Banks Give Wall Street
A Run for Its Money

The banking industry, facing little opposition from regulators, extended a recent market-grab at Wall Street in 2003, taking away market share from securities-industry rivals through the strategic use of loans.

Banks are using loans like a loss leader, a teaser product to entice corporations into giving the bank more lucrative stock-and-bond underwriting or merger advisory business. This tactic has been made more effective by the recent economic slump that made corporate loans hard to get. Borrowers welcome the strategy, and even demand their traditional Wall Street underwriters join banks in providing loans. Securities firms have little choice but to expand their own portfolios of low-margin loans.

Some wonder how long this will go on as financial markets recover and loans become more plentiful. For now, though, the gains reflect a subtle shift in the way that U.S. corporations finance themselves, seizing on deregulated capital markets as an opportunity to play financial institutions against one another.

As of Dec. 19, Citigroup Inc., J.P. Morgan Chase & Co. and Bank of America Corp. -- all traditional lenders -- had a combined 22% of stock-related underwriting, up from 12% in 2000, according to market-research firm Thomson Financial. The combined share of Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. -- three leading securities firms -- dropped to 30% in 2003 from 37% in 2000.

The securities firms say these numbers aren't conclusive because they include bonds that convert into stock, a hot market in 2003 but one that generally earns the underwriter less in fees. But even in plain stock underwriting, a quiet market in 2003, the three banks had 18% share, up from 12% in 2000, while the share of the three securities firms fell to 29% in 2003, down from 36% in 2000.

Even those who question whether commercial banks can sustain these gains see a danger to Wall Street firms. "The threat is real," said Reilly Tierney, a financial-industry analyst at the Fox-Pitt, Kelton unit of Swiss Re.

Banks have tried for years to elbow their way into Wall Street, prompting the brokerage firms who dominate its markets to cry foul.

The securities industry accuses banks of illegally "tying" loans to other services, but those charges have carried little weight with regulators. The Justice Department concluded in a recent comment letter to the Federal Reserve that tying is good for competition because it allows corporations to play financial institutions against one another, adding that a 34-year-old law against the practice has "probably outlived its usefulness."

The letter, in some ways, is an epitaph for an era in which Wall Street firms were protected from competition from rivals in the lending industry. Congress paved the way for this battle in 1999, when it repealed Depression-era legislation known as the Glass-Steagall Act, which separated banks and brokerages into separate markets. Banks had found ways around those restrictions before the 1999 repeal, but they were often marginal players in the securities industry.

But 2003 offered compelling evidence that banks are no longer also-rans. Citigroup, the nation's largest bank, ranked second in the global market for stock-related underwriting work in 2003, with $24.4 billion, a higher volume than either Morgan Stanley, with $22.2 billion, or Merrill Lynch, with $16 billion, the Thomson data showed. Only four years ago in 2000, Citigroup ranked fifth. Today, Citigroup's 10.9% share of the total is only a fraction behind that of Goldman, the market leader whose share stood at 11.5% with $25.6 billion in stock underwriting for 2003.

In the global market for advising clients in mergers and acquisitions, known as M&A, the market-share statistics are less revealing because they give multiple firms credit for the same deals. But Citigroup in 2003 was now third in this market, just behind Goldman and Morgan Stanley, and ahead of Merrill Lynch, which just barely squeezed ahead of lender J.P. Morgan for the fourth spot. Compare that with 2000, when Citigroup and J.P. Morgan were fifth and sixth in the M&A business, respectively.

The big securities firms, of course, are still the most profitable players in these markets. Even Merrill Lynch, which has fared the least well of the top-three securities firms in the rankings, was recording quarterly profit margins in 2003 that were wider than at any time in the past 25 years.

Goldman, meantime, the market leader in both stock underwriting and merger advisory, is still seen by corporate treasurers and chief financial officers as the one firm that can complete a tough deal no matter the market conditions.

"We have built our reputation over many years by consistently focusing on the quality of the advice and execution we provide to our clients," said Jide Zeitlin, chief operating officer of the investment-banking division of Goldman Sachs.

Officials at Morgan Stanley, Merrill Lynch and Citigroup said executives were unavailable to comment. "We have successfully continued to gain share across the board," said David Coulter, a vice chairman at J.P. Morgan Chase, a traditional lender.

At the center of this battle is the most mundane product in finance: the simple loan. Large corporations rely on loans or credit lines as a cheap source of financing or an emergency source of capital, usually in the form of "syndications" in which a number of banks pool their credit together. This business isn't a huge money-spinner for the lender, so banks are hoping to get rewarded by ancillary business.

When Houston Exploration Inc., a Texas oil and gas concern, sold investors $175 million in bonds in June, it gave the brokering business and fees to Wachovia Corp., a Charlotte, N.C., bank best known for its lending. In an earlier time, that business might have gone to a securities firm that specialized in the sale of such securities.

"We have a policy, whenever we can, to do business with our syndicated-loan group," said Houston Chief Financial Officer John Karnes.

Now, Merrill, Morgan Stanley and Goldman, which could once focus on the most profitable businesses like underwriting or M&A deals, must be big players in the low-margin lending business to fight off the growing threat from lenders, and they are joining more loan syndications. The securities firms note that they have always extended loans to their customers on a limited basis. That lending is growing.

In 2003, Wall Street firms participated in 82% of the big syndicated loans to top corporate clients, up from 58% in 1999, according to the Loan Pricing Corp., a research company that follows the loan market. If lenders continue to climb up the market-share rankings, securities firms may come under more pressure to merge with banks to stay competitive.

Write to Jathon Sapsford at jathon.sapsford@wsj.com¹

Updated January 5, 2004