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Curatia Analysis for Mon, Sep 9

Boutique Banks Quietly Pressure Bulge-Brackets on M&A

An overwhelming media emphasis on the existential threats Big Tech and fintech firms pose to bulge-bracket banks has largely left boutiques toiling in obscurity.

They’ve made the most of their opportunity, belying for now the suggestion that a tech pivot favors the largest banks. Investors are skeptical that they can continue to shine amid slowing M&A activity and stiffening headwinds for banks, however.

Outperformance

In the trading space, Jefferies raised eyebrows when it reported revenue jumped 29% YoY in Q2, defying a trend that saw industry heavyweights JPMorgan, Citigroup, BAML, Goldman Sachs, and Morgan Stanley all log YoY trading revenue declines.

For the most part, though, boutiques have flexed their muscles in the dealmaking arena. Over the past decade, Evercore has produced a nearly 600% total return on the back of nearly tenfold growth in advisory revenue from $180M to $1.74B. The KBW Bank Index returned 190% over the same span.

The bank credits selective hiring for its outperformance, which has allowed it to surpass Citigroup and BAML and elevated it into direct competition with the likes of Goldman, JPMorgan, and Morgan Stanley.

The move reflects broader growth in North American M&A markets even as European markets have struggled. Those dynamics have forced European banks like Deutsche Bank and UBS to retrench in investment banking, leaving personnel and market share exposed to growth-minded boutiques. Like Evercore, Moelis has flourished, quintupling its revenue in the last decade.

Boutiques’ dealmaking momentum was evident in Saudi Aramco’s selection of Lazard and Moelis last month to advise on its expected $100B IPO. Earlier this year, Lazard’s work on a blockbuster Aramco bond sale impressed the oil giant.

Virtuous Cycle

Such wins have touched off a virtuous cycle by allowing thriving boutiques to raise pay and pluck talent from larger rivals who are struggling.

After growing advisory revenue by 22% YoY in Q2 while all five bulge-bracket banks suffered declines, Evercore upped its Q2 investment-bank compensation allocation pool 19%. It has hired 14 senior MDs in its equities and advisory businesses YTD.

Middle-market M&A specialist Houlihan Lokey meanwhile increased compensation and benefits costs 17% following four consecutive quarters of earnings beats and continues to hire around 12 new MDs per year, bucking an industry downsizing trend.

Perhaps the best indication of the growing pressure boutique banks are putting on bulge-brackets is the frequency with which they are claiming large banks’ top talent.

Cowen recently hired a team of 10 high-touch sales traders from Deutsche Bank in London and brought former Nomura MD Peter Finn into its M&A team. In August, Jefferies recruited Deutsche Bank dealmaker Andrew Zarnett to lead its US gaming investment banking team. And last week, Moelis poached Deutsche Bank head of fintech banking Tommaso Zanobini.

Collectively, the moves emphasize the vulnerability of European banks (and Deutsche in particular). They also highlight boutiques’ focus on M&A as an automation-resistant redoubt for middle-market firms, which are parrying big bank tech gains fueled by massive R&D budgets.

Trouble Ahead?

The long-anticipated threat of such gains accruing disproportionately to bulge-bracket banks has so far failed to materialize. Instead, nimbler boutiques have kept pace in part by relying on third-party providers for key tech infrastructure — a hallmark of the boutique business model.

That approach has allowed smaller banks to hold their own on the tech front — with Jefferies even building its own outsourced trading desk, for example — while wresting M&A market share from larger rivals.

The trend is another facet of the deconstruction of bank functions that has included ceding market-making duties to electronic trading firms and a budding competition with electronic bond trading platforms like MarketAxess and Tradeweb.

For boutiques reliant solely or primarily on deal revenues for their success, however, that run of success could be in danger as analysts forecast slowing deal activity.

For the 12 months ended mid-August, fretful investors punished the top six independent banks — Moelis, Lazard, PJT, Greenhill, Houlihan Lokey and Evercore — to the tune of a 36% dip in average stock price, versus a 15% drop in FactSet’s US Major Banks index.

More broadly, banks now face added headwinds from the specter of lower interest rates that figure to crimp lending revenues.

Interestingly, though, lower rates could disproportionately penalize large lenders and regional commercial banks while coming to the rescue of boutiques, for whom lower rates make deal financing cheaper. Given that dynamic, an opportunity may exist for boutiques and investors who understand rate fluctuations’ differential impacts on banks — if only the Fed and other central banks will cooperate with an aggressive program of cuts in the weeks ahead.