Can commercial banks successfully underwrite initial public offerings?
That's the question being asked as commercial banks continue to enter the securities business. Banks' aggressive hiring of investment banking talent, and deals such as Bankers Trust New York Corp.'s pending acquisition of Alex. Brown Inc., have put commercial banks in position to enter the IPO business.
For now, the opinions are lining up along predictable lines. Investment bankers say they're skeptical of commercial banks' ability, but the handful of commercial banks with experience in the IPO field beg to differ.
"Firms that believe that they have a monopoly on a certain client base, or on a certain client, are lulling themselves into a false sense of security," said Clayton Rose, managing director of global equity at J.P. Morgan & Co.
"Just because an investment bank has that shingle hung out doesn't mean that they are a provider of high-quality client service in the equity arena," he added. "And just because a commercial bank hasn't done that business before doesn't mean that it couldn't potentially be able to do it."
Morgan, the commercial bank most active in underwriting IPOs, began building its capability about six years ago. Last year, it took 12 companies public, raising $1 billion of new equity and ranking 12th among IPO lead managers.
Market leader Goldman, Sachs & Co., meanwhile, underwrote 51 IPOs, raising $9.8 billion of new equity.
Many commercial banks want to move high on the list of IPO managers because the business offers the highest margins in investment banking. IPO managers get an average of 7% to 10% of the deals they underwrite, but fees can go higher for some managers and issuers.
IPO fees are also considerably higher than the roughly 1% fee that many bond underwriters receive.
"The premise is that this is the most profitable part of investment banking," said Michael Burd, senior vice president at First Albany Corp. and head of its financial institutions group.
But the IPO business will not be an easy one for commercial banks to crack. For one thing, the market, which has been hot for the past three years, is now cooling down, with 1997 producing very few blockbuster deals.
Many companies that had expected to price their deals during the first quarter are still waiting to make their debut in the new issues market. And observers say they do not expect the market to improve anytime soon.
Another problem for commercial banks is that they do not have the expertise to deal with the small to midsize companies that make up the majority of initial public offerings, said Warren D. Bagatelle, managing director at Loeb Partners, a New York-based firm that invests in IPOs.
He predicted that larger issuers who do not foresee any difficulties selling their new stock would be the most likely to turn to commercial banks.
Further troubling for banks is that they lack ties to the institutional investors that typically buy IPOs, Mr. Bagatelle added. Banks "are not well-suited" to underwrite IPOs, he contended.
Bankers Trust is circumventing many of these problems by buying Alex. Brown. The Baltimore-based investment bank will provide Bankers Trust with the research capability that is central to the IPO business.
"A high-quality research capability is a fundamental building block in being excellent in the equity business," Mr. Rose said. Morgan invested a large amount of time and resources into its sell-side equity research team, he added.
The Alex. Brown deal will also give Bankers Trust the talent it needs to compete in the IPO market, observers said.
"Bankers Trust will retain the strong presence in the marketplace that Alex. Brown already has, provided that they ... keep the professionals that Alex. Brown has," said Charles Nash, managing director of corporate finance at Interstate/Johnson Lane Corp.
He suggested that Bankers Trust keep its investment bank and commercial bank separate to avoid culture clashes between the two.
Cornerstone Realty Income Trust, whose $47.3 million offering hit the public equity market last month, was pleased by the Bankers Trust/Alex. Brown merger, which was announced mid-way through the Cornerstone roadshow.
"I think that it is positive," said Glade M. Knight, president and chairman of Cornerstone. "For a number of years commercial banks have been aligning themselves as a sort of one-stop shop for the real estate investment trust industry and for corporate America."
Paul Grangaard, director of corporate finance at Piper Jaffray Inc., a Minneapolis-based investment bank, is not so sure of the one-stop shopping technique.
Mr. Grangaard, who used to work in commercial banking, said he believes that clients will go to specialists with track records and expertise in specific banking products.
"Clients don't like to be anyone's guinea pigs," he said. "No one wants to be anyone's first deal."