Shotgun Mergers Could Result In Uneasy Union

The Age

Saturday September 20, 2008

Eric Johnston, Financial Services Editor

IT'S BECOMING the revenge of the Main Street banks. The world's biggest investment banks are rushing into the arms of dowdy cousins better known for selling deposits, credit cards and mortgages in the suburbs.

For years stand-alone companies such as Morgan Stanley, Merrill Lynch and even Macquarie Group have been home to the brightest graduates, fattest pay cheques and the biggest deal makers.

But after a week that pushed global markets to their very limits, doubts have been raised over investment banks' ability to continue without a big bank partner.

Already this year Wall Street has undergone the most dramatic overhaul since the Great Depression after five of its investment banking pillars crumbled into just two.

And the panic that pushed Lehman Brothers into bankruptcy and prompted Merrill Lynch to seek a $US55 billion ($A69billion) merger with Bank of America Corp continues to weigh on survivors Goldman Sachs and Morgan Stanley. Similar questions are being asked about Australia's Macquarie Group.

Morgan Stanley remains locked in merger talks after a share price slump during the week. These include separate talks with Washington-based retail bank Wachovia and a Chinese sovereign wealth fund.

Goldman, which owns 40% of Australia's Goldman Sachs JBWere, is also showing signs of vulnerability after reporting a 70% fall in third-quarter earnings. Still, Goldman executives have dug in and are determined to retain the independence of the 139-year-old company.

The biggest concern weighing on investment banks has been their high leverage. While this can be easily managed during more normal markets, anything that operates under a high debt sets alarm bells ringing in credit markets.

This freeze-up in capital markets has pushed companies including Merrill Lynch into the arms of the big deposit-rich banks so the investment entities can tap pools of funding when debt and sharemarkets grow jittery. For Lehman, a deal came too late and its remains are being picked over by British bank Barclays.

But shotgun mergers, while potentially life saving, could result in an uneasy union.

"Wall Street is heading into a brave new world," a veteran investment banker said yesterday. "The business models of these investment banks that have merged are likely to come out quite different."

Heavy regulation of the retail banks, combined with their culture of taking less risk, is likely to translate to slower earnings growth for the investment banks.

"There's no doubt these organisation will face a much greater level of scrutiny of their conflicts of interest and the adequacy of their capital base," the banker said.

Investment banks that have ready access to capital through their large retail banking franchises in their home countries, including Citigroup, Deutsche Bank and JPMorgan, have been less affected by the global sell-down.

"The commercial banks are really filling the void," said a former Macquarie executive. "It's the investment banks that associated with commercial banks and which are subject to regulation that are mostly going to be the ones that do better in this environment."

Like Wall Street's Morgan Stanley or Goldman Sachs, Macquarie's business is not distressed. But the confidence that is fundamental to their smooth operation has evaporated.

An analysis of Macquarie's balance sheet shows it operates at a much lower rate of leverage than its Wall Street rivals when measured by assets to equity, yet Macquarie's's shares were subject to the same roller-coaster ride this week, falling to a five-year low.

Analysts including JPMorgan's Brian Johnson say Macquarie is well funded and that its $15 billion in refinancing commitments over the next year is achievable.

Only last year Macquarie split its traditional banking from its investment banking arm under a non-operating holding company structure.

© 2008 The Age

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