Wall Street’s banking-as-a-service has a problem

A street sign for Wall Street is seen outside the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S. December 28, 2016.

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NEW YORK, Sept 23 (Reuters Breakingviews) – Call it banking-as-a-service. The rise in deals done by private equity firms, accounting for $553 billion of M&A so far in 2022, per Refinitiv, generates lucrative fees for investment banks like Goldman Sachs and Morgan Stanley (MS.N). But that isn’t just from one deal. The nature of the buyout business means there are asset flips, equity offerings, follow-ons, and recapitalizations that all generate recurring fees. That depends on healthy capital markets, but amid debt-market snafus and falling equity values, this could be another subscription-like business wounded by the downturn.

Private equity clients are ideal for investment banks that otherwise have to schmooze large companies like Microsoft (MSFT.O) for years before receiving a one-off deal. Firms like Apollo Global Management (APO.N) and Blackstone have generated fees of $6.5 billion so far this year, a 44% jump compared to the same time last year.

It helps, too, that they create new business streams that keep paying. A leveraged buyout of a Midwestern, family-owned industrial firm might provide the first mandate. Then there are bolt-on acquisitions to grow the company, capital markets-funded dividends, and an eventual sale. If that exit is to another sponsor, the gravy train continues. Such sponsor-to-sponsor transactions were up 85% year-over-year in 2021, making them the second-most-common form of exit, according to data from Bain.

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Still, fees from capital-markets work— raising the piles of debt sponsors rely on, or completing initial public offerings — are key to the proposition, and that could be in trouble. Global equity issuance is down 67% in the first half year-over-year, per Refinitiv. Banks took $700 million in losses to offload loans supporting the sponsor-led purchase of Citrix Systems (CTXS.O) this week, Reuters reported. A bunch of other debt packages are stuck on banks’ balance sheets — and until they’re cleared, banks’ ability to write further big checks is constrained.

Economic uncertainty makes people – and investors – become more discerning about how they spend their cash. Subscriptions, whether it is Netflix (NFLX.O) or to a favored investment banker, only makes sense when customers are flush. For Goldman and its brethren, life may be about to get harder as belts tighten.

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CONTEXT NEWS

Private equity firms accounted for 26% of M&A deals in the first six months of 2022, according to Refinitiv, a record-high share.

During that time, investment banks earned $6.5 billion in fees worldwide from providing services to financial sponsors, Refinitiv data show.

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Editing by Lauren Silva Laughlin and Sharon Lam

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