New York--An obscure company's small public stock offering currently being managed by Baltimore-based Alex. Brown & Sons, the country's oldest investment bank, has reverberated throughout the securities industry by introducing a powerful new participant into the business.
The deal, a $56 million equity offering for Pittsburgh-based AMSCO International Inc., marks the first time since the early 1930s that a commercial bank has even indirectly participated in a stock issuance. Working behind Alex. Brown is J. P. Morgan Securities Inc., an affiliate of the bluer-than-blue-blood commercial bank J. P. Morgan & Co. Inc.
While entering the securities business now, given its well-publicized problems, would seem nothing short of suicide for most companies, Morgan's move resembles that of a well-endowed heir reclaiming a birthright. Among the large money-center commercial banks, it alone maintains a top credit rating, with an illustrious client base and a door-opening name. At the beginning of the century it was among the most powerful securities underwriters in the world. It gave up this aspect of finance, commonly referred to as investment banking, during the Depression when the business was awful and regulators required Morgan to chose between dealing in securities and the other side of finance, known as commercial banking, which is structured around deposit-taking and lending.
For the past decade Morgan has argued that changes in the financial markets have made the distinction irrelevant for sophisticated clients. It is a major underwriter in Europe, where banks are permitted to work both sides of the business, and has taken advantage of grudging contraction of the U.S. regulations to become a major force in the debt markets. In the past year it has underwritten deals for Commercial Credit, Allied Signal, Westinghouse Credit and other companies that can pick and chose among financial advisers.
Recently, Washington has begun moving more aggressively to open the door for Morgan still wider. The administration has just presented Congress with a proposal for the first broad re-regulation of the nation's financial structure since 1933. And last September, the Federal Reserve Board granted Morgan a special waiver allowing it to begin trading stocks and underwriting securities. The AMSCO deal is the first result.
Not surprisingly, given its novelty, the deal has provoked differing reactions.
"I think a commercial bank should not do an equity offering," said Edward O'Brien, president of the Securities Industry Association, Wall Street's trade organization. He noted that Congress has yet to approve any re-regulation and that rules have not been instituted to bar conflicts of interest.
"This is a perfectly natural evolution," responded Benjamin GriswoldIV, chairman of Alex. Brown. "We have worked with Morgan and other banks on securities transaction for years, though it happened to be debt, not equity. It was clear over time we would work with them on equity securities."
The discord is more than an intra-industry difference of opinions. The laws restricting commercial banks to lending and deposit-taking and barring them from underwriting stock and debt precluded some of the worst financial schemes practiced early in the century from reoccurring. Some New York banks, for example, were reported to have channeled deposits into dubious securities offerings, undermining both themselves and confidence in the banking system.
But recently, the separation itself may be undermining the banking system. With the recent evolution of a broad range of new tradable securities, credible companies that once brought their business to banks now go straight to the securities markets. Banks are left with the dregs. The result has been the widespread deterioration in the loan portfolios of most of the major banks that traditionally relied on corporate loans.
The AMSCO deal highlights some of the controversial issues. About $10.4 million from the offering will be used to repay a debt to Morgan's commercial banking affiliate. The Pittsburgh-based hospital supply manufacturer, which was known two leveraged buyouts ago as American Sterilizer Corp., has transformed its capital structure over the past four years from more than 100 percent debt to about 50 percent debt, 50 percent equity. More equity will further bolster its balance sheet, ordinarily a prudent move. But is the repayment of a Morgan loan through a Morgan offering a conflict? Morgan says the repayment is fully disclosed in the prospectus and is therefore proper.
"In all financial transactions there's potential for conflicts. It's the managing of [those conflicts] that makes a firm trustworthy," said John Morris, a Morgan spokesman.
The AMSCO deal is also notable for what it isn't: a blockbuster entrance. With $336 million in annual sales and $17 million in profits, AMSCO hardly ranks among the huge corporations that crowd Morgan's envied client list, though they have had a long-standing traditional banking relationship. And Morgan isn't trumpeting its entry into the business by going it alone. It has teamed with Alex. Brown, an establishment Wall Street firm despite its location far from Wall Street.
Alex. Brown has a specialty focus that isn't directly threatened by Morgan's arrival. "The entrance of J. P. Morgan Securities in our little world does not materially change the competitive dynamic," Mr. Griswold said.
Other major firms, such as Goldman Sachs, Salomon Brothers and Lazard Freres, which for years have been the investment advisers for the same large utilities, manufacturers and corporate giants that have banked with Morgan, are likely to feel differently.
Other deals, Mr. Morris said, are under discussion, but Morgan appears to be moving slowly.
"They'll do this deal, then another, then another, and soon they will be one of the leading firms," predicted Ingo Walter, head of the Salomon Brothers Center at New York University's Stern School of Business.
David Beim, a professor of banking at Columbia University, said that Morgan tried a more aggressive approach in the German banking market in the 1960s, moving in quickly and alone, without forming alliances with other German banks. "They had their head handed to them," Mr. Beim said. "It's useful in securities work to have company."
Several years ago it was thought that Morgan's move into the securities business would be followed by numerous other banks. But currently, with a decade's worth of dreams by would-be J. P. Morgans buried beneath a barrage of failed deals and bad loans, only Bankers Trust is generally thought to be a likely candidate on a national scale in the near future.
At the moment, question's arise about why any bank would want to increase its exposure to the business anyway. "An investment banker will tell you that the last thing the industry needs is another investment bank, but this too will pass," Mr. Walter said.