Regulation To Boost Costs And Cut Profits

Investment banks' invitation to borrow at the Fed's discount window will ``come with a price tag,'' Gross wrote on Pimco's Web site today.

Leverage and gearing ratios of securities firms will in a few years resemble those of commercial banks - resulting in reduced profitability for major houses.

Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. will earn less and face higher borrowing costs because of increased regulation of investment banks, Pacific Investment Management Co.'s Bill Gross said.

These banks will likely be forced to raise expensive capital and/or reduce the bottom line footings of their balance sheets.

This will be costly, and bond spreads as well as stock prices should begin to reflect it.

Bloomberg – Fed Rules to Cut Wall Street Profits, Boost Costs, Gross Says

Guardian - New Capital Raising To Be Costly For Banks

Q1-08 Deals

Global M&A volumes fell 31% to $661 billion in the first quarter of 2008, according to Thomson Financial.

Buyout firms led the collapse in deals as their buying power evaporated and they saw a 77 percent fall in acquisitions after 6 years' growth.

The credit crunch has dented banks' confidence in lending to buyout firms, which rely on debt to achieve their returns.

Meantime slowing U.S. and European economies and volatile markets are making corporate CEOs reluctant to take large risks.

After four years U.S. M&A activity is on track to see its first annual decline since 2002, according to a recent report from Thomson Financial Proprietary Research.

Europe remained ahead of the U.S. in terms of deal volumes and also better-weathered the downturn. European M&A activity accounted for 301 bln usd, which is 10 pct lower than in the first quarter 2007.

Goldman Sachs advised on the most merger and acquisition deals worldwide in the first quarter of this year, followed by Lehman Brothers and Citigroup. Morgan Stanley, which had led the rankings in the same period last year, dropped to number 6.

The top global M&A advisors in the first quarter of 2008 are, in descending order:
Goldman Sachs , Lehman Brothers , Citigroup , Credit Suisse , Deutsche Bank, Morgan Stanley, Centerview Partners, JP Morgan, Merrill Lynch.

Goldman Sachs worked on 81 deals worth $231.5 billion, followed in the second and third spots by Lehman Brothers and Citigroup Inc, which advised on global deals worth $203 billion and $190 billion, respectively.

Citigroup was the most active adviser on deals with a European element. It worked on 42 of these transactions worth $161.6 billion. Credit Suisse was the next most active bank in this respect, working on 36 deals worth $149.7 billion, followed by Goldman, which advised on deals worth $147 billion.

Goldman led in terms of estimated fees for the quarter as well. It earned fees of $399.9 million from its global M&A work, including $200 million for deals including European element.

Merrill Lynch and Credit Suisse were the next most profitable in terms of global fee revenue. Merrill earned $291.8 million and Credit Suisse earned $287.6 million.

In Europe, Morgan Stanley (MS) was the second most lucrative fee earner. It generated $181 million in fees from M&A, followed by Merrill Lynch, which earned $168.6 million.

Announced M&A deals in the US were even lower at a five-year low of 189 bln usd, 53 pct lower than in the first quarter 2007 (401 bln usd). The US recorded the lowest first quarter figures since 2003 (71 bln usd).

Thomson Financial's M&A review also showed a shift in the ranking of investment banks advising on M&A deals in the first quarter of 2008.

Globally, Goldman Sachs Group Inc reached pole position in the year to date, with mandates for deals valued at 231.5 bln usd. In the first quarter of 2007 it was ranked second.

The investment banking arm of Lehman Brothers Holdings Inc soared from sixth place in the first quarter of 2007 to second place in the global ranking, with mandates valued at 203.5 bln usd this year.

In the category of transactions with any European involvement, Citigroup Inc led the pack in the first quarter of 2008, with mandates worth 161.6 bln usd, followed by Credit Suisse Group (149.7 bln usd), Goldman Sachs (147 bln usd) and Lehman Brothers (141.2 bln usd).

U.S. merger volumes are estimated to reach only about $1 trillion in 2008. Still, report said “Looking at the second half of 2008, an improving credit market along with a significant level of available funds for private equity to put to use will likely boost the environment for M&A gains,” the.

News and Related Story Links:

Reuters – Global M&A volumes tumbled by a third in Q1

The Age – M&A bankers suffer 35% drop in fees

CNN Money – Global M&A value drops 31 % to $661 bln in Q1; US value drops 54%

Money Morning – Don’t Be Fooled by a Lull in M&A Activity, More Deals Are on the Way

J.P. Morgan Still Biggest Hedge Fund

Assets at the largest US hedge funds grew by more than a third last year, even though three of the 10 largest funds lost a combined $24bn in assets. According to the biannual survey by Absolute Return magazine.

JPMorgan retained its position as the largest US hedge fund manager, with $44.7bn under management at yearend, even though it lost $8.5bn in assets over the course of the year. The losses were mainly due to redemptions and losses from a statistical arbitrage fund.

JP Morgan has a number of hedge funds under its management, including JP Morgan Asset Management and Highbridge Capital Management

The biggest loser of 2007 was Goldman Sachs Asset Management, which fell to seventh place from second as assets dropped 27% in the second half to end the year at $29.20 billion. D.E. Shaw fell to sixth place, from third.

Goldman Sachs also lost heavily as a result of problems at quant funds that fell victim to heightened market volatility.

The second-and third-placed firms were Bridgewater Associates and Farallon Capital Management, both of which now manage $36bn in assets.

Renaissance Technologies, which took a hit in its quant funds, recovered to rise to fourth place with $34bn.

Och Ziff Capital Management, which went public last year, rose to fifth place with $33.2bn.

Not surprisingly, the biggest winner in terms of asset growth last year was Paulson and Company, which entered the top 10 for the first time after its assets soared 306 per cent last year to $29bn as a result of its early and correct bet against the US subprime mortgage sector.

CNNMoney.com

Goldman – Got Fired

Feb 7, 2008 - The Massachusetts state pension fund has fired Goldman, terminating a $1.2 billion contract, dissatisfied with Goldman's performance and changes in senior management.

The pension fund was especially unhappy with way the new group would be run, after it learnt that Robert C. Jones, a senior money manager, would give up daily investment duties, replaced by Mark Carhart, who came from the hedge fund side.

Mr. Carhart runs Goldman's Global Alpha Fund, which lost about 40% last year. In spite of the dismal performance of his hedge fund, Goldman Sachs’ Mark Carhart is getting a promotion. But that promotion is getting a rude welcome from an important client.

The personnel changes involve the merging of Goldman's quantitative equities group, whose head Robert Jones managed the pension fund's money, with its quantitative strategies group, which was led by Mark Carhart and Ray Iwanowski and invested more in alternative assets.

“It all comes down to confidence in the managers,” Stan Mavromates, chief investment officer of the pension fund, said at a meeting yesterday. “They are having significant management changes. We feel very uncomfortable with those changes.”

At the same time, performance was lackluster, with Goldman returning only 2.86% for the pension fund's accounts while the benchmark Standard & Poor's 500 index (excluding tobacco) gained 5.29% last year.

Massachusetts temporarily transferred money to State Street Corp's State Street Global Advisors unit, which will invest temporarily in a passive fund that tracks the index until it completes a review of its domestic equity allocation.

Late last year the pension fund took back $1.5 billion from money managers Boston Co and Wellington Management Co amid poor returns.

MSFT-YHOO: A Look at the Advisers

Feb 5, 2008 - Morgan Stanley and alternatives investor The Blackstone Group were picked up by Microsoft to advise on $44.6bn bid for Internet search provider Yahoo! This would be the largest technology takeover in history.

Neither Morgan Stanley nor Blackstone had done much deal-advisory business with Microsoft before. In fact, out of Microsoft’s five biggest deals, only one firm advised the company more than once: Goldman Sachs. The I-Bank advised Microsoft on its failed bid for Yahoo last year.

But this time, Goldman is representing Yahoo in its potential defense, along with Lehman Brothers. Goldman previously advised Yahoo in its biggest-ever deal, the $6.62 billion purchase of Broadcast.com.

Morgan Stanley, which suffered losses of $10.6bn from the credit crunch and collapse of subprime mortgages in America, is expecting $150m if Microsoft is successful. Leading the Morgan Stanley team is global head of mergers Paul Taubman, a media and telecommunications specialist who advised media group Time Warner on its ill-fated $164 billion merger with Internet services provider America Online at the height of 2000 dotcom boom.

Blackstone, which began as a mergers advisory shop, is lead banker on the deal, Jill Greenthal, advised Yahoo in her previous job at Credit Suisse, for $1.45 billion purchase of Overture Services in 2003.

Morgan Stanley is well versed in tech deal-making; last year, it and Credit Suisse essentially tied for second place in Dealogic’s league tables measuring advisory work on global tech mergers; each had a market share of nearly 15 percent by volume.

However in M&A advisory, it's always good to be on the sell side, because you're guaranteed your fee: if Microsoft fails to win Yahoo for whatever reason, Morgan Stanley and Blackstone are likely to go home largely empty-handed, while Goldman and Lehman will still be paid.

The proposed deal will be one of the biggest for years, although analysts warned it was unlikely to spark a rush of M&A activity.

Paying for 'Goldman Envy'

Rush Into Risky Endeavors Is Costly for Some Rivals; Beware Chimps on Steroids

Why did some banks and brokerage firms get so badly scorched by the subprime debacle and others come through relatively untouched? What's the difference between Citigroup and J.P. Morgan Chase? Morgan Stanley and Goldman Sachs? UBS and Deutsche Bank? Merrill Lynch and Lehman Brothers?

On the face of things, these companies may look quite similar to those they're paired with. But Citi, Morgan Stanley, UBS and Merrill have among them written off $65 billion so far because of the credit crisis. Meanwhile, J.P. Morgan Chase, Goldman, Deutsche and Lehman have racked up write-downs totaling around $9 billion.

There are several reasons for this. One is luck. But something else explains a lot of the difference.

One common response among those lagging behind has been to try to emulate the alpha males of the banking world -- in particular by increasing their bets in the once-booming fixed-income market.

The losers were infected by what one could call Goldman envy.

Former Merrill boss Stan O'Neal would frequently berate his subordinates for not delivering Goldman-like results. Morgan Stanley's ex-second-in-command Zoe Cruz was constantly using Goldman as the yardstick for her firm's performance. And Citi executives described the megabank as a growth stock until just recently, putting its businesses under pressure to show commensurate earnings growth.

The snag is that mere desire doesn't turn a chimpanzee into a gorilla. Building successful operations takes time. Part of Goldman's success comes from the fact that its risk-taking approach -- and the accompanying discipline of risk management -- derives in part from betting its employees' money.

But desire can drive reckless growth. Take Citi and Merrill. Five years ago, neither was a big player in underwriting subprime-mortgage bonds and collateralized debt obligations, or loans often tied to risky mortgages, that were repackaged into different levels of risk. But by 2006, they were at or near the top of the league tables for both markets.

The snag is that a bank is unlikely to manage things well when it's expanding rapidly and doesn't have experience. It may put the wrong people in place, not institute the right controls and implement the wrong incentive schemes.

The banks and brokers with the biggest problems seem to have made such mistakes. UBS, for example, quickly ramped up its residential-mortgage business. But not because there was any strategic value in being in that market. Rather, it decided it wanted to bulk up in the hot securitization business, and trading and underwriting residential mortgages and CDOs was the easiest part of the market to enter.

So why were others relatively immune to Goldman envy? Well, Lehman had a big, lucrative mortgage-lending and structuring business, so it didn't need to engage in a breakneck game of catch-up. Deutsche arguably also had a more ingrained risk-taking culture. Meanwhile, J.P. Morgan had more market-savvy leadership in James Dimon than, say, Citi had in Charles Prince.

All this suggests two lessons. If you are a chimp, don't try to kid yourself that you're a gorilla. And, if you see a chimp pumping itself frantically with steroids, sell its stock.