Shift in re-emerging capital markets creates need to re-define role of analysts

James K. Wicklund
Banc of America Securities LLC
Houston

There has been a marked shift in the role and impact of investment banking, research, and overall capital markets over the past two years. These changes impact how the business is done, who does what, and who does it well.

As an analyst, it is my job to get to know the sector in which I work, the companies, and the dynamics of the industry in order to do my job. Analysts must try to understand the impacts of different businesses inside a company, the level and capability of competition in the market, and generally try to determine what changes could make a company better, with "better" relating to market share, profitability, product lines, geographic focus, and other variables.

We incorporate this study into studies of many other industry factors, valuations, and commodity price frameworks – all in order to enhance our ability to pick stocks, for the benefit of our firm's clients.

Over the past two years, the attorney general of the State of New York has collected more than $1.4 billion from stock brokerage/investment banking firms without any criminal indictments. A number of firms were accused of issuing misleading research reports to promote the sale, trading and investment banking fees of their clients. There were many excesses associated with the technology boom of the late 1990s.

Very few analysts were implicated in these misdeeds, in part because all firms have procedures in place to provide checks and balances to prevent such conflicts from arising. Nevertheless, a small number of analysts – either through greed or intimidation – did not make use of these existing procedures. Unethical and easily intimidated professionals rarely last long in this business and are of no benefit to any firm, as all firms know. But, as a response to the excesses of a few, the rules were changed.

Chinese Walls have always existed between research and investment banking. But many times, investment bankers in the energy sector did not understand the implications of new technologies or even how the technology was applied. They could come to the analyst and learn what basins were hot and which ones were playing; what the impact of rotary steerable drilling and the attendant formation-evaluation-while-drilling would have on conventional wireline; and whether the outlook for drilling would trend up or down over the next year.

These general understandings of the market allowed them to better do their own research on possible acquisitions or divestitures, formulate an appropriate financing structure, and understand which regions' reserves would best extend RP ratios.

Lines were never crossed because it would be unethical and not in the best interest of the client, which is the paramount concern. I have never known or worked with an analyst who did not have the highest ethical standards. The investment bankers that I have worked with are the same. None have ever enriched themselves at the expense of shareholder, client, or anyone else. Maybe it is just the firms that I have worked for, but this continues to be a highly ethical and responsible industry.

Today, industry analysts – myself included – can no longer give that help or advice without such onerous restrictions and time constraints that many no longer bother. Without a chaperone from a compliance group, I cannot talk to an investment banker. I am unable even to directly e-mail a banker. And, if we run into one another at church, weather and religion are the only safe topics.

As a result, investment bankers at the large commercial banks have a much harder time providing any strategic solutions or suggestions to clients. They rely increasingly on the "check book" that their company might provide rather than any detailed expertise, region, or product line advice.

That said, there are still some very good bankers. At Banc of America Securities and our parent bank, having the best, most knowledgeable bankers in the business is a point of pride. But the negative side of these new restrictions can be seen across the board, with some firms doing a better job of coping with them than others. The impact on our industry is apparent.

Small boutique investment banks are forming or existing ones are blossoming, and these should not be overlooked by companies in either E&P or oilfield services. Generally, these bankers are those closest to the ground. Many come from the petroleum sector, and they are much more aware and in touch with the industry than the biggest and best investment banks. They do not need the expertise of an analyst to be effective in their work since they are much closer to it than their large competitors. But when you know that you do not have the advantage of the check book, you try and compensate and you have a great deal more time, since the large competitors spend most of their time on check-book work.

There is always financing available in the market. At what price, how much and what structure are usually the primary issues. Whether a company can borrow, lend, buy, or sell depends on many issues, but any transaction is enhanced by principle agents, the bankers, knowing you, your industry, your competitors, and the nuances of differentiation.

Analysts have been taken out of the loop. And any benefit we provided to bankers and the firm's clients in the past is now gone. Some bankers at the biggest firms do not even notice, as they are so thoroughly familiar with the business, research was little help

We have seen what happens to oil and natural gas reserves when an industry specialist on reserve determination is not used. There are not enough petroleum engineers in the industry today to enable all companies to use that expert advice. Good advice is limited. Any good advice that analysts and their research provided to virtually every aspect of my firm and every analyst's firm is now virtually non-existent.

Recently, one of my CEOs asked, at the end of a chat about his business, to have our investment banker call him. It took two days and three interviews with attorneys to pass the message along.

There is a great deal of money sloshing around in the industry today. The financial markets are getting more complicated and the market is truly dynamic. As a result, companies should make sure they have the right specialists working in the right way to optimize potential returns.

Understand what different capabilities different groups provide. Lose the ego of only using a bank well recognized at the country club. Understand that the capital markets have shifted over the past two years. The change might not be terribly obvious to many on the outside, but the changes on the inside are very obvious and have implications that impact any company that uses large commercial and investment banks.

With the global trend to specialization and the shifts inside the capital markets over the past two years, it has become increasingly important to be more selective of skill sets, capabilities, and priorities. Rewarding old friends with business in the era of Sarbanes-Oxley does not fulfill fiduciary responsibility.

Use the best people and the best sources of capital. If they are not always the same, use all. Winning is measured in basis points and having a balanced team improves the odds. Do your homework.

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