Immoral bankers

By Felix Salmon
December 14, 2010
Institutional Investor Council has issued a blistering report on the excessive fees that investment banks charge companies to issue new shares -- fees which one issuer are "usually immoral".

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The UK’s Institutional Investor Council has issued a blistering report on the excessive fees that investment banks charge companies to issue new shares — fees which one issuer are “usually immoral”. It certainly seems that way, looking at this chart: fees have been steadily increasing over time, even as the discount at which the new shares are issued has got larger and larger. The bigger the discount, of course, the less risk taken on by the underwriter, since the more that the share price would have to plunge overnight in order for the underwriter to risk losing money on the deal.


Yes, this chart includes the financial crisis, and it stands to reason that fees for rights issues would rise during a crisis. But we’re not in a crisis any more, and the fees aren’t coming down to their historical levels, even though the discounts are still enormous. And it’s notable that fees hit these highs on a percentage basis just as the amount of underwriting was surging:


What we’re seeing here is a textbook example of banks squeezing every last dollar they can out of their clients just when those clients are most desperate for money. And it stands in stark contrast to legal fees, which were considered fair by issuers and which have not risen visibly at all over the past few years.

None of this is illegal, of course, but it’s fair to call it unethical, if ethics are fundamentally based on the principle of “treat others as you would like to be treated”.

Christina Rexrode had a long article on banking and ethics in Sunday’s Charlotte Observer, and she concentrated on the kind of behavior which steps close to or even over the line into outright illegality. Maybe it’s just so blindingly obvious that banks behave in a fundamentally immoral manner most of the time that her editors considered that not to be news — charging $35 for a $2 cup of coffee, slapping enormous overdraft fees onto those who can least afford them, pushing high-interest credit cards on desperate customers, locating credit-card operations in South Dakota where usury laws are at their laxest, encouraging people to use the bonkers anachronism that is signature debit, steering customers into the financial products which pay the highest commissions, etc etc. All of this is legal, and all of it is designed to funnel as much money as possible from the customers’ pocket to the bank’s bottom line, and none of it is in the customer’s best interest, which means that none of it can really be considered moral.

More generally, Wall Street is an inherently adversarial place, where players are constantly trying to benefit from the misfortune of others. I’ll happily sell this stock to you at $40, because I think it’s going down, and I think that you’ll be sorry you bought it. Ethics and morals are very narrowly defined, when it comes to finance, and generally just mean being honest. Of course there’s much more to morality than simple honesty — and in any event honesty in financial markets is never simple.

So the issuers are absolutely right that the bankers are immoral — and the bankers are going to continue to ignore such questions, because ignoring such questions is how they make the big bucks. Here’s Rexrode:

The Observer broached the topic of banking and ethics with more than 50 people, almost all of them bankers or former bankers. Only 10 of the bankers agreed to be interviewed on the record. Some said they would speak only under anonymity because they feared retaliation from their employers…

People who spoke up could be seen as disloyal. The units that churned out the most revenue held the most sway with executives and other decision makers.

“To throw a flag in the sand and say, ‘I’m not sure about this’ – you’re not having a philosophical discussion with your priest, you’re saying to the guy in the next cubicle, ‘I’m not sure you should be making as much money as you’re making,’” said William Atwood, executive director of the Illinois State Board of Investment, an investor in major banks.

Ethics are great, of course. But money? In finance, that’s always greater.

(HT Dealbook, although they neglected to link to the report.)


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With JP Morgan owning Bear, Lehman Gone, and BoA buying Merrill Lynch, competition in the top tier has declined substantially. I wonder if that alone is enough to explain the higher fees we see today.

Posted by OneEyedMan | Report as abusive

It seems like any beat-up on banks is welcome these days, Felix. Excuse me if I don’t weep for issuers.

Posted by Mike.Gayner | Report as abusive

When the only thing you worship is the almighty dollar and your credo is greed is good, what else is to be expected.

If morals and ethics were important to the USA there would be a hue and cry for leaders that had some… and for white collar criminals to be brought to bear. The Rico Act should have been cited and some heads rolled. Instead it was swept under the carpet.

*taps fingers waiting for wikileaks BoA Exposé*

Posted by hsvkitty | Report as abusive

Well there are other risks, for instance they need to do a certain amount of due diligence. Is there not a question of needing to do more of it with more complex issues? Not a rhetorical question, genuine one.

PS I noticed this bit:

“Issuers suggested that they wanted the best not the cheapest; that may mean that they pay over the
odds.” – weird… I thought higher fees for a middleman automatically meant the client was being screwed…

Posted by Danny_Black | Report as abusive

Mike.Gayner, especially given around half the issuers were banks. It is the buyside i have zero empathy for.

Posted by Danny_Black | Report as abusive

empathy and sympathy.

Posted by Danny_Black | Report as abusive

Discount to TERP is meaningless BS for idiots who don’t know what a rights issue really is and can’t do mathematics.

As for “the more the share would plunge overnight”… ha! Twaddle.

What matters in a rights issue is how much capital is raised relative to the current market cap.
That explains how much current shareholders need to pony up in order to maintain their current holding, i.e. not be diluted.

The risk an underwriter takes is that the shareholders won’t take up their rights.
If the rights are taken up then the underwriter ends up owning none of the company and has no capital at risk.
If the capital raising is unsuccessful the underwriter ends up with a bunch of shares in a company that it doesn’t really want which it then has to unload on a market that is already swallowing more volume than is customary.

If you are raising $100m for a $1,000m mkt cap company, the risk is FAR LOWER than if you are raising $500m for the same company.

The discount to TERP is irrelevant. That is pure marketing spin.
If you understand the maths of TERP you will understand that the “discount to TERP” is just another way of writing “rights discount” which again is irrelevant for the risk an underwriter takes.

Posted by TinyTim1 | Report as abusive

Get me rewrite! “Immoral bankers” is redundant.

P.S. Why don’t we turn the banks into regulated public utilities?

Posted by lambertstrether | Report as abusive

TinyTim, I’m not sure I follow. If the underwriter ends up buying a bunch of shares that it doesn’t really want, but it buys them at a level well below the secondary-market level, that’s not a risk, right? It can just dump them onto the market.

Posted by FelixSalmon | Report as abusive

Sorry Felix, I was being dumb.
For some reason I had convinced myself that the underwriters pay TERP for their stock.

If they pay the rights price then of course they are well in the money.

But if that is the case, surely every underwriter is PRAYING for the issue to fail. They would make an absolute killing, since a fully underwritten issue would never trade below TERP (ceteris paribus).

Posted by TinyTim1 | Report as abusive

Felix, let me explain why the IIC report is so flawed and why a TERP discount is irrelevant to shareholders.

First, let’s remember that the IIC is a trade body of four other trade bodies of portfolio managers (institutional investors). Their principal complaint is that banks don’t pay them enough when they subunderwrite rights issues to institutional investors. This report is all about paying portfolio managers more and bankers less. This isn’t a moral question or even a regulatory question; it’s two big boys fighting it out over fees. The IIC is a very self-interested report by a trade body and for that reason, the investment banks generally didn’t cooperate.

I’ll quote from the International Financing Review, which is part of the Thomson Reuters family, I believe: “The starting point for the report is that institutions claim their share of the fee pot has shrunk as subbing fees have failed to keep pace with underwriters’ fees. Yet the report then states that shareholders have an incentive to keep subbing fees low.”

Second, the report completely overlooks the requirements of confidentiality. The report recommends n “club” to underwrite capital increases by issuers….but these offerings often require weeks/months of advance work, substantial due diligence and complete confidentiality. Institutions are not set up for this purpose and certainly not able to take on liability for the prospectus. (It’s pretty clear that no securities lawyer reviewed the IIC report before it was published.)

Third, what is exactly the basis for saying the rights issues fees are “too high”? Generally speaking the going rate is 2-3%. In the US investment banks charge 6-7% for share offerings and THEY ARE NOT UNDERWRITTEN – IT IS AGENCY BUSINESS. This is RISK business as the rights issues are underwritten often for 3-4 weeks, during which time share prices CAN fall below the underwritten price. This happened on the HBOS rights issue in 2008 for example and Morgan Stanley lost a lot of money. Should we really be browbeating banks to underprice their risk capital? Isn’t that how we got into trouble in the first place.

The IIC report is a disingenuous attempt by fund managers to exploit the anti-bank mood to demand more fees for themselves. These funds managers are under a lot of pressure because most are closet index-huggers and their performance isn’t great. So they effectively want to be paid subunderwriting fees for subscribing for new shares in companies they already own. (NB: a bank doesn’t have to subunderwrite. On the Continent the deals generally aren’t subunderwitten. But in the UK it is expected (by no means required) that the underwriting banks will subunderwrite ca. 50%

Finally, the DISCOUNT DOESN’T MATTER TO SHAREHOLDERS? Why? Because the discount is to the benefit of shareholders who can either (a) buy the new shares at the discount or (b) sell the right to buy at such discount (and the value of the right is of course directly related to the gap between the subscription price and the prevailing share price). The underwriters generally care because the deeper the discount, the less risky for them. But for shareholders it’s irrelevant, just as the precise metrics of a share split is irrelevant. For managements it’s relevant only for “macho” reasons.

Oh, let me add that the IIC assumes the company managements are weak lillies. My experience is that FTSE 100 and FTSE 250 companies are very savvy in negotiating down fees from banks. Again, we’re talking about adults.

I think, Felix, that you have it wrong here.

Posted by THELEGEND99 | Report as abusive

Why don’t all companies use auction like Google did with their IPO? It is simple and logical.

Posted by Developer | Report as abusive

To Developer: you can’t auction that easily because you have to issue a prospectus and there is a requirement to conduct detailed due diligence. Otherwise you can be subject to ruinous liability. That due diligence, along with the weeks of structuring work, takes many weeks and months. You can’t just auction out underwriting like it’s a piece of meat; this isn’t commoditised unless you want to eliminate the requirement for due diligence and prospectus liability (which I don’t think anyone would want to do).

That said, issuers can and do issue requests for proposals (RFPs) to banks and ask them to quote fees and indicative terms, just as you would for any other service.

Posted by THELEGEND99 | Report as abusive

Thank you for the explanation.

Posted by Developer | Report as abusive