Financial services ready for change
The international banking market is changing rapidly. What is the future of traditional merchant banks in this new world? CIARAN RYAN reports
Whereas a merchant bank might advise - in return for a fee - a corporate client raising off-shore borrowings, an investment bank would be in a position to advise and lend the money. In the case of a stock market listing, the investment bank might underwrite the issue and acquire a substantial portion of the equity.
The essential difference is the size of the balance sheet. Merchant banks' balance sheets are generally small, which precludes them from large-scale investment banking activities. They tend to focus on advisory services which make little or no claim on the balance sheet which, though small, are underpinned by intellectual capital in the form of specialist skills. Investment banking is, if anything, even more skills-intensive.
Analysis of the global banking industry shows investment banks generally trade at higher price: earnings (p:e) ratios than traditional high-street banks, where the emphasis is on lending activities. The same is true of "niche" banking shares listed on the JSE. BOE, for example, trades on a p:e of 47, as against 55.6 for Coronation, 46 for RMB (listed in the insurance sector) and 30 for Investec. This compares with PE ratios of between 14 and 17.8 for the Big Four "lending" banks - Absa, First National Bank, Stanbic and Nedcor.
Tom Boardman, managing director of BOE NatWest, says global deregulation of the financial services sector is blurring the distinction between retail, merchant and investment banks and building societies. Investment banks enjoy higher market ratings because of their higher quality earnings underpinned by assets under management which generate recurring income streams.
The message is clear - lending, particularly to the corporate market, is a low-margin business subject to ferocious competition.
Up to 70 foreign banks have entered the local market, most of them competing alongside the domestic banks for the banking business of the top 100 corporations. Some foreign banks, such as ABN Amro, have been outstandingly successful, particularly in the foreign syndicated loan market. Other foreign entrants, notably the Malaysian-owned TA Bank and New Republic Bank, have made moves on the mid-sized corporate market.
This competitive onslaught is good news for the top 100 companies. Banks are extending loans at margins as low as 0.25% in the hope of picking up more lucrative work elsewhere, such as in structured finance, corporate finance, foreign exchange dealing and asset management.
Jacko Maree, the managing director of Standard Corporate and Merchant Bank (SCMB), says: "There will always be a need for lending, but we see this as a declining part of the total business mix."
Maree says: "Over time we expect to see margin income declining relative to fee and commission income."
Two years ago Standard Bank merged its corporate banking and treasury activities with those of SCMB to eliminate duplications and strengthen the balance sheet of the merchant banking operations.
FirstCorp's treasury activities folded into First National Bank in 1995, leaving the merchant banking operation focused on corporate finance, asset management and private equity investment.
Increasingly, the deal flow is determined as much by the capital backing of the bank as its specialist skills.
Disintermediation - where borrowers find it cheaper to by-pass the banks and borrow from non-banking sources - has exerted further pressure on lending rates. The emergence of money market funds earlier this year should breathe life into the corporate paper market, allowing companies to borrow short-term money at attractive rates from investors who are able to trade this paper on the money market.
Some larger companies have found it more attractive to issue bonds than approach the banks.
This, and globalisation, is reshaping the banking industry. Competition for lending has forced banks to diversify into fee earnings services.
The decline of merchant banking in SA mirrors an international trend which took hold in SA with the scrapping of financial sanctions in 1994. The deregulation of the JSE a year later paved the way for corporate ownership of stockbroking firms, and within no time virtually all the top 10 broking firms had been bought by foreign banks.
Foreign banks acquired these firms for their ready-made research capacity and network of contacts and clients in the local corporate and public sector markets. Many have used stockbroking to launch other services and products.
A slew of new competitors - ranging from foreign banks to boutique advisory shops and broking and accounting firms - nibbled away at the traditional core of merchant banking. Retailers such as Pick 'n Pay, Pepkor and Game have announced their intention to use their store networks to market low-cost financial products, opening a new front in the battle for the retail savings market.
Corporations seeking to raise capital abroad gravitated towards foreign banks capable of opening doors in London, New York and Frankfurt. Local merchant banks are generally relegated to the status of junior advisers in these off-shore deals.
Most merchant bankers agree a shake-out is imminent: "There has been a proliferation of corporate finance teams and boutique operations, and I would expect to see many of these merge," says Richard Collier, a director of Kagiso Financial Services.
"The market has been conducive to this proliferation, but it cannot be sustained. Given the skills shortage which has developed, I would expect many of the boutiques to merge."
This would also bring an end to the practice of poaching staff from competitors, and bring moderation to pay packets being demanded by skilled staff.
Boardman says three types of bank will emerge from the revolution wrought by deregulation and globalisation: universal, international and niche banks. Universal banks are those with global networks offering a full suite of services. International banks have limited geographical spread and offer a wide range of services, and niche banks are limited either in geographic spread, product range, or both.
The universal banks will dominate because of their ability to meet the needs of clients across the globe.
Future banking success will depend on capital adequacy, credit ratings, and the ability to support clients by way of lending and underwriting and distributing security issues to investors.
Research by Morgan Stanley shows that the market will be dominated by fewer than a dozen universal banks by 2000. Top of page