One reason for the weakness is that companies such as Uber Technologies are staying away from public markets
US equity capital markets revenue for banks is lower than it has been in more than 20 years, according to Dealogic.
So far this year, banks have taken in $ 3.7 billion in fees from US-listed equity deals, which besides initial public offerings include share sales for companies that are already public and convertible-debt issues, according to Dealogic data this week.
That’s the lowest since 1995, when the business generated $ 2.6 billion up to this point in the year, or $ 4.1 billion after adjusting for inflation. At the height in 2000, it was a $ 9.1 billion business year to date, or $ 12.7 billion adjusted for inflation.
The prime reason: cheap capital. With interest rates plumbing historic lows, companies, which are increasingly shunning public equity, have an abundance of low-cost funding options. When they do tap it, they are finding ever cheaper ways to do so.
IPOs are the highest-profile casualty.
As of September 16, just 68 companies had gone public on US exchanges this year, raising $ 13.7 billion, according to Dealogic. At this point in 2015, 138 companies had listed on US exchanges, raising $ 27.3 billion – a 62% drop from the same period in 2014.
One reason for the weakness is that companies such as Uber Technologies and Airbnb are staying away from public markets. Private funding sources are providing robust capital instead. Investors have poured money into private equity firms and other private investments that offer potentially high returns amid long-term low interest rates.
The declines are especially painful for banks, given that IPO underwriting is the highest-margin product within a bank’s equity capital markets business.
Equity underwriting revenue at Goldman Sachs, Morgan Stanley and JP Morgan all fell by between 40% and 60% in the first six months of this year, compared with the same period in 2015. Some bankers and analysts expect the weakness to continue, especially if IPO activity fizzles toward the end of the year, as expected.
JP Morgan, Goldman and Morgan Stanley rank first, second and third respectively for US-listed equity capital markets underwriting by deal volume so far this year, according to Dealogic.
The IPO drop comes in a market environment that should be hospitable: Stocks are near all-time highs and volatility is relatively low. That has fed the concern that the reduced stature of the business is here to stay.
Despite the sharp drop in fees, banks don’t yet appear to be making big moves to cut staff, fearful that doing so could hamper relationships with corporate clients that dole out other assignments they covet like merger work.
Such cuts are necessary, however, said Brad Hintz, a finance professor at New York University’s Stern School of Business. “The capital markets businesses on Wall Street are all the wrong size,” said Hintz, a former longtime Wall Street bank analyst. “It’s a business with too many players in it. Prices have been pushed down to levels that don’t always pay for the lights.”
IPO volume has picked up since Labor Day, but activity is expected to taper off soon due to political uncertainty and other factors. Wall Street businesses are notoriously cyclical and factors like a return to more normal interest-rate levels could reverse the decline. Saudi Arabia has also disclosed plans to take its oil colossus, Saudi Arabian Oil, or Aramco, public within the next two years, an offering that could generate more than $ 1 billion in underwriting fees.
An important change in the market involves the way public companies are using follow-on offerings to raise money. There has been a sharp rise in share sales known as block trades, a type of follow-on in which banks buy slugs of stock from companies or their investors at a discount and quickly look to sell them into the market. The difference between what the bank pays for the block and what it sells it for is the fee.
That amounts to roughly 2% on average for deals under $ 1 billion, according to Dealogic’s data, which go back to 1995. It isn’t always clear how much banks gain or lose on block trades. The average fee for a traditional follow-on offering is 4.9% and for IPOs, the shared fee for deals less than $ 1 billion averages roughly 7% of an IPO’s size, according to Dealogic.
Block trades account for 44% of US equity capital markets volume this year, the largest share in Dealogic’s database. In all of 1995, block trades accounted for less than 1%.
“The absolute low amount of fees is very challenging,” said one equity capital markets banker at a major Wall Street firm. He echoed others in the industry who worry about when and how the IPO market will rebound and whether block trading has permanently dented fees.
Banks’ corporate clients like block deals because they save time and money and are less risky. With a traditional follow-on deal, corporate executives can spend several days trying to persuade investors to buy their shares in a shortened version of an IPO roadshow. If they fail to drum up enough interest, companies must either sell shares for less than they hoped, and bear the cost, or scrap the offering.
With block trades, banks bid against each other for the right to buy shares at a predetermined price. Banks then take on the risk of reselling the stock and bear any losses or gains that result.
When volatility ground IPO activity to a halt in early 2016, Christopher Volk, chief executive of real estate investment trust Store Capital, said he fielded calls from banks proposing block trades.
Store Capital’s private equity owner, Oaktree Capital, unloaded roughly $ 1.7 billion of stock through block trades between January and March. In the largest of those deals, Goldman Sachs purchased $ 842 million of shares at a 0.71% discount to what it subsequently offered them for, according to Dealogic.
“The process was very competitive,” Volk said. He added that raising capital has never been so cheap or easy in his experience.
Goldman is No. 2 in US-listed block trades this year, with $ 12.1 billion to its credit, behind JP Morgan, and followed by Credit Suisse and Barclays, which have ridden a wave of energy company deals.
“There certainly has been a trend where sellers like the certainty and the efficiency of the block-trade market,” said Thomas Morrison, a senior managing director in the capital-markets group at Blackstone Group. Of the private equity firm’s 31 stock sales this year, 26 have been block trades and none have been IPOs.
Write to Maureen Farrell at email@example.com
This article was published by The Wall Street Journal