Banks profit from capital raising

American BanksLeave it to Wall Street to figure out a way to win big from a government-mandated rush by banks to raise capital.

Some financial companies including Morgan Stanley and Wells Fargo & Co. are using their own in-house bankers to advise them on large public stock offerings that are being done to bolster weak balance sheets following the conclusion of “stress tests” that regulators did on them earlier this month.

These advisers don’t work for free, even when they’re doing deals for their own companies. The fees they charge will ultimately go back into corporate coffers, a roundabout way for the banks to generate profits.

Securities law experts say these maneuvers also can mask a company’s financial health and potentially open the door for conflicts of interest.

“Commercial banks that need capital are going down the hall and asking their colleagues for investment banking advice. Then they are charging themselves a fee for helping themselves,” said Anthony Sabino, a professor of law at St. John’s University. “That sure doesn’t sound like it propagates independent thinking.”

These arrangements don’t violate securities laws and the companies are fully disclosing that in-house advisers are part of the underwriting group. But Sabino and other finance experts still say this is something investors need to keep tabs on as banks look for ways to boost profits in tough times. One thing to watch is what kind of fees they charge.

It’s not that the banks wouldn’t need the services of investment bankers otherwise. Whether they hire their own staff or an outside firm, these advisers are helping them figure out how to raise money or expand their businesses. That could result in selling off business units, making acquisitions, issuing debt ? or as we’ve seen in the last week, selling common stock to the public.

That has been the favored route to quickly raise capital in the wake of the government’s May 7 release of the “stress tests” conducted on the nation’s 19 largest banks and other major financial institutions.

Those tests found that 10 of the banks need to raise a total of $75 billion in additional capital in order to be strong enough in case the economy gets even worse. That has spurred the likes of KeyCorp, Morgan Stanley and Wells Fargo to rush out stock offerings to fill the capital holes the government found.

Others that aren’t required by the government to boost capital have decided to raise funds anyway. Bank of New York Mellon Corp., U.S. Bancorp, Capital One Financial Corp. and BB&T Corp. say they want to use the proceeds from common stock offerings to repay federal bailout funds received last fall.

Since the results of the “stress tests” were announced, there have been about $20 billion of stock offerings from banks that accepted money from the government’s Troubled Asset Relief Program, according to data-tracker Dealogic. The fees for advising those deals top $530 million.

The typical fees for lead underwriters handling an initial public offering ? the first time a company sells stock to the public ? can run around 5 percent or more of the amount raised. Fees run around 3 percent to 5 percent when a company does a subsequent, or follow-on offering, which is what the banks are currently doing.

That means for a $1 billion follow-on offering, the underwriters get as much as $50 million in fees.

“The bank ends up with the same amount of cash (from the stock sale) no matter who does the offering,” said Philipp Schnabl, an assistant professor of finance at New York University’s Stern School of Business.

By hiring its own advisers, “they get to retain the profits,” he said.

In the last week, Wells Fargo raised $8.6 billion in a follow-on offering of common stock. Lead underwriters were JPMorgan Chase & Co. and Wachovia Securities, a division of Wells Fargo.

For its work, Wells Fargo’s Wachovia unit made nearly $35 million in fees. JPMorgan’s cut was $78 million, according to a securities filing from Wells Fargo.

Morgan Stanley’s in-house bankers were the lead advisers on its own $4 billion stock offering this month, receiving $105 million in fees from the transaction. Citigroup, which was also an adviser, got $5.5 million, according to regulatory filings.

For both deals, the underwriting fees were below 3 percent, which is on the low end of current industry norms.

Both companies declined to comment.

These arrangements may be viewed as just moving money around within a company, but they do have some upside to them, said Bruce Krasting, a 25-year Wall Street veteran and now a private investor and financial blogger.

The banks’ own advisers could be in the best position to place the new equity since they already have relationships with existing shareholders like mutual funds, Krasting said. Those investors may also be inclined to hold onto their shares longer, rather than just flipping them to make a profit, he said.

Even though these deals are perfectly legal, investors should remember that even an arm’s length transaction might wind up just moving money from one pocket to another.

Copyright 2009 The Associated Press.