L.A.’s INVESTMENT BANKERS : Wall Street Firms Discover There’s Gold in Southland

As a leading investment banking firm, Morgan Stanley & Co. is known and used by corporate giants worldwide. But to many California cities who use investment bankers to manage their bond offerings, Morgan Stanley has been a virtual stranger.

That is because the firm entered the public finance business only three years ago and ran it solely from its New York headquarters. Because it had no investment bankers based in Los Angeles or San Francisco, the firm often was not considered for many California bond offerings.

“We wouldn’t even hear about them (the offerings), and our people would not be put on their mailing lists,” said Jeffrey R. Holzschuh, Morgan Stanley’s Western manager of public finance.

But Holzschuh now hopes to change that. He opened Morgan Stanley’s first public finance office in Los Angeles in June and expects to land some new deals in a few weeks.

Morgan Stanley is not alone. Lured by Southern California’s strong economic growth and the need to be closer to their clients, most major New York-based securities firms have started or expanded investment banking operations in the Los Angeles area in the past three years.

E. F. Hutton, Paine Webber, Morgan Stanley and Bear, Stearns & Co. are among several major Wall Street companies that have established new corporate or public finance offices here. Merrill Lynch, Salomon Bros., First Boston and Drexel Burnham Lambert are among those that have expanded their offices.

Challenging Rival

The push reflects Los Angeles’ challenge to San Francisco as the West Coast’s leading center of investment banking and other financial activities. Investment bankers in Los Angeles contend that the city has already surpassed its longtime rival to the north.

The bankers’ moves in Los Angeles--with its natural ties to the Far East--also reflect the growing internationalization of worldwide capital markets. Soon, some experts predict, Japanese and other foreign firms also will station investment bankers here.

The heightened activity also reflects how investment banking--which generally includes corporate finance, public finance, underwriting and arranging mergers and acquisitions--has provided an increasing share of the revenue and profit for Wall Street firms that traditionally relied on commissions from selling stocks and bonds.

The explosion of new and complex investment banking products and services--including leveraged buyouts, corporate restructurings and the securitization of mortgages, car loans and other assets--has raised fee income for Wall Street firms and increased the number of companies using investment banking services.

“The deals are much more complex, and it takes more help now to work a deal,” said Jeffrey C. Barbakow, managing director and head of investment banking in Los Angeles for Merrill Lynch Capital Markets.

Bowen H. McCoy, managing director and head of Western investment banking for Morgan Stanley, said, “We can create our own business opportunities by having ideas” to offer potential clients.

Demand Increasing

Smaller companies are joining big ones in issuing their own debt or equity securities as a way of raising funds, rather than by borrowing from banks, investment bankers say. That also has boosted demand for investment banking services and made it economical to station investment bankers closer to clients.

Many Wall Street firms are seeing such a demand for their services that having Los Angeles offices is necessary to handle the workload. Salomon Bros., which helped pioneer the business of packaging credit card loans, car loans and other bank assets into marketable securities for sale to investors, has made this business a major activity of its Los Angeles office, said Richard J. Barrett, Salomon Bros.’ senior officer in Los Angeles. The office now works with nearly every major California banking institution, he said.

However, the growth of investment banking in Los Angeles has its costs. The market has become more competitive, with the result that some California-based firms are losing customers and market share.

“We’re now scrambling with the Merrill Lynches of the world for business that they used to give to us,” said Bruce C. Juell, manager of corporate finance at Los Angeles-based Bateman Eichler, Hill Richards. Bateman Eichler lost business to New York invaders in the early 1980s, a factor behind the financial losses that preceded its takeover in 1982 by Kemper Corp., Juell said.

Richard B. Dixon, treasurer of Los Angeles County, the nation’s largest issuer of municipal securities among counties, said that 10 years ago, Bank of America had the California public finance business as its “private preserve.” (Banks, although not permitted by law to underwrite corporate securities, may underwrite certain municipal bonds.) But, since then, Wall Street firms have taken away much of B of A’s dominance, Dixon said.

May Cause Shakeout

This increased competition in public finance, Dixon said, could result in a shakeout, particularly if proposals are passed in the Senate-House tax reform package that would limit the tax-exempt status of many types of municipal bonds. Also, tax reform and other factors could prompt many municipalities to join forces in issuing bonds, Dixon said, and that could reduce the number of investment bankers needed to service such issues.

“I’m not sure there’s enough room for all the competition we see out here,” Dixon said.

Others, however, say that there is more than enough business to go around and that tax reform will increase the demand for investment bankers to develop new methods of public financing.

“The volume is so amazing that there’s a lot of room for a lot of people,” said John Landers, head of West Coast municipal finance for Paine Webber.

To be sure, Wall Street firms are not total newcomers to the Los Angeles area. Several New York-based firms have had sales offices here for decades to buy and sell stocks, bonds and other securities. Such operations required being close to customers.

But, for the most part, these firms’ investment banking activities for decades remained centralized in New York. They kept their investment bankers in one place because the field was so specialized and required such large commitments of capital.

“There was a philosophy on Wall Street that New York was the mecca and everything had to originate out of there to get the economies of size,” said Richard E. Waldron, regional managing director of First Boston’s Los Angeles office.

Some firms, however, opened West Coast investment banking operations in the 1970s but put them primarily in San Francisco, long regarded as the chief banking center on the West Coast, given its role as headquarters of B of A, then the nation’s largest bank. Mergers or underwritings in Southern California were often handled by investment bankers flown in from New York or San Francisco, or were simply given to smaller regional firms.

Base Has Shifted

But developments over the past decade have made it more profitable for New York firms to base investment banking professionals in Los Angeles.

For one, issuance of corporate and public securities in California has exploded far faster than the nation as a whole, with much of the boom centered in Southern California. Issuance of corporate stock, bonds and other taxable securities in California has nearly quadrupled since 1981, growing to $24.3 billion in 1985 from $6.4 billion, according to Securities Data Corp., a New York research firm. Nationally, growth has tripled.

Growth in California public finance has been even more dramatic. The value of new issues of long-term tax-exempt municipal bonds in California increased nearly 10-fold between 1981 and 1985, to $25.6 billion from only $2.8 billion in 1981, according to the Public Securities Assn., a trade group. Nationally, the increase has only been about fivefold.

With such growth, “you cannot afford not to be (in Los Angeles),” Lee K. Barba, manager of municipal securities at Paine Webber in New York, said.

One reason for California’s faster recent growth is the increasing presence of investment bankers here, experts say. These investment bankers helped California local governments develop newer and more creative types of bonds to fund hospitals, energy projects, public housing and industrial development--the kind of project that generates revenue that helps to pay off the bonds. Local governments in the East had developed these types of bonds sooner, partly because of their greater access to investment bankers.

Proposition 13 has generally not spurred growth in municipal bonds here, experts say. The 1978 measure, which restricted local governments’ taxing powers, may have discouraged them from issuing more traditional types of bonds used to finance highways, sewers and other projects largely dependent on tax revenue.

More Asian Investment

Another spur to Los Angeles investment bankers has been the increasing investment in Southern California by investors from Japan, Hong Kong and elsewhere in Asia, who have traditionally favored investing in the San Francisco area, said Marshall S. Geller, resident managing director of the Los Angeles office of Bear, Stearns.

Geller cited one client, a Hong Kong investment group that recently acquired a 7% stake in Angeles Corp., a Los Angeles investment management company. “It was their first look at the Los Angeles market,” Geller said of the Hong Kong group, adding that until now, many Chinese investors have preferred the San Francisco Bay Area “because they know it. Someone in their family probably lived there.”

Los Angeles also is benefiting from the need for investment bankers to be closer to their clients. That need to be closer has become crucial in the public finance market, where smaller cities are becoming increasingly involved in bond issuance. New York investment bankers, knowing little about such cities, are not likely to get their business.

“They (New Yorkers) think Palo Alto’s down around L.A. or somewhere, or Pasadena is up around San Francisco,” First Boston’s Waldron said.

The packaging of tax-exempt bonds also is becoming increasingly complex, requiring local attention, investment bankers say. Bear, Stearns’ Geller cited his firm’s recent role as lead underwriter of a $66-million bond offering in June by the California Public Works Board to fund energy efficiency projects for six different state agencies. “You have to have someone on the local scene to deal with all these agencies,” Geller said.

The need to be closer--and to move lightning quick--also is increasingly crucial in mergers and acquisitions.

Location Landed Job

Waldron said local persistence was a key factor in his firm winning the role of sole financial adviser to Calabasas-based Lockheed in its recent $1.2-billion takeover bid for Sanders Associates, a defense electronics firm. Goldman, Sachs has been Lockheed’s primary investment banker for years, Waldron said, but First Boston officials in Los Angeles had been calling Lockheed officials for two or three years hoping to win some business.

Finally, in July, when Sanders needed a “white knight” to save it from a hostile bid by Loral Corp., First Boston officials called Lockheed officials again to offer ideas on a possible takeover. This time it worked.

“That’s the perfect example of the importance of having investment bankers on the spot,” Waldron said. “We didn’t have any other relationship with Lockheed other than the people in our Los Angeles office.”

Such deals--and the lucrative fees from them--are spurring additional growth here by many of the Wall Street firms. For example, First Boston, which already has doubled its investment banking professional staff in Los Angeles to 25 in the last year alone, plans to double it again in the next year or so as it adds public finance and mortgage finance operations, Waldron said.

Perhaps the fastest and most impressive growth here has been by Drexel Burnham Lambert. Its Beverly Hills office now has 60 investment bankers in corporate finance alone, up from only three at the beginning of 1983, said John H. Kissick, the firm’s managing director in charge of West Coast corporate finance.

Self-Sufficient Office

Unlike most other Los Angeles-area investment banking offices of New York-based firms, Drexel’s Beverly Hills office is virtually self-sufficient, capable of doing its work with little supervision from New York, Kissick said. That office has done nearly $22 billion in corporate financings since 1983--for such clients as Occidental Petroleum, Ted Turner and Wickes--far more than any other Los Angeles corporate finance office, he boasted.

Aiding Drexel’s local growth in corporate finance is its office’s tie-in with the firm’s giant Beverly Hills-based securities trading operations run by Michael Milken, leading guru of high-yield “junk” bonds.

The growth and financial clout of the Wall Street giants worries many of the California-based regional firms, which lack the capital resources and nationwide connections to bid on many larger deals. But the regional firms say they have some advantages that can help them to survive against the New York behemoths.

Some have developed specialties. San Francisco-based Hambrecht & Quist, for example, has made a name for itself managing initial public offerings of high-tech firms.

Some regional firms also are in demand because of their California retail client bases. Issuers of municipal bonds, for example, often want their securities distributed to as many retail buyers as possible--as opposed to pension funds, insurance companies and other institutions--because retail buyers will usually accept a lower interest rate on the bonds and are more likely to hold on to them, Los Angeles County Treasurer Dixon said.

For example, Bateman Eichler, with its extensive local retail network, won a role as a participating underwriter in a recent $708-million bond offering for the Los Angeles Metro Rail project. Winning such a role on a large project was seen by some public finance officials as a major coup for Bateman Eichler, given that it only recently entered the public finance business.

But perhaps more than anything else, local firms say they can survive by offering more personalized service. “We can be better at local hand-holding than the New York firms,” Bateman Eichler’s Juell said.

ISSUANCE OF LONG-TERM MUNICIPAL BONDS Billions of dollars

California U.S. 1981 2.8 47.9 1982 6.4 79.1 1983 9.6 86.6 1984 15.6 108.0 1985 25.6 222.2 1986 (first 8.7 69.5 seven mos.)

Source: Public Securities Assn. ISSUANCE OF CORPORATE STOCKS, BONDS AND OTHER TAXABLE SECURITIES Billions of dollars

California U.S. 1981 6.4 64.5 1982 9.0 78.1 1983 14.2 106.7 1984 15.9 132.4 1985 24.3 168.3 1986 20.4 160.5 (first half)

Source: Securities Data Corp.