Fees for underwriting junk bonds have fallen dramatically over the past five years, as more and more commercial banking companies have entered the market.
The average amount paid by a noninvestment-grade company for having its corporate bonds underwritten dropped by more than 40% between 1994 and 1998, according to Thomson Financial Securities Data. In the first half of 1999, fees averaged just 0.73%, compared to 1.73% in 1995.
"This correlates with a shift in market share among major underwriters," said Dwight Sipprelle, managing director and head of high-yield at Morgan Stanley Dean Witter, the third-largest high-yield underwriter after No. 1 Donaldson, Lufkin & Jenrette, and second-place Salomon Smith Barney. "The business became very competitive in the 1990s," he added.
Some of this competition has come from commercial banking companies such as Chase Manhattan Corp. and Bank of America Corp., which boosted their underwriting capabilities in a bid to offer more capital markets products to their corporate customers.
Chase, for example, rose two notches to fourth place in the underwriting league tables in the first half of this year, with $6.1 billion in deals. Bank of America also jumped two places to number 11 in the same period, with transactions worth $2.2 billion.
"Banks are pushing into this business, and one way for them to compete is to offer lower fees," said Peter Nerby, vice president and senior analyst at Moody's Investors Service.
Fees had already reached a low point prior to the emerging markets financial crisis of 1998. Junk bond underwriters earned an average of only 1.19% in 1997, in what bankers called an easy year for issuance.
However, a high-yield banker at a money-center bank said that underwriters increasingly do not disclose fees. Investment banks and section 20s in the business may actually be receiving more than the average, but because that information is not public, published fee data can look artificially low, the banker said.
Volatility in the financial markets since last summer has made it more difficult for new high-yield issues to be successfully completed. During the first half of this year, new high-yield issues totaled a slim $64 billion, in contrast to $101.6 billion during the first half of 1998.
As a result, "fee erosion stabilized a year ago," Mr. Sipprelle said. "Now, I think it's possible for fees to trend upwards in the future."
For emerging market corporate and sovereign bonds, high-yield underwriting fees have already increased.
Mr. Sipprelle reasoned that with uncertain market conditions, investors and issuers are more likely to seek firms that have the capital to provide liquidity and a platform to bring deals to market. "We expect to see fewer competitors next year," he said.
While some commercial banks have been making gains as high-yield issuers, analysts said that it is hard for institutions to take share away from market leaders. "It's much more difficult to sell and there is a limited universe of buyers" for junk bonds as opposed to more standardized debt products such as investment-grade bonds, Mr. Nerby said.