Regional banking companies have a rare chance to take business from bigger competitors in capital markets, but their own problems are making it tough.

Corporate and investment banking has been in upheaval since last year's near-meltdown of financial markets and the rapid disappearance of several leading firms. Subsequent layoffs have had thousands of employees, including investment bankers, dusting off their resumes.

Executives at the regionals are aware of the unique opportunity to expand, and they ideally would like to bulk up before the economy turns the corner. Many, however, are facing substantial constraints such as lingering credit issues and continued reliance on capital from the Troubled Asset Relief Program.

It is a bind that observers said could apply to other businesses at small and midsize banks.

Joseph H. Moeller, a managing director in the investment banking group at KBW Inc.'s Keefe, Bruyette & Woods Inc., said the challenges for capital markets units highlight the balancing act between husbanding capital and growth.

"Capital is incredibly precious right now," Moeller said during a roundtable discussion last month hosted by American Banker. "You've got to make sure you're allocating it properly."

Several companies say they are coping by streamlining their businesses or making selective acquisitions to avoid drastic increases in expense.

"We've been spending a lot of time making sure we're well positioned as we come out of this cycle," said Mark Chancy, the chief financial officer at SunTrust Banks Inc. "This is not a robust environment overall in terms of profitability. We're not looking to be all things to all people … but we are investing in units we think can drive revenue."

The size of the capital markets arms at regional players such as SunTrust, PNC Financial Services Group Inc. and KeyCorp creates a predicament.

The units are much smaller than those of the big firms. And though most capital markets arms have remained profitable during the recession, they lack the scale to offset heavy credit losses in their parent company's traditional banking units. Normally a company would either invest to expand the business or sell it.

But investment is expensive, and selling does not make sense in the current market.

Christopher Marinac, an analyst at FIG Partners LLC, described capital markets businesses as "a necessary evil" but said "it is also a challenge to prudently invest in that business."

SunTrust Robinson Humphrey, the capital markets unit at SunTrust, has been focusing on hiring personnel displaced or disenchanted by bigger firms. Since early 2008, JPMorgan Chase & Co. bought Bear Stearns Cos., Bank of America Corp. bought Merrill Lynch & Co. and Wells Fargo & Co. bought Wachovia Corp. Some of those acquirers have been paring costs — including laying off investment bankers and others.

SunTrust's Chancy would not discuss specific hiring situations, though he said there "have been opportunities due to uncertainty." The $176.7 billion-asset Atlanta company prefers to reallocate resources, knowing that expansion that adds lending relationships would tie up capital or raise expenses. For example, the unit de-emphasized businesses such as securitization and sale/lease-back advisory services, moving personnel to other areas such as fixed-income.

Morgan Keegan & Co. Inc., the capital markets unit of the $142.8 billion-asset Regions Financial Corp. in Birmingham, Ala., has been making small niche acquisitions. In December, Regions bought Burke Capital Group LLC, an Atlanta firm that serves financial companies, and Revolution Partners LLC, a Boston investment bank that focuses on technology.

Collie Krausnick, the president of Morgan Keegan's equity capital markets division, said investments must be made regardless of Regions' issues with credit quality. "We need to run our business to grow revenue and earnings and we need to be mindful of the bigger picture," he said. "We're making investments prudently and strategically."

Another challenge with building up a capital markets business is the expense associated with running one, analysts said. Because much of the cost structure is directly associated with compensation, it can prove tricky to cut expenses to free up capital for reinvestment.

"If you try and drive expenses down too much, you are going to really hurt yourself in terms of execution," Marinac said.

If the business is so costly and generates such a small percentage of total revenue, why not sell it and bring in more capital? Analysts said that while it may sound good in theory, regional banks would find it difficult to part with their capital markets businesses at a respectable price. Moreover, the businesses are profitable at a time when banks can use all the bottom-line help they can get.

First Horizon National Corp., for instance, exited its national mortgage and small-business operations and sold most of its branches outside Tennessee in recent years. But the $28.8 billion-asset Memphis company has been reluctant to part ways with FTN Financial, its capital markets unit.

"While it sounds great to sell business lines, I think the universe of potential buyers out there for any kind of business is fairly small right now," Mark Fitzgibbon, the director of research at Sandler O'Neill & Partners LP, said at the roundtable. "You're better off continuing to manage it and then re-evaluating down the road."

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.