ARE BANKS GUILTY OF PREDATORY PRICING ? / THE WALL STREET JOURNAL

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JUNE 16, 2009, 10:28 A.M. ET

Are Banks Guilty of Predatory Pricing?

By SIMON NIXON

Irresponsible pricing? Predatory practices? Accusations are flying thick and fast in the City of London. J.P. Morgan reckons the sudden unexpected recovery in risk appetites has extended to rival banks, some of whom are trying to win back market share by offering to underwrite deals for a pittance, undermining the profit pool for the whole industry.

Except this is not how it looks from the other side of these deals -- from the perspective of companies trying to raise equity to stabilize their businesses. For the corporate sector, a bit of competition could offer welcome respite from fees that have soared since the crisis started. The cost of raising equity in the U.K. has nearly doubled from a decade ago.

Not so long ago, the cost of raising equity in London was typically around 2.25%, of which 1.5% went to investment banks and 0.75% to sub-underwriters. Today, the banks get around 2% and the sub-underwriters 2%. True, this total of around 4% is still some way below the U.S., where raising equity can cost anything from 5% to 7%, but it hardly suggests a market that has become more efficient thanks to competition.

J.P. Morgan claims this steep increase in fees is justified because the cost of capital has risen for banks and sub-underwriters who need to make a commercial return on the capital they put at risk. What's more, J.P. Morgan argues, an underwriting agreement is like a put option and at a time of rising volatility, the cost of that option has increased.

But these arguments are largely self-serving. True, the cost of capital has risen, but not by 100%. And if an underwriting agreement is an option, it is a deeply out of the money one. In recent deals, banks have protected themselves by substantially increasing the discount to the theoretical ex-rights price from a historic average of around 15%-20% to about 40%-50%. It's not clear how much risk the banks are really taking.

That J.P. Morgan should be concerned that competitors may be driving down fees is hardly surprising. Expectations of much higher margins underlie much of the optimism that the bank sector can earn its way back to full health. But the reality for most companies looking to raise capital is that competition is very weak since they can't shop around. If predatory pricing is a problem, it is more likely to be banks overcharging their clients.

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