Abigail with attitude: No one rings a bell at the top of a market

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By:
Abigail Hofman
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Abigail's biography

Is it bonfire night or bonfire of the vanities at Credit Suisse? The Swiss bank has reported mediocre third quarter results for 2010. Group net income plunged by 74% (year over year) to SFr609 million, pre-tax profits at the investment bank were down 50% from the second quarter and group return on equity was 7%.

Last year, Credit Suisse set out a new strategy for the investment bank: focus on client flows and de-emphasise risky proprietary trading businesses. This model seemed much more in tune with the post-crisis environment.

The problem is that when client activity is low, Credit Suisse’s investment bank does not get the flows it needs and therefore returns will be limited. To make things worse, private banking, which is an excellent business for Credit Suisse and enjoyed strong net inflows of over SFr12 billion, also suffered a drop in profits quarter over quarter.

Brady Dougan, Credit Suisse’s chief executive is adamant that the bank has the right model and will outperform once market conditions improve and clients come back
Brady Dougan, Credit Suisse’s chief executive is adamant that the bank has the right model and will outperform once market conditions improve and clients come back. This has been the case for the first few weeks of the fourth quarter, so I will watch the bank’s earnings with interest. They say no one rings a bell at the top. In April, a Credit Suisse Performance Incentive Plan paid out large amounts for the group’s most senior bankers. Given my pessimistic nature, I wondered at the time if it was wise for them to accept such high pay-outs. Although the money was part of 2004 compensation, which had a lengthy five-year gestation period, I still thought that such stupendous stipends were hostages to fortune and shareholders might not forgive the bank if it stumbled. Ironically, this year’s high for Credit Suisse shares was in April, around the time the PIPs vested, and it has been downhill ever since.

Brady Dougan is the banker’s banker — he is admired and feared by his peers in equal measure. All big banks found the third quarter tough but another quarter of under-performance will be difficult to explain for Credit Suisse. It has one of the best tier one capital ratios among the global banks and pays a decent dividend. But if profitability continues to decline, I would expect shareholders to start grumbling about unjustifiable compensation costs. In the most recent quarter, Credit Suisse set aside 54% of investment banking revenues for staff compensation — that is too high. Goldman Sachs, which didn’t disappoint on earnings in the third quarter, reserved 43% of net revenues for staff.

During the summer, I met a Credit Suisse board member and I mentioned that I thought UBS would outperform Credit Suisse over the next year. The board member looked at me as if I had confessed to murder. "Of course, that won’t happen," was the fierce riposte. Complacency never pays. So far this year, Credit Suisse shares are down 21%, while UBS shares (despite bad third quarter results in the investment bank) are up 5%. I would say that is 15-Love to the Abigail with attitude column.

It would be mean to begrudge UBS its moment in the sun. After all, the larger Swiss bank has experienced a Wagnerian cycle of hubris, nemesis and rebirth in the last few years. A mole whispers an interesting titbit. Apparently, the investment bank’s senior management are wringing their hands about the higher capital requirements demanded by the Swiss National Bank. Profitability and plump pay-outs could be under threat so there are rumours that part of the investment bank may be relocated to Singapore.

This seems absurd, but it just might be true. So far the big banks have run circles round the regulatory authorities and I don’t see any reason why this game of high-stakes poker should not continue. By the way, I was intrigued to see that the co-heads of investment banking at UBS were recently torn asunder. Carsten Kengeter was promoted to sole head and Alex Wilmot-Sitwell became co-chief executive of Asia Pacific. I have always believed that appointing co-heads of key divisions was an abrogation of decision making. I congratulate the legendary Ossie Grübel, UBS’s chief executive on accentuating accountability.

Morgan Stanley reported disappointing third quarter results. Chief executive James Gorman also has co-heads of the institutional securities division: Colm Kelleher and Paul Taubman. However Greg Fleming, former co-president of Merrill Lynch, has sole responsibility for the asset management division.

Morgan Stanley's hedge funds

In October Morgan Stanley agreed to cede control of its FrontPoint Partners hedge fund unit. Morgan Stanley purchased FrontPoint four years ago. Do you remember when the good times were rolling, investment banks developed a fetish for taking stakes in hedge funds? I never saw the point of this strategy. A minority shareholding is a poisoned chalice. Surely in business (especially risk businesses), control is key?

Of course, the hedge fund community was delirious with delight. Essentially they were able to obtain an exit on hefty multiples for people businesses that would otherwise have been difficult to sell. It is said that banks always buy at the top and sell at the bottom. Banks piled into this trade in 2006 and 2007, yet 2008 was probably the worst year ever for hedge fund returns. Morgan Stanley still holds minority stakes in several other hedge funds but I wonder how long this passive partnership will continue.

I was therefore intrigued to see that as Morgan Stanley retreats, others rush in. This autumn, the respected Canadian bank, RBC gobbled up the independent fixed income manager, BlueBay Asset Management (which has a big hedge fund business) and Credit Suisse took a minority stake in the alternative asset manager, York Capital. These investments are great for the hedgies: the premium for BlueBay’s shares was 30%, which finally brought them back to pre-crash levels. But why are the bankers so keen?

The only reason I can see is that they are able to offer their private clients access to alternative asset investments where capacity is limited. However if you are Credit Suisse, one of the world’s biggest wealth managers, you should be able to gain access anyway. Another possible rationale might be growth. Banks outside the emerging markets are having a hard time of it. Essentially, with less leverage and higher capital requirements, returns will dwindle. Hedge funds are one area which might still enjoy growth. Maybe the banks want a slice of the pie, especially as they are all cutting down on proprietary trading. Isn’t a hedge fund just a prop desk in drag?

Someone who has decided to make a clean break is Pierre-Henri Flamand. Flamand, was previously head of Goldman Sachs’ Principal Strategies, a multi-billion dollar internal hedge fund. He resigned from the investment bank in early 2010 and this November will launch a new event-driven hedge fund called Edoma. Flamand is highly intelligent, thoughtful and passionate about markets. I hope his new venture does well. Edoma will be based in London. It is cheering to know that despite the best efforts of UK politicians, some people still want to do business in our capital.

Ondra's birthday

I have written several times about another group of bankers who decided to set up their own firm in London — the founding partners of Ondra. In October, it celebrated its second birthday and held a small party for those who have been closely involved with the company since its inception. I was honoured to be invited and intrigued to see several senior bankers, past and present, there. I particularly enjoyed talking to Zoe Cruz, a former co-president of Morgan Stanley who now runs a hedge fund: Voras Capital. Phil Purcell, once Morgan Stanley’s chief executive, was also in the room. I have often wondered what became of Purcell who vanquished John Mack, then president of Morgan Stanley, in a brutal battle of the elephantine egos, and was then banished himself.

Perhaps the most surreal moment of the party was a conversation between Stuart Gulliver, HSBC’s chief executive designate and Patrick Jenkins, the Financial Times journalist. Jenkins recently broke all the stories about the dysfunctional HSBC succession and obviously has several well-placed moles in the HSBC hierarchy.

"I wonder," mused Gulliver, "if we will find out who was leaking all that information to the FT?" I have a lot of respect for Gulliver who must be a good poker player. Jenkins must know the source of the leaks. But it was not clear to either Jenkins or myself if Gulliver also knows the culprit. I suspect he does and was indulging in a game of double-bluff.

Gulliver will take over as HSBC chief executive in January 2011. Inevitably, this will mean changes for the next level down. Apparently, there is much jockeying and sharp elbowed behaviour from subordinates. As part of the succession plan, it was announced that Samir Assaf and Robin Phillips will co-head the global banking and markets division. However a mole murmurs that this may not be for long and Assaf will assume the senior role in GBM before the year is out. Time will tell.

Konthal vs. Semerci

By the way, talking of jockeying for power, did you notice that the spat between former senior Merrill traders Jeff Kronthal and Osman Semerci rumbles on? This month, a new book on the financial crisis, All the devils are here, will be published. Both Vanity Fair magazine and Here is the City website published advanced extracts from the book which Bethany McLean and Joe Nocera co-authored.

I understand that lawyers acting for Semerci have demanded retractions of the text, which they claim "is a complete fabrication". I look forward to reading the book as McLean wrote the gripping account of Enron’s rise and fall — The smartest guys in the room.

However, I would have advised Bethany to treat Semerci with kid gloves. When I met him a few years ago, he had several large files documenting his time as head of FICC at Merrill Lynch. Indeed, I remember him showing me an email from former Merrill chief executive, Stan O’Neal.

I assume those files are still in Semerci’s possession and this allowed his lawyers to write: "The willingness of Vanity Fair to publish such inaccurate content reflects a concerted choice to publish a story purely for entertainment value and without regard for the truth..." As for me, I’m starting to wonder what the next financial scandal will be which will prompt us all to start scribbling books?

How was your month? Please send news and views to abigail@euromoney.com.