Pity the traditional investment bank.

To read the news last week (“Congressional hearings on Wall Street research practices!” “Major initial public offering launched without any help from either Merrill Lynch & Co. or Goldman Sachs Group!”), time and market forces had left behind their high-margin, low-capital business model, one that for years had been the envy of the financial services industry.

As usual, the story is not quite so simple.

To begin with, both Merrill and Goldman were given the opportunity to participate in an $8.7 billion IPO for Kraft Foods. Their absence from the deal was certainly noteworthy and served as the backdrop to major stories in both The Wall Street Journal and The New York Times on Friday, but it’s clear that each took an investment banking opt-out because of their unwillingness to participate in lending to the company.

The decision was yet another occasion on which the companies declined to commit capital to a low-margin relationship for the sake of keeping an investment banking relationship.

This time, however, both firms showed an increased willingness to carry the message about the shifting balance of power to their troops and outside their walls. So it was that the Times story carried comments from senior Goldman and Merrill executives — though in the case of Merrill chairman David Komansky, repeated at arm’s length by those who heard them.

Still, the message from Mr. Komansky to Merrill’s brokerage force — confirmed in content by a spokesman — was direct in characterizing the shifting market forces as a challenge. “Clearly, the banks are using their muscle,” he said.

Indeed, the Kraft offering extended a trend that’s been developing for some time and accelerated when bank lending and capital markets began to tighten last year, one in which balance sheet strength has been brought to bear on investment banking deals.

Not surprisingly, Bank of America Corp. and J.P. Morgan Chase & Co. (as well as European banks with U.S. arms) have been among the companies publicly pressing to link low-margin lending to high-profit advisory and underwriting business.

But before any tears are shed for Merrill and Goldman, consider how quickly the two firms have closed the size and scale gaps with their commercial banking competition.

Merrill’s efforts on the balance sheet side have been impressive. Its deposit raising drive in the past year has pushed it to 13th in the industry in FDIC-insured deposits, with more than $50 billion. This effort has to rank as one of the great peacetime fund-raising drives ever. It also suggests that Merrill has the financial wherewithal to open the lending tap if it finds that recent market trends are going to remain in place for the long haul.

Goldman, too, appears poised to embark on a serious funding campaign, given its shelf registration filing last Friday. Though details were scant — the offering is earmarked for general corporate purposes and to fund operations — the filing means Goldman has a total of $25 billion on the shelf.

However, Goldman has been most active on the distribution side, shoring up one avenue of relative disadvantage by stitching together a formidable array of partnerships that give it a national retail footprint, albeit an indirect one.

With last week’s acquisition of the online investment banking firm Epoch Partners, Goldman gained access to customers of Charles Schwab & Co. and TD Waterhouse, a group that totals 10 million, though it is unlikely the relationship will involve every one of those accounts.

(TD Waterhouse, which is owned by Toronto-Dominion Bank, is still in the process of determining the extent to which its clients will have access to Goldman content. Executives at the firm believe the arrangement may be especially valuable as a way to enhance TD Waterhouse’s relationship with the independent investment advisers that work with it.)

And what does Goldman give in return for access to all those customers? “This acquisition will provide TD Waterhouse customers with high-quality U.S. equity research and equity offerings,” Steve McDonald, chief executive officer of TD Waterhouse, said when the deal was announced, evidence that the market value of Wall Street’s analysis has not yet quite reached zero, congressional hearings notwithstanding.


With Goldman eyeing retail, Merrill building its banking, and Bank of America expanding in underwriting, it is only fair to pay heed to Schwab’s diversification play.A day after Goldman bought out Epoch — in which Schwab, like TD Waterhouse, was an investor — Schwab acquired Epoch’s quantitative trading business.

This move, according to Lon Gorman, the vice chairman who is also president of Schwab Capital Markets, reflected Schwab’s commitment “to expanding its institutional business and becoming a significant player in this growing arena through electronic trading.”

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.