Sell Side

Regional Banks See Muni Opportunities

The economic crisis has hit public finance hard, with deals delayed, financing troubles for issuers, and job cuts at many Wall Street firms. But despite the turmoil, many mid-market and local investment banks have continued to expand their public finance departments, saying the current crisis has opened up many opportunities.

Over the past 10 months, Bear, Stearns & Co. was purchased by JPMorgan, UBS Securities LLC closed its public finance department, and Bank of America Corp. acquired Merrill Lynch & Co. With the decrease in number of large banks involved in public finance, market participants say smaller banks are in a good position to benefit in the future.

"My guess would be yes, regionals are going to play a much, much, much bigger role, particularly as the importance of needing a fully rounded bank or other types of services goes away," said Bay Area Toll Authority chief financial officer Brian Mayhew.

Although sometimes classified by the catch-all term "regional," the banks finding opportunities in the current market come in all shapes and sizes. Many do, in fact, cater to specific geographic areas even as they have expanded their footprint, while a few are mid-market investment banks that have branched out so far they've essentially left the regional designation behind. Others include minority- and women-owned firms, as well as boutique investment banks that may focus on a specific sector, such as education or health care.

No matter how they're classified, though, the firms stand to benefit because they operate much differently than many larger banks that have historically topped the league tables. The parent companies of many of the largest public finance banks have amassed billions of dollars in losses amid broader financial turmoil, which has had repercussions throughout those institutions.

Outside of that group, banks in public finance tend to work with much lower - if any - leverage, and have avoided mass exposure to structured finance products and other exotic instruments that led bigger banks to massive losses.

Many smaller firms are privately owned, which allows them to focus on long-term standing rather than next quarter's results, according to Keith Kolb, head of public finance at Robert W. Baird & Co., which has increased its public finance staff to 66 from 51 since January 2006. He says the employee-owned and operated structure of his firm gives it a "key advantage."

"It gives the flexibility to play offense because we are in control of our destiny," Kolb said. Baird, for instance, has aggressively expanded its competitive underwriting business, moving to fourth in 2008 from 23d in 2007, according to Thomson Reuters.

In addition, many of these banks stake a larger portion of their business on public finance. At Wall Street banks, the enormous losses have led to pullbacks across the board, which means the resources at the public finance department can get cut through no fault of their own.

But at Piper Jaffray & Co., a publicly owned company, head of public finance Frank Fairman sits on the management committee, giving him direct access to the firm's top executives. Fairman said his bankers often assure "clients that public finance and municipals are just much more relevant at a firm like Piper, which makes us a lot more committed to the business."

Piper Jaffray itself has already directly benefited from the pullback at larger firms. It recently served as the sole lead underwriter on a $148 million revolving fund bond issue for the Iowa Finance Authority, an account it used to co-manage. Its original partner on the account, UBS, is no longer in the muni business.

"That's actually an example of where we've been able to expand our business a bit because of Wall Street," Fairman said.

To be sure, larger issuers may still gravitate toward bigger firms. And with those issuers generating a majority of the municipal market's volume, any gains smaller banks make may not cause any kind of major upheaval in the league tables. In fact, the same eight dealers - all primary dealers that can trade directly with the Federal Reserve - topped the rankings again in 2008, losing just a percentage point of market share from the year before.

But that doesn't mean there aren't opportunities for regional banks willing to grow their businesses. In many cases, with reduced staffs and resources, bigger banks will limit their focus to bigger deals, leaving many small- or mid-sized issues for the taking. In other cases, the difficulties of distributing deals amid tough market conditions will mean bringing more firms into deals to reach the maximum number of buyers, providing more opportunities for smaller firms to work on large city or state-level deals.

"It's going to be economically advantageous ... because it will allow some of the bigger firms to distribute risks and it will tap our ability to distribute bonds," Kolb said. "I do think we are going to see more involvement ... in larger syndicates."

Personnel moves, though, have been perhaps the most visible sign of the shift. With Wall Street firms shedding staff, regional firms have seen a good amount of talent available for hire.

The structure of smaller outfits - including their often more commission-based compensation systems - may allow for them to bring more people on, market participants said.

Examples of big bank talent finding new homes at smaller banks are easily found. Bear Stearns' former head of public finance Dan Keating and three other Bear professionals this summer joined Samuel A. Ramirez & Co. after JPMorgan purchased their firm. Siebert Brandford Shank in August announced it had hired four UBS bankers and a JPMorgan analyst. Stone & Youngberg LLC hired three public finance bankers from UBS in June and has also added five people to its taxable staff.

"What we're now seeing is that there are some very talented people that are joining regional firms," said Kenneth Williams, president and chief executive officer of Stone & Youngberg and vice chairman of the Regional Bond Dealers Association.

With public finance's focus on relationships, it's not exactly unexpected that the new hires could bring new clients through the door with them.

"I think what we're going to see is that the dealer community and the regional and minority level has an opportunity to pick up some nice talent, and exploit the relationships that they have with that upgrade in talent," said Robert Lamb, president of financial adviser Lamont Financial Services.

Piper Jaffray has increased its business in California since it announced in June it had hired UBS' West Coast education and land-secured finance teams from the former industry leader. Piper served as the senior manager on 23 deals in California in the first half of the year. It has served as the senior manager on 38 deals in the state since then, more than any other underwriter but Citi.

At Morgan Keegan & Co., the crisis has given the bank the opportunity to hire as it expands its geographic reach. Despite its historical focus on servicing the South, Morgan Keegan already ranks as a top 10 senior manager.

The firm, which is owned by Regions Financial Corp., has in recent months hired nine municipal professionals from large banks - including Morgan Stanley, JPMorgan, and UBS - to bulk up its Northeast business.

Morgan Keegan recently served as lead underwriter on a $10.5 million New Hampshire Bond Bank deal as a direct result of talent brought in from UBS, according to Robert Baird, an executive managing director and president of fixed-income capital markets at Morgan Keegan.

"It's a huge opportunity," Baird said. "We have been building our public finance group well before this particular opportunity presented itself. And it's consistent with our strategy. When firms start reducing staffing, we typically pick up some very good bankers."

Firms have also used the opportunity to build their distribution capabilities, adding to their buy-side client lists. In some cases, they have simply hired sales and trading professionals who have these contacts. In other cases, new institutional clients have called to do business with them, thankful of the liquidity some of the banks were willing to provide.

With bid-ask spreads wider, dealers can get more profit from the trades they complete. For some regional dealers willing to open their books, sales and trading operations have been profitable.

"Regional firms have started to get better access to institutional clients," Williams said. "Accounts are now calling, not getting the same service from bulge-bracket firms."

Regional dealers have also played a stepped-up role in Washington since they formed their own trade group, the Regional Bond Dealers Association, last March.

In the roughly 10 months since its founding, the group has grown to 25 members from 14, and is the only broker-dealer group to focus exclusively on municipal and other domestic fixed-income securities issues. The group is headed by two Securities Industry and Financial Markets Association alums, Michael Decker and Mike Nicholas.

California-based De La Rosa & Co. has continued to expand its business despite the market turmoil, said president Edward De La Rosa. Through the first nine months of the year, it picked up an additional $1.4 billion on its remarketing book, mostly from larger firms. It has added new units, including a taxable desk and investment advising group for municipal treasurers and finance officers of nonprofit organizations.

De La Rosa & Co. has added a number of members to its sales and trading staff, including Chris Tota, former director of tax-exempt risk and senior managing director at Bear Stearns. De La Rosa estimates the size of his staff has grown between 60% or 70% over the past year.

"This financial storm has tested every firm's commitment to California," he wrote in a recent newsletter to clients. "From the outset, many Wall Street houses diverted capital to shore up lagging balance sheets and cut staffs. De La Rosa & Co., I'm proud to say, has stepped up our commitment."

Even as they pick up new business, many firms say they don't necessarily plan to change their strategy.

PNC Capital Markets' Thomas Henson says his unit has benefited from its connection to the commercial banking arm of PNC Financial Services Group and plans to expand within the commercial bank's footprint.

Earlier this year, it hired three Wachovia professionals in Pennsylvania and New Jersey and will likely add to its staff to match the geographic distribution of National City Corp., which PNC recently acquired.

PNC expects it will have more chances to be involved in state-level issues, which on occasion it has lead managed in the past. But Henson says the firm will still focus on its bread-and-butter issues.

"We've always had a strategy that we're PNC and we do certain types of deals," Henson said. "We're very big in the local government market, the school district market, the health care market, the private university market, the 501(c)(3) market. Our strategy has always been that we want to be a very big player in this marketplace in the places where the bank has a footprint."

Fred Prager, founding partner of Prager, Sealy & Co., said many people - including those within his own organization - criticized him for passing up lucrative opportunities that would have required taking more risks in recent years. But he says the conservative strategy he held to has paid off, and the firm was profitable once again last year.

Prager said his company has seen opportunities increase in the higher-education advisory area, one of the firm's focuses. On the broker-dealer side, Prager has added top salespeople from UBS and JPMorgan.

But Prager doesn't necessarily want to change his business model. Prager Sealy, which advises institutions such as Harvard and Stanford universities, will think closely about which clients it takes on, Prager said. And although it does have a broker-dealer service, the firm hasn't expected its advisory clients to use its underwriting services in the past and doesn't plan to in the future.

"We're not looking to fill the vacuum that appears to have opened or presented itself in this meltdown," Prager said. "We're not quite sure what the landscape is going to look like; we think the business model that we have works best for us and our clients. We're not looking to tweak that."

Kolb summed up what many of the firms feel. Baird & Co. has added to its public finance team and expanded into the Northeast. It sees opportunities, but realizes it can only do so much in the market.

"Even though we have opportunities to greatly expand what we do, we realize we're not going to be all things to all people," Kolb said. "But what we do, we're going to do really, really well. The fact that we've taken that conservative approach - not highly leveraged, strong capital structure - will all serve us really well."

Andrew Ackerman contributed to this story.


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