Maybe it is a Drexel thing, but two of FT Alphaville’s favourite tour guides on the evolution of high finance are Marc Rowan and Ken Moelis (both went to Wharton in the early 1980s and, after graduation, ended up at the House of Milken).
Moelis, the founder of his eponymous boutique bank after stints at Drexel, DLJ, Credit Suisse, and UBS, spoke at Goldman Sachs’ financials conference this week and didn’t disappoint. His explanation for how starting his advisory shop just at the outset of the financial crisis proved unexpectedly fortuitous ended up being a fascinating look at the current landscape.
Below are some of his comments about how the blow-up of big banks not only created the golden age of private credit managers but why he thinks firms like his are going to clean up as a result in M&A advice.
We haven’t cleaned up the transcript to preserve the unplugged vibe. All the emphases below are ours.
The back-story:
“ When we started — we started right before the crisis. And then once the crisis hit, I was terrified like what stupid thing have I tried to do here [by starting Moelis & Co]. And then I quickly realized the crisis was the best — the ‘08 crisis was the best thing to happen as bankers became available, we didn’t have leverage, we had raised money. And what I thought in that time frame was, I always said, if you went to sleep as Rip Van Winkle in 2008, you woke up 30 years later, I thought somebody would say, if you were financially curious, when did Glass-Steagall get put back in place. Because the whole system would spin out into different — away from where it was. What’s surprised me, and it’s happening right now is that it’s not taking 30 years. I think what people are missing is the entire transaction finance world is radically changing from a bank-centric market where it was for most of my career to alternatives, life insurance, pension funds, sovereign wealth, match funding . . .
What happened in the 1990s:
So again, the whole thing was transaction-based meaning the banks wanted to be in the room when M&A was being thought about. So they went — they figured that out in the ‘90s and that’s when they all consolidated the industry. Citibank buys Salomon Brothers, JPMorgan buy 5 companies, UBS buys 5 investment banks, Deutsche Bank buys 5. And the reason they did that is they were trying to fill their balance sheets, right?
They had $1 trillion balance sheets and the place where the most profit was, was at the moment a transaction was happening, so they wanted the investment bankers who are in the room when M&A was being thought about so that they can then finance it. And because those financings were always done at a margin of profit significantly better than a revolver, okay.
Then the global financial crisis of 2008 happens:
The crisis happens, and I think the regulators start waking up to the fact that financing of system with 5-day deposits, 5-day liquidity on deposits and 5-year loans is a bad business. And by the way, everybody said, ‘08 only happens once every 1,000 years. Well, that’s bullshit. There was — as I said, they wouldn’t have made the movie. It’s a Wonderful Life if it happened once every 1,000 years. 80 years ago, Mr. Potter had to jump in and stop what was the bank run. There’s no — I think it was Mr. Potter. He might have been the bad guy, right? Mr. Potter, I think is the bad guy.
Then March 2023 happens:
But the — it was 5 days now SVB, Credit Suisse and the rest of it happens, First Republic, and you figure out it’s 5 seconds. 5 seconds and no relationship, no time for Mr. Potter to ask you not to take your money out, and that’s just completely not acceptable for the taxpayer to bridge the gap on that basis. And I think the regulators saw that. And that’s why they’re making it so difficult for the banking system now to put these assets on their balance sheet. So the whole system, all these M&A that was set up to bring investment bankers in to create assets is a dead system.
Maybe banks should not be in the storage business?
I think that system is being squeezed out by the regulators. By the way, I think it’s the right answer as the taxpayers should not be funding the largest banks ability to go into fintech and do all sorts of things. I mean if you’re going to be regulated, utilities are regulated. They don’t even have their liabilities guaranteed, but they can’t do super growth things. They can only do things that are in the interest of what the regulation is for. And for some reason, we had the banks out of that for many years. It’s going away.
A lot of stuff is still to migrate out of banks and into other corners of the financial system:
That whole system is going to — so all of — right now, there’s $2 trillion in private credit I think very rapidly, the $20 trillion that’s left in the banking system of below investment-grade credit is going to move over here. And that will reshape everything. The reason that a lot of people might have used I went to UBS in the early 2000s because I wanted the balance sheet. It was below market. I would use the balance sheet to provide an extra turn of leverage in order to win business. Off the table, there’s no — it can’t be done. In fact, the capital is probably less flexible than in private credit capital. So $20 trillion is going to move, and I think that’s going to reshape our industry in a way. Look, I still think when trillions of dollars move in any direction, people want to have competition around it.
There is a private credit arms race and Ken Moelis is fortunately an arms dealer:
This was again, this old system was a little closed garden, if you remember like the old AOL and tech, where everything was in your garden. So if you — if I was at UBS, my answer to every question about where is the best capital tended to be UBS as the solution because I was creating — I was there to create assets for their balance sheet. And over here, I think it’s going to be open architecture. And so what that open architecture, I think, leads to is 50 to 100 institutions that can provide this $25 trillion of capital and 5 or 6 of the independents that are not conflicted. We don’t have a balance sheet to feed.
That’s why we don’t want a balance sheet. We want people to look at us and say, they don’t have a conflict we want to place $2 billion of a pref or some instrument. Why don’t we use them and let them auction it off amongst the most — amongst those new credit providers. And I think this whole change in the financial system is what is surprising me, right now is what it means for us. Again, we went public, I never saw our ability to get to a $5 trillion or $6 trillion market — $1 billion, sorry, I wish it was $1 trillion — $5 billion, $6 billion market cap.
And so — but what I’m seeing is the reason what might be happening is we are sitting in the middle of the greatest change in the history of transactional finance.
The big alternative investment managers know that the future is not private equity but private debt:
You’re thinking of private equity and sponsors. Now remember, yes, we go to market every day, and we want to — and I’m going to use 2 names, just KKR, Blackstone. You’re talking about addressing their $25 billion funds in private equity and maybe they’re putting out 10 a year. I don’t know if that’s right, I’m making up numbers. And that’s pretty good because there’s 20 of them.
So we’ve — but those companies are now putting out $100 billion a year in alternatives. I think — that’s why I think the fee pool from sponsors will be much larger than people think because they’re not all — if you go to their programs here, I bet none of them are talking about their private equity. It’s become almost a pimple on their — not that they don’t do it, and we want to make those M&A fees and we’re going to. But I want us to be involved in the $100 billion to what might become $200 billion a year, if you listen to the per year, they’re going to put out in alternatives [private debt].
The big banks monopoly on deal finance and the huge fees is over:
And they’re going to — like we’re in the middle of a transaction right now. I don’t think it’s been announced or done. But it’s like $1.5 billion pref in a deal, not M&A deal, and we showed it to one of the direct lenders. That’s one of the best things we’ve ever done for them. They’re extremely happy with where they are. I think it’s a $30 — it’s $25 million to $30 million type fee. So it’s M&A type fee for coming up with a capital for the other parts of the firm. So again, I think people are underestimating how these large chunks of capital, and they’re going to be large these 5 — a couple of private equity firms have done $5 billion to $10 billion direct loans they originated.
I think over time, the companies are going to say, I mean it’s all novel last year that this was happening, but they’re going to say, well, aren’t there like 10 of these firms that can do $5 billion direct and their boards or their advisers everybody is going to say, “Well, why don’t you give it to an independent [boutique bank] and let them auction that and find out if there’s 50 basis points more you can get, run a clearing price on a $5 billion deal, why wouldn’t you? Why wouldn’t you talk to 5 different capital sources and run a mini process and get the best terms and the best — I mean that’s what you do on investment-grade financing, you go out and you talk to everybody and you don’t just take anybody’s bid, you take the best bids.
Are you an M&A banker? Get ready learn private credit, buddy:
So I think we could play an amazing — it’s just a great role in there for independents. And the fees are pretty good because these assets, if you can put a $5 billion asset on your direct lending book, that’s as profitable if it’s — you listen to Marc Rowan, you listen to all — that’s more interesting to him. He’s more focused on that than they are almost on their PE, so they will pay fees to be shown that stuff.
And I think that the fee pool from sponsors is going to be a lot larger if you think of them in the way I’m thinking about it. And we have to be on top of that. I’ve been very much pushing our capital markets to make sure they’re in that market because I think it’s going to explode and it’s not going to be easy to get the talent and get in the market and be — not every M&A adviser is interested in capital markets. Some of them just want to be M&A advisers. It’s not the same talent base to have a banker who does M&A and a banker who does capital markets.
https://www.ft.com/content/d8f42dd4-ad27-452b-833a-439ab16da0c2
