The frozen market for initial public offerings is depriving major banks of hundreds of millions of dollars in lucrative underwriting fees at a time they desperately need to shore up their finances, with little relief in sight.
The underwriting of IPOs has always been one of the most profitable activities for investment banks, typically earning them about 3.5 percent of an IPO's proceeds, and often up to 7 percent. They've also made large profits in bull markets by flipping IPO stocks.
But 2008 saw a 64 percent drop-off in industry-wide fees to $931 million, according to data from Thomson Reuters and Freeman & Co, and the IPO market came to a near halt in the last months of the year.
The sole IPO in the fourth quarter of 2008 - a $144.9 million deal by on-line university operator Grand Canyon Education Inc - yielded fees of only $10 million, split among six underwriters. "The fall-off in IPOs is going to have a major negative impact on the earnings of investment banks for some time," said Bill Hackney, a managing partner with Atlanta Capital Management Co, who does not see IPOs recovering until 2010.
In a research note last week, Alliance Bernstein senior analyst Brad Hintz estimated that Morgan Stanley and Goldman Sachs, each made about 5 percent of their revenues from equity underwriting and lowered his price targets for both stocks.
The evaporation of those fees comes when major underwriters are suffering enormous losses and asking the government for assistance. J.P. Morgan Chase & Co on Thursday posted a 76 percent drop in quarterly profit, while on Friday, Bank of America obtained a $20 billion capital infusion from the US government and posted its first quarterly loss in 17 years.
Another major underwriter, Citigroup, said on Friday it plans to divide itself into two units, after losing more than $28.5 billion in the last 15 months. Goldman Sachs earned the most IPO-generated fees in 2008, with $185.5 million, a drop of about 15 percent from 2007, but its rivals fared worse. Morgan Stanley's IPO underwriting fees fell 88 percent to $32.3 million, while Credit Suisse's fell 80 percent to $38 million.
Banks are facing the prospect of fewer deals, with those IPOs that do get off the ground more likely to be smaller than those in the recent boom years, as is typical when the IPO market hits its trough.
Rubbing salt in the banks' wounds, the only deal currently on the calendar is a $172.5 million IPO by homeland security firm O'Gara Group. That IPO is set to price in February and be underwritten by a regional investment firm, Memphis-based Morgan & Keegan & Co, with no major banks on board. The lack of deals will force banks to compete fiercely for any business, leading to a smaller cut of an IPO's proceeds.
"With IPOs on life support, there is no question you will see lower fees," said Matt McCormick, an analyst and portfolio manager with Bahl & Gaynor Investment Counsel in Cincinnati. Some of the pain in 2008 was mitigated by the robust pace of follow-on issues by already public companies needing to recapitalize as the financial crisis grew.
Those included a $12.6 billion follow-on by Wells Fargo & Co in November and an $11.5 billion issue by J.P. Morgan Chase in September. Deals like those earned the banks a total of $4.3 billion in fees in 2008, a 53 percent increase over 2007.
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