Wall Street's Winding Road

• James Detar
• On 5:47 pm EDT, Friday October 30, 2009

Investment banks rode out the recent financial storm along with the rest of the banking industry.

But a year after the collapse of Lehman Bros. -- a fall that threatened to take the entire industry down with it -- analysts say the destructive winds finally seem to be dying down.

Still, investment bankers say it'll take time for things to settle down completely.

"You have had such wealth destruction and confusion in our market," said Johnathan Merriman, cofounder and chief executive of Merriman Curhan Ford (NasdaqCM:MERR - News), a boutique investment bank in San Francisco. "And there is negative perception toward investment banks. I think the whole investment banking picture has to settle out."

When the stock market turned up in March, services offered by investment bankers were in demand again. As a result, says Sean O'Connor, chief executive of International Assets Holding (NasdaqGM:IAAC - News), things are looking up.

"It appears the worst of the financial crisis is now behind us with the situation perhaps stabilizing," he said in a recent conference call highlighting the company's earnings. "The markets have started to become more rational."

As of Friday, the Investment Banking group ranked No. 38 among IBD's 197 Industry Groups, up from No. 85 six months ago.

1. Business

Investment banks help clients raise capital and advise them on financial matters.

They manage mergers and acquisitions, and advise companies on acquisitions and investment matters. They also advise on and assist clients with issuing stocks and bonds.

Investment banks don't usually hold deposits for clients. Nor do they engage in checking and other consumer services performed by full-service banks like Bank of America (NYSE:BAC - News) and Citigroup (NYSE:C - News).

Credit Suisse (NYSE:CS - News) is the biggest bank in IBD's Finance-Investment Brokers group, with annual sales above $41 billion.

The group also includes other large financial services firms that engage in investment banking. Among them: Jefferies Group (NYSE:JEF - News), Charles Schwab (NasdaqGS:SCHW - News) and Japan's Nomura Holdings (NYSE:NMR - News), which along with Barclays (NYSE:BCS - News) scooped up most of Lehman's assets.

It also takes in boutique banks like Merriman, which has annual sales of just $35 million. Jonathan Merriman says his mission "is to be the leading researcher/trader/financier of companies under $1 billion in market cap."

He admits giants like Credit Suisse have had an advantage this past year.

"When you get into a crisis period, people tend to run toward liquidity," he said. "And that's not in small companies."

Still, he says boutiques can differentiate themselves by offering top-notch service to clients.

Name Of The Game: Recruit brokers who know their markets and specialists who can provide expert advice to clients. If you're a small boutique bank, provide great service. If you're a global investment bank, provide a broad array of services at the best prices.

2. Market

Companies of all stripes use the services of investment banks when they want to invest in stocks and bonds, buy another company or sell.

Banks serve clients in the U.S. and abroad. China, the world's third largest economy behind the U.S. and Japan, continues its explosive growth, posting an 8.9% pop in gross domestic product last quarter.

Startups there and in other hot emerging markets like India and Eastern Europe are going public. Larger companies are trying to sort out financial issues to compete in global markets. Both trends open the door for investment banks.

Raymond James Financial (NYSE:RJF - News), a midsize bank with annual revenue of $2.6 billion, is targeting emerging markets. Frederick Lane, the firm's vice chairman of investment banking, says he's "absolutely certain" his company will grow in emerging markets.

"We do business in China and in Europe," Lane said. "At this point 14 time, it's not focused on investment banking but more on researching investment ideas for clients there.

"Honestly, given the structural chaos we see in the U.S. investment market, we think there's a lot of low-hanging fruit right here."

3. Climate

The industry has changed in several key ways. Lehman Bros., one of Wall Street's former giants, no longer exists. The U.S. government owns stakes in several big banks. And the industry employs far fewer people than it did last year.

Last year's near-collapse and scandals such as Bernie Madoff's massive Ponzi scheme left people more suspicious of banks and bankers. That has led to new legislation and policy changes aimed at reining in excessive risk taking.

Policymakers are looking to clamp down on executive pay, regulate exotic investments and ban certain kinds of equities trading.

Banking has been turned on its head, said Richard Ketchum, CEO of the Financial Industry Regulatory Authority, a nongovernment agency sanctioned by the Securities & Exchange Commission to oversee the industry.

Speaking to bankers Oct. 27 in New York, he said basic strategies long used by banks "have been trashed, or at least subject to complete rethinking."

Ketchum says Finra is working to help members rethink what they do.

4. Technology

Investment banks constantly adopt new technology to help clients. But they often do so more slowly than other industries to ensure the technology is safe and reliable.

"Our industry is a little hidebound and cautious in terms of technology adoption," said Raymond James' Lane. "Part of it is that it is expensive" to invest in new technology.

Still, Lane says his company is moving to new management software to leverage its customer database.

"One important thing we're doing is using databases to share knowledge, to cooperate," he said.

He says the company is just doing this internally for now. But it plans to open up its database and management tools to customers and partners.

Finra's Ketchum says that some new technologies pose challenges. For example, when bankers and clients communicate via social networking sites like Facebook, the site may erase their exchange before they can make a record of it as required by law.

Finra has formed a Social Networking Task Force to explore this and other issues created by new technology.

5. Outlook

Investment bankers are seeing more opportunities as the markets begin to rebound.

"Clearly, since the market turned, the capital markets' operating environment has been consistently improving," said Devin Ryan, an associate director with Sandler O'Neill. "Liquidity has started to come back into the system. Going forward, I see competition in the investment banking sector starting to pick up."

The total value of stock that banks underwrote in the third quarter rose to about $225 billion, nearly doubling the year-ago figure, according to an Oct. 12 report by the financial services firm.

The merger-and-acquisitions sector is thawing as well, albeit more slowly. Mergers and acquisitions "remained lackluster" the report said. But M&A volume "has recently begun to show signs of life," the report noted.

The biggest issue for banks is how best to help companies get their financial houses in order after the chaos of the recession, says Raymond James' Lane.

Companies not able to pay principal or interest -- or both -- on a loan come to investment banks to help them restructure debt. That's actually good news for Raymond James' 20-person restructuring unit and similar units of other financial firms.

"A lot of companies are overleveraged," Lane said. "In absence of strong economic rebound, which I think unlikely, the restructuring will continue."

Upside: Fast global economic recovery could spur faster-than-expected growth in the investment banking services sector.

Risks: Some economists fear the possibility of a "double dip" recession. Analysts also worry that the commercial real-estate sector could slide further, holding the recovery in check.

Buzz up!