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AmericasSeptember 3 2012

Equity bankers waiting to bridge the gap

Emergency capital raisings are over, conditions for new listings are still unattractive and equity capital markets divisions are under pressure.
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The €7.5bn rights offering by UniCredit in January 2012, executed successfully in the most stressed market conditions but at the cost of a 43% discount, ultimately marked the end of attempts to raise bank equity on the public markets. Other banks had moved earlier to shore up their balance sheets, or – in the case of the eurozone periphery – will be seeking their capital injections from national or multilateral bail-out funds.

That means the end of the road for a lucrative source of work for equity capital markets (ECM) bankers, but it is not yet clear where the next flow of equity issuance will come from. The European Central Bank’s Long-Term Refinancing Operation was supposed to restore market sentiment, but its benefits were short-lived.

A survey by Deutsche Bank in late 2011 suggested that institutional investors were on balance ready to step up equity exposure, especially in emerging markets. But by mid-2012, equity funds had actually seen net outflows. While European stock correlation halved in the first three months of 2012, creating a good environment for investor stock-picking and initial public offerings (IPOs) by companies with a positive story to tell, correlation rose again sharply in the second quarter.

No respite

Even so, market conditions have been far better in the first half of 2012 than in the second half of 2011. Three-month equity volatility is not far above 20%, compared with more than 50% in mid-2011. Yet this has not translated into a healthier IPO market. European primary issuance in the first half of 2012 was at its lowest level for a decade, at less than €50bn. Even higher growth emerging markets in Europe are not delivering significant transactions, with only two completed IPOs from Russia this year (and many more postponed), although issuers in the Middle East are having more success.

The reasons for this are macroeconomic. Growth forecasts in Europe and China are being cut, signals of a US economic recovery at the start of the year have weakened, and central banks in the US and western Europe are looking for ways to ease monetary policy still further in an environment where interest rates are already rock bottom. These are not the right conditions for equity investing, or for potential issuers to make the kind of capital investments that would justify raising equity.

And just as the market for IPOs appeared to be gradually reopening, Facebook’s precipitous slide after its $16bn IPO in May closed the door for the largest offerings and for social media-related issuers, at least temporarily. The first article in our report examines the consequences of the Facebook fiasco for future offerings.

Exits needed

While many companies may have deferred capital investment plans, there is one group of potential issuers whose needs are more urgent. Private equity sponsors who made acquisitions at the height of the boom in 2007 are now reaching a point where investments need to be exited to begin repaying limited partners, and to avoid refinancing loans at a time when bank appetite for leveraged finance is contracting.

Our final article in this report examines the exit strategies pursued by private equity sponsors. Crucially, many private equity sponsors still face a gap between the boom-time valuations at which they invested and the likely pricing of a public offering today.

With IPO conditions difficult, block trades – where investment banks arrange over-the-counter equity sales to one or a small group of buyers – have become a significant means of private equity exits, and a major source of revenue for ECM bankers. According to Dealogic data, such bought deals accounted for $40.8bn of total ECM activity worldwide from January to the end of July 2012, which is roughly equal to the $41.4bn total value of IPOs minus Facebook.

Cutting capacity

Block trades are a highly competitive and low-margin business, and ECM teams cannot live indefinitely on the revenues from what is normally a marginal part of their activity. Since there is every indication that European economies will remain subdued for some years while sovereign and financial sector deleveraging takes place, investment banks are being forced to reconsider their commitment to a business line that is so dependent on growth.

As noted in our Agenda article this month, the heavily restructured Royal Bank of Scotland has already pulled out of its equities businesses to focus on debt, derivatives and transaction banking. While banks that did not need to be nationalised in 2008 maintain that they are in a different position, there is every sign that RBS is, in reality, the canary in the coal mine.

Crédit Agricole is already in discussions to sell its equities brokerage, Chevreux, while UniCredit has closed down its equity sales and trading activities in London and elsewhere. Other leading banks are still hoping that something – perhaps yet more ECB intervention – will help to bridge the gap and restore ECM activity, but they are rapidly running out of road.

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