Low U.S. IPO Volume Hits Wall St. Bottom Lines

NEW YORK (Reuters) – The frozen market for initial public offerings is depriving major banks of hundreds of millions of dollars in lucrative underwriting fees at a time when 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 have 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 online university operator Grand Canyon Education Inc (LOPE.O) — 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 (MS.N) and Goldman Sachs (GS.N), each made about 5 percent of their revenue 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.

JPMorgan Chase & Co (JPM.N) on Thursday posted a 76 percent drop in quarterly profit, while on Friday, Bank of America (BAC.N) obtained a $20 billion capital infusion from the U.S. government and posted its first quarterly loss in 17 years.

Another major underwriter, Citigroup (C.N), said 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 (CSGN.VX) fell 80 percent to $38 million.

For a table of fees earned by leading underwriters by bank click on: [ID:nN15148215]


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 company O’Gara Group (OGAR.O). 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 (WFC.N) in November and an $11.5 billion issue by JP Morgan Chase in September.

Deals like those earned the banks $4.3 billion in fees in 2008, a 53 percent increase over 2007.

But follow-ons are less lucrative, earning banks about 2 percent of proceeds, and analysts do not expect them to continue to keep up that pace in 2009.

In his note, Bernstein’s Hintz estimated that secondary equity issues would decline 40 percent in the next year.

The desperation for deals will also likely force leading banks to chase smaller deals, Bahl & Gaynor’s McCormick said.

“You’ll see even bigger guys like Goldman Sachs going downstream, and do deals that to some extent they may have considered beneath them in the past,” he said. “Beggars can’t be choosers.”

But in any case, bankers will have to be patient.

“Banks should not expect out-sized profits, because for IPO markets to improve, the economy and markets have to improve, and that’s going to take a while,” McCormick said.

By Phil Wahba
(Editing by Tim Dobbyn and Maureen Bavdek)