Smaller Investment Banks Jump Into Equity Capital Markets

Boutique and regional firms are hoping 2010 will be the year of equities. That's why some midsized advisory and investment management firms, such as Evercore Partners Inc. (EVR) and Sanford C. Bernstein, are expanding into the lucrative, yet competitive, business of equity capital markets.

"Capital markets is a popular business to start today," said George Ball, chairman of Sanders Morris Harris Group, which does have a capital markets arm.

Firms are attracted to the capital markets business, which can include research and handling sales and trading among other activities, because it generates high revenue and it offers one-stop shopping to corporate clients. Moreover, the investment banking landscape has been shaken--with the collapse of Lehman Brothers, and the acquisitions of Bear Stearns and Merrill Lynch by J.P. Morgan Chase & Co. (JPM) and Bank of America Corp. (BAC), respectively. And now, the industry is forecasting a big pickup in equity capital markets activity.

However, the expansion isn't without risks. The business is competitive, and bulge bracket firms, such as Goldman Sachs Group Inc. (GS) and JPMorgan, have a strong hold on the underwriting business that boutiques will have to break through.

When a firm only advises companies on raising capital, it ends up passing on a large percentage of underwriting fees to other banks. "M&A firms have long been uncomfortable watching their clients take capital-raising transactions to another firm," David Trone, analyst at Macquarie Securities, wrote in a note last month.

In 2009, as equity capital markets performed poorly, many banks churned profits in fixed income. Now, analysts expect profits from fixed income trading to wane. Citigroup analyst Keith Horowitz wrote in a note last week that fixed income trading volume will fall 15%-20% this year.

By contrast, this year merger and acquisition activity, equity underwriting and equities trading will benefit from the rebound in the global equity markets and pent-up demand, Trone wrote in a note Friday.

The financial crisis left buy-side clients skittish about their relationships with large Wall Street investment banks. Many institutional investors are now willing to form partnerships with smaller firms and boutiques in order to diversify risk and have trading capabilities with a number of firms.

"Some traditional relationships have been disrupted by the crisis and some well known firms have an opportunity to expand into the market," said Bob Gach, global managing director in Accenture Plc's (ACN) capital markets practice.

Additionally, now is the time for firms to hire bankers at a lower cost than years prior, as Wall Street laid off many high-quality professionals. Some bankers are still worried about potential regulatory restrictions on compensation at the large Wall Street banks.

Evercore plans an aggressive push in the area with an expected launch of the unit in the first half of this year. The boutique has attracted experienced bankers to start the business including Jim Birle, who spent 20 years at Merrill Lynch in capital markets. He will advise Evercore's clients on strategic capital markets issues. Bart McDade, former global head of equities at Lehman Brothers, has come onboard as an investor in the business, which will be majority-owned by Evercore. He will also serve as an adviser to the new equities business and help recruit talent.

Sanford C. Bernstein, the brokerage unit of AllianceBernstein Holding LP (AB), is re-entering the capital markets business after a seven-year break. It brought on board Tom Morrison, who recently was a managing director in equity capital markets at Bank of America, to head the effort.

However, challenges lie ahead. David Weild, founder of Capital Markets Advisory Partners, said "capital markets is a tough business to get started in as margins are razor thin, and you can really kill yourself if you don't do it properly."

Ball of Sanders Morris said, "investment banks tend to have a lemming instinct to them, so a number of other boutiques will likely be tempted by the waters."

-By Jessica Papini, Dow Jones Newswires; 212-416-2172; jessica.papini@dowjones.com

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