscle and the market strength."
Size, it seems clear, really does matter.
A version of this article appeared in
The Banker magazine in March 2000
Brian Bollen
Freelance Writer, Editor & Media Consultant
3 Ebbsgrove
Loughton
Milton Keynes
England MK5 8BD
Tel: +44 1908 234952
Fax: +44 1908 235053
Email: brian.bollen@virgin.net