Good lord. The folks at Keefe Bruyette & Woods seem to have totally forgotten it’s not OK anymore to pimp out their research to investment banking clients.
Do these people not know the 1990s are over? There’s apparently nothing they won’t do for a fee. Last May, recall, KBW flagrantly whored itself when it upgraded Western Alliance Bancorp (WAL) just four days after it led a needlessly large, fee-packed (and massively dilutive) secondary offering of Western’s stock. It’s hard to be more coldly commercial than that. Everyone involved in the transaction got what he wanted—except Western’s hapless shareholders, who saw the size of their stake in the company drop by 40% as a result of the offering. Fees to KBW from the deal: an estimated $7 million.
Do you wonder whether they wore their fishnets to the closing dinner? The reason I mention this now is that KBW was up to its old tricks again a couple of weeks ago. This time the issuer was Umpqua Holdings (UMPQ), but the pattern was the same. On August 11, Umpqua said it would raise $175 million via a common stock offering, with KBW as co-manager. At the time of the announcement, KBW rated the stock “underperform.” Two days later, Umpqua upsized the deal by 29%, to $225 million. It sold it all (except for the green shoe) later that day.
You know what happened next. Suddenly the scales fell from the KBW analyst’s eyes, and he saw that Umpqua wasn’t the dog he once took it for. On August 17—just four days after it co-managed the deal—KBW upgraded Umpqua to “market perform.”
Not to put too fine a point on it, but that’s not equity research, it’s blatant prostitution.
If you doubt it, take a look that the rationale KBW offered for its upgrade. It was pathetic. Umpqua now has enough capital, KBW argued, to absorb its estimate of remaining losses for the cycle. But KBW’s estimate of remaining losses for the cycle is ridiculously over-the-top. And even without the capital raise, Umpqua would still have had enough capital to absorb them. In particular, under KBW’s stress test, Umpqua’s cycle losses would have reduced the company’s tangible capital ratios by 134 basis points. With the capital raise, the company’s tangible common equity ratio would be a super-plump 7.81% at the end of the cycle; without it, TCE would merely be a plump 6.47%. Given that, what difference should Umpqua’s capital level make in the analyst’s opinion of the stock? None. He was just grasping for a reason to upgrade.
It gets worse. The analyst also managed to raise his 2010 estimate by 4 cents, to 18 cents—even though, following the deal, Umpqua’s shares outstanding jumped by 38%. And his price target went to $11 from $7. Which is to say, before the $225 million deal, KBW thought Umpqua should be worth $420 million. Now, after the deal, it thinks Umpqua should be worth $950 million. Let’s just say the arithmetic behind that logic eludes me.
KBW clearly has no compunction about selling its research ratings if the price is right. I’m at a loss to understand why anyone would rely very much on its research in making an investment decision. In fact, given KBW’s view of the banking industry, I don’t get why anyone would rely on its research at all. The S&P Financials have more than doubled over the past five months—yet the entire time, KBW has been “cautious” on the group. It rates just 22% of the names in its universe “outperform”!
If KBW can’t make money for its clients in this environment—and from what I can tell, it hasn’t—I doubt it can make money for clients ever. Then again, based on how the firm seems to run its business, it seems to have stopped even trying.
