JP Morgan targets subordinated debt to boost fees

By Quentin Webb

LONDON (Reuters) - JP Morgan (JPM.N: Quote, Profile, Research, Stock Buzz) is focusing its debt capital markets (DCM) efforts on high-margin products such as hybrid bonds and subordinated bank debt as a gaggle of competing banks drive down the returns to be made on straightforward bond issues.

Viswas Raghavan, the head of the bank's capital markets business outside the Americas, said the dozens of banks vying for European bond mandates made little or no money from standard senior debt issues.

"My whole view for the DCM space is, if you want to be high-margin, you need to innovate," Raghavan told Reuters Investment Banking Summit in London on Tuesday. "There's just so much overcapacity right now in terms of the number of banks who all have a claim to fame and who want to do everything.

"The only way you preserve margins, get yourself paid and your shareholders rewarded, is to focus on the structured, higher-margin side of the business," he added.

Europe's syndicate bankers often complain rivals take deals at cutthroat rates in a bid to boost league table rankings or to win other, more lucrative business from borrowers. Some say fees can be just half of U.S. rates.

Raghavan said issuing senior bonds for financial institutions had turned into a "league table game", with banks spending tens of millions of euros to boost their positions, while corporate bonds were "increasingly pretty low-margin".

"I think the entire senior bank debt financing market doesn't make any money, and high-grade bonds increasingly don't make money," Raghavan said. "Quite often you find that more money is made on the overlays. You make more money on the swap on the back of it than doing the bond itself.

HIGHER-YIELDING

"The real scope for making money is in the corporate hybrid space and in the bank capital Tier I, Upper Tier II kind of space," he said.

Banks have become avid issuers of higher-yielding Tier I and Tier II debt, which helps them meet regulatory requirements on solvency and capital adequacy ratios, while corporate borrowers have flocked to issue hybrid bonds over the past 18 months.

Hybrid bonds blend features of equity and debt, allowing companies to raise funds more cheaply than shares, while placing less strain on credit ratings than normal bonds.

Tier I, Tier II and hybrid bonds are all subordinated debt, meaning they rank behind senior debt in the queue for repayment but pay investors a higher return.

Corporate borrowers have sold more than 12 billion euros ($15.4 billion) of euro and sterling hybrid bonds since a rating agency rethink opened up the market last year, with Linde, Lottomatica and Siemens all selling deals to help refinance takeovers.

"Increasingly, the way equity markets are going, the cost of equity is going higher and higher," Raghavan said. "So the way you finance (M&A) has to be more ingenious. It has to be smarter, so you're not just lifting your WACC (weighted average cost of capital) by putting it all in equity finance."