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The Path Forward

In the wake of the banking crisis, utilities lead the way to financial stability.

Fortnightly Magazine - October 2008

I-Banks

The energy industry still is grieving the loss of two major investment banking institutions—Lehman Brothers and Merrill Lynch—and trying to understand the implications of their acquisition by Barclays and Bank of America, respectively. Additionally, on September 21 the Federal Reserve cleared Goldman Sachs and Morgan Stanley to become bank holding companies, even as Morgan Stanley was announcing a strategic partnership with Japan’s Mitsubishi UFJ Financial Group.

Despite the shakeup (see Figure 1) , these firms presumably will continue providing investment banking and risk-management services to the industry—and arguably they’ll be more flexible when the market stabilizes. “The changes on Wall Street, in which the investment banks will now be regulated by the Federal Reserve, will expand opportunities for funding,” Nastro says. “Broader access to the Fed window will provide additional liquidity and flexibility.”

On the other hand, from the utility industry’s perspective, Wall Street’s consolidation might be bad news—if only because it means competition is shrinking among providers of financial services. And just as important, commercial banks bring a different strategic focus and financial model, compared to those of stand-alone investment banks. Whether the new banking model will benefit energy and utility companies seems uncertain at best.

“This dramatic reshaping of Wall Street has an immediate impact on the utility sector,” says Mark Williams, executive-in-residence at Boston University’s finance and economics department. “Losing all of the independent investment banks will reduce competition for underwriting utility bond deals, and less competition will equate to higher fees.”

Additionally, as the financial-services industry consolidates and downsizes, firms will lose institutional knowledge and experience that’s developed over a period of years and even decades. “Having a banker who knows the company’s management, its history and its risk appetite can be invaluable when structuring bonds, as well as providing M&A guidance,” Williams says.

Further, banks’ approach to the market might change as U.S. lawmakers seek to impose greater regulatory controls on the financial-services industry. Momentum toward re-regulation already was building before September. “The systems of setting bank capital requirements, both economic and regulatory, which have developed over the past two decades will be overhauled substantially in light of recent experience,” wrote former Federal Reserve Chairman Alan Greenspan in a March 2008 Financial Times commentary. 1 September’s financial crisis and the related federal bailouts open the door to broader government intervention into the financial-services industry than almost anyone would have predicted a year ago.

Plus, non-U.S. institutions that already operate under tighter regulatory standards are playing a bigger role in American capital markets—the most obvious examples being Barclays’ acquisition of Lehman Brothers, and Mitsubishi’s one-fifth position in Morgan Stanley. “We’ll see a lot more global players than we’re used to seeing,” says Jean Reaves Rollins, managing partner with the C Three Group in Atlanta. “Maybe you’ll be dealing with some of the same people, but they’ll be working on global banking terms—and European [and Japanese] banks are more conservative than American banks.”

Tighter controls and stricter credit-quality standards—whether they result from federal regulation or cross-border takeovers—will drive financial firms to adjust their policies and strategies, and to