Why in the world are you doing that?

Thomas O'Neill acknowledges that is the question on the lips of many in the financial world, after he announced plans to start a bank advisory firm Tuesday.

After all, the bank M&A market of the last few years has fallen short of expectations, and he'll go head to head with established players — including the legendary firm he co-founded, Sandler O'Neill & Partners.

It's a simple case of demand exceeding supply, O'Neill, 66, replies matter-of-factly. Thousands of financial institutions, each with a litany of needs, will always need advice, he says. With that in mind, O'Neill and other partners have started Kimberlite Advisors to target community and regional banks.

"There are 6,900 banks out there, and I don't believe there is any one firm that can handle all of them," O'Neill says.

Kimberlite will primarily give advice to banks, typically on mergers and acquisitions, O'Neill says. Kimberlite won't provide underwriting. Instead, O'Neill will refer those inquiries to his old firm, Sandler O'Neill, which he founded in 1988 and left in 2010.

O'Neill will serve as co-chief executive of Kimberlite with Michael Coster, a former Lazard Frères managing director. Other involved in the venture include Lewis Ranieri, a former Salomon Brothers vice chairman who pioneered mortgage securitization, who will serve as advisor to Kimberlite; Alan Pomerantz, a former Weil, Gotshal & Manges real estate lawyer; and Kenneth Hamlet, the former president of Holiday Inns.

The investment bank landscape has undergone significant changes in recent years, one reason why "it's somewhat curious" that O'Neill is starting a new firm now, says Robert Rogowski, head of investment banking at McAdams Wright Ragen in Seattle.

"Sure, there are plenty of banks out there, but the consolidation trend will continue, and there will be fewer opportunities for M&A," Rogowski says. "It's a shrinking pie."

The investment banking industry itself has undergone turmoil, Rogowski says. Sandler O'Neill in 2010 sold minority stakes to the private-equity firms Carlyle Group (CG) and Kelso & Co. This year, Stifel Financial (SF) acquired KBW, creating the largest U.S. investment bank advisor to commercial banks, as measured by M&A deal value.

But other recent changes in investment banking mirror O'Neill's plans with Kimberlite. The prominent banking analyst Richard X. Bove, after leaving Rochdale Securities, in December joined Rafferty Capital Markets, which is a research-only shop.

And there is a constant stream of bankers leaving larger firms to form their own boutique operations. Derek Cunningham left Commerce Street Capital, a Dallas investment bank, to become managing principal and CEO at U.S. Strategic Capital in Atlanta. His partners include former Bear Stearns partner Clark Reed and Derrick Williams, formerly of Robert W. Baird & Co.

Further, investment banks generally have raised their fees over the past decade thanks to a variety of factors, including more work being required to close more complicated deals.

The advice-only business plan has its risks, Rogowski says. Because McAdams Wright Ragen is diversified into multiple investment banking services, it can better withstand market downturns.

"A pure advice firm, you will hit droughts, pure and simple," Rogowski says. "You have to have enough capital to live through the droughts."

Kimberlite will provide services to the real estate industry, too. It acquired Ranieri Real Estate Advisors last month; O'Neill had been working as CEO of Ranieri Financial Services Group.

Still, with plenty of competitors already in the market for M&A advice, O'Neill acknowledges that some of his friends say he "nuts" for starting Kimberlite, which refers to the ore from which diamonds are extracted. But O'Neill thinks there will be plenty of work for his firm.

"Everyone is kind of waiting for [bank industry] consolidation and there is plenty of advisory work as it relates to that," O'Neill says. "There will be balance sheet restructuring, particularly if rates spike up. The deferral of trust-preferred securities hasn't played out, in my mind. There is a whole menu of things going on."

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