Prime brokerage was not a priority at either JPMorgan Chase & Co. or Citigroup Inc. until recently, but both companies are emphasizing the business at a time when it may be a standout among other market-related businesses.
JPMorgan is to enter the equity prime brokerage business when it closes its deal for Bear Stearns Cos. next month, and doing so could eventually add $750 million of annual income to the New York company's investment banking arm, James Dimon, JPMorgan's chief executive and chairman, said this month.
Vikram Pandit, Citi's chief executive, helped build Morgan Stanley's successful prime brokerage unit before leaving in 2005 to found Old Lane LP, a hedge fund, which Citi bought in 2007. Since taking over as Citi's CEO last December, he has said he wants to build up the prime brokerage business even as he looks to shed up to $400 billion of assets elsewhere.
"While we have a lot of cost to take out, we also believe we've got investments to make," Mr. Pandit said May 9 at the company's investor day. In equities, he added, "our growth is weighed down by the fact that we don't have a sizable prime brokerage business … and we'll get it right here."
The companies' interest comes as prime brokerage units based in the United States are poised to reap $11 billion in revenue, collectively, this year, a 15% rise from 2006, according to a study released this month by the TABB Group in New York.
(Tabb did not complete a study in 2007.) Prime brokers help finance business and clear trades for more than 3,000 U.S. hedge funds, with more than $1.8 trillion under management.
Monica Schulz and Matthew Simon, research analysts and co-authors of the TABB study, estimated that "industry revenues generated from financing, stock loan, custody, and other prime services will surpass other institutional business lines by 2010, in particular the cash equity business," which hovers around $12 billion a year. Ms. Schulz said in an interview Monday that, despite turbulent times in stock markets and the accompanying elevated risk level, hedge funds have pushed growth initiatives. As a result, she said, "their appetite for prime services isn't shaken by volatility."
Goldman Sachs Group Inc. and Morgan Stanley have long dominated the prime brokerage arena, and each New York firm said on earnings conference calls this year that these business lines grew in the first quarter.
The TABB Group researchers interviewed 61 hedge funds based in the United States during the first quarter and found that more than half worked with either Goldman or Morgan Stanley.
But the researchers said there is room for others to find growth.
John Havens, the chief executive of Citi's institutional clients group, said at the company's investor conference that the parent will build "a much bigger and broader prime brokerage business." Citi plans "far more focused investment in technology, much more integrated distribution of the product across the asset classes, and a real focus on the emerging markets," he said. Mr. Havens also hails from Morgan Stanley, and Mr. Pandit noted May 9 that they both helped develop that company's prime brokerage business.
Meanwhile, JPMorgan's Mr. Dimon told investors at a conference this month that acquiring Bear Stearns' equity prime brokerage business fits with other services the company offers. "A lot of people say they'd like to have a prime broker account or correspondent clearing account at JPMorgan Chase so they never again have to worry about credit," he said. (JPMorgan Chase already has a small prime brokerage presence in fixed income.)
According to TABB, nearly one-fifth of the hedge funds it surveyed used Bear Stearns' prime brokerage services; close behind were Citi, Lehman Brothers, UBS AG, Deutsche Bank, Bank of America Corp., and Merrill Lynch & Co. Inc.
Mark Fitzgibbon, the head of research at Sandler O'Neill & Partners LP, noted that Bear Stearns lost clients during the first quarter amid its rapid meltdown. And B of A in January announced it would try to sell its equity prime brokerage business as it downsizes its investment bank. Each of these situations offers openings to Citi and others to cherry-pick new clients, Mr. Fitzgibbon said in an interview last week. "And the number of hedge funds out there is simply growing, and so the need for prime brokers will ultimately grow too," he said.
A B of A spokeswoman declined to say if the company was currently in negotiations with a buyer, but she said B of A remains committed to selling its prime brokerage unit
Mr. Dimon acknowledged the client hemorrhaging at Bear Stearns, saying, "If you look at balances and stuff like that, volume is probably down about 30% or 40%" since JPMorgan announced plans to buy the firm. But "we have a lot of expectations it's going to come back" after the deal closes, he said, noting the sheer demand for the service.
Adam Sussman, TABB Group's director of research, said in an interview Monday that expanding in prime brokerage is of course not riskless. Though he expects overall growth in hedge funds, he said, some will inevitably fold. But he also said the investment banking arms of money-center banks can draw on their parents' broader resources to attract hedge funds looking to expand internationally. Timed right, when the credit cycle is near its bottom and hedge funds are looking to expand, "there are real opportunities for investment banks that do not have significant share now to grow by leveraging the intrinsic strengths of their companies," he said.
