Banks Cut Ties With Brokerage And Investment Banking Operations

Two recent deals in the financial services industry signal a realignment of the battered retail brokerage sector and provide fresh evidence that financial supermarkets are not for all players. Wachovia Corp. agreed with Prudential Financial Inc. to combine their brokerage businesses and form a jointly owned operation with client assets of $537 billion and estimated revenue of $4.2 billion, making it the country’s third-largest brokerage firm. In a second restructuring move, U.S. Bancorp decided to spin off its Piper Jaffray investment banking operation to shareholders. Wachovia, which will manage the business, and Prudential are hoping that, when combined, their two mid-sized businesses will gain the scale needed to compete successfully. In getting rid of Piper Jaffray, which includes its onetime technology-focused investment banking unit, U.S. Bancorp is following in the footsteps of other commercial banks that have shed or considered dropping their investment banking operations. FleetBoston National Corp., which folded Robertson Stephens last year, is a prominent example. Experts assume that the Piper Jaffray spin-off is a response to tepid interest in the unit by potential buyers. U.S. Bancorp bought Piper Jaffray for $730 million in cash in 1998 and it is now valuing it at about $650 million. Financial results began to go south after the stock market took a nosedive beginning in early 2000, which also figures strongly in the change of heart at other banks. Piper’s investment banking and mergers advisory businesses were hit hard. Behind the divestiture of Piper Jaffray is U.S. Bancorp’s desire to concentrate on the more predictable earnings generated by its commercial banking operations. One conclusion drawn by observers of the two transactions is that in a weak stock market, hampered by low valuations and a series of corporate governance scandals, there is a shortage of buyers for most financial services sector assets. “Apparently, Wachovia sees something that nobody else in the business is seeing,” says Dick Bove, an analyst at Hoefer & Arnett. “Many of the larger brokerage firms are scaling back and believe that there is a substantial change in the industry, not just a cyclical downturn.” Bove says that one motivation for Wachovia’s acquisition is simply to expand its distribution system to reach the western U.S., especially California. He adds that although Prudential Securities is only marginally profitable, Wachovia thinks it can upgrade Prudential’s low-value-added products in a way that would increase the flow of products with higher markups and enhance profitability. Bove says that Wachovia’s strategy is based on the belief that the aging of the population will increase the opportunities to accelerate the sales of financial instruments. But as Wachovia seeks to increase its distribution chain, it, like many of its competitors, is neglecting underwriting, research, and other services. “Firms are making the wrong decision in getting out of the manufacturing side of the business and concentrating on distribution, which is what the Wachovia deal is all about,” he says. Demand lags brokerage capacity The problem with the Wachovia-Prudential merger, according to Bove, is that the financial services distribution industry is building capacity faster than any increase in demand. Wachovia is betting that when the stock market recovers, retail customers will flock to buy investment products through its advisers, which generate additional fees for the company. The new venture would have increased market share in major cities and retirement communities. But if Bove is correct about overbuilding in retail brokerages a second point of his is worth heeding: He believes that the valuable assets on the financial services landscape would be the manufacturing operations. “In 1975, we saw the whole underwriting structure wiped out, research cut back, and it took four or five years to rebuild. I’d recommend putting money into the people who are going to be doing the rebuilding in the manufacturing sector when this cycle of retail expansion peaks.” Copyright 2003 Thomson Media Inc. All Rights Reserved. (http://www.thomsonmedia.com)