Abigail with attitude
"Stay close to the shore." It’s a sophisticated phrase that I’ve always considered full of pregnant implications but never properly understood. Recently a friend explained: "It’s short for stick to things you know or where you have an edge."
After a terrible August when many financial titans were reduced to the status of tadpoles, staying close to the shore has a reassuring resonance rather than appearing to be the slogan for wimps who have no sense of adventure. Watching the share price of big financial institutions wilt like plump spinach leaves in a boiling cauldron was unnerving.
When a share price lurches lower, you always ask yourself: is this cheap or does someone know something I don’t know? In mid-August, the well-run and conservative bank HSBC hovered near the £5 mark – a level that it last traded at in July 2009.
Market participants were mesmerized by the gyrations in Bank of America’s share price. In the month from July 21, it crumpled from around the $10.20 level to an intra-day low of $6. By putting money into one of the largest banks in the US, an investor would have suffered an evisceration of 40% of their capital.
Of course, the problems at Bank of America would never have occurred had Ken Lewis, the former chief executive, stayed close to the shore. Ken had a vision: he wanted to create the biggest financial services group in the US. During his 40-year career at Bank of America and its predecessor organizations, Ken helped to create a finely honed acquisition machine.
But his success sowed the seeds of his downfall. As the US sub-prime housing market started to collapse in 2008, Ken rode to the rescue and purchased Countrywide, one of America’s largest mortgage lenders. Sources murmur that Ken surrounded himself with acquiescent acolytes and did not tolerate dissent. That is a shame because Lewis is now unloved and his legacy is tarnished.
I don’t feel sorry for Ken but I feel a twinge of sympathy for his successor, Brian Moynihan. Much has been made of the fact that Moynihan got the top job by default: no one else wanted it enough. And there is almost an endearing naivety about Brian.
When I met him in mid-2010 he reproached me for being overly pessimistic. He was certain that Bank of America was moving forward and that the strength of the US economy would propel those gains. It is true that I see dragons lurking behind every bush but Brian might have done well to look for a few dragons himself. This summer, as investors decided that the welter of mortgage litigation and liabilities facing the bank were unquantifiable, they fled from the stock.
And Moynihan has done himself no favours by appearing to vacillate. Initially the bank insisted that it had no need for additional capital. But then beefy Brian performed an unseemly pirouette and tumbled into the arms of uncle Warren. Bank of America undertook a $5 billion fund raising with Berkshire Hathaway. This deal has been criticized as being overly generous to Berkshire shareholders. A few days later, Moynihan sold roughly half of Bank of America’s stake in China Construction Bank and thus increased his bank’s capital ratios. (see Bank capital: BofA sells CCB stake, takes Buffett’s cash, Euromoney, September 2011)
The muttering has started. One source grumbled: "Moynihan’s star is waning." This view might be ill conceived. It’s not easy to find bank chief-executives-in-waiting these days. There’s a paucity of talent at the top, especially in the more pedestrian ranks of commercial bankers.
Anyway, we might be looking at the Bank of America conundrum from the wrong direction. Perhaps it’s not Moynihan who lacks the required skills. Perhaps the bank is too big to manage. Why in an era when regulators were paranoid about "too big to fail" did they permit the creation of a multi-headed hydra like Bank of America that employs over 250,000 people globally?
Amid all the fuss about Moynihan’s manoeuvrings, did anyone notice that over at Bank of New York Mellon the chief executive, Robert Kelly, exited the stage? In a bizarre development, it was revealed that Kelly, once hailed as a straight shooter who could do no wrong, had abruptly resigned "due to differences in approach to managing the company".
The fact that Kelly could depart so precipitously when most commentators thought the ship was sailing smoothly is a testament to keeping a low profile. One now has to assume that BNY is a mess. I take no comfort from the fact that Gerald Hassell, president and long-serving board member, was immediately anointed chief executive.
Bank of New York merged with Mellon Financial in 2007. There have been whispers that the integration was uneasy and, perhaps symptomatic of this, rival computer platforms are said to have operated until recently. Before the merger Kelly was Mellon’s chief. Hassell, however, had a senior role at Bank of New York, having been named president of the company in 1998. Perhaps fiefdoms persist within the new empire?
It is often said that Moynihan won the top job at Bank of America because he was favoured by the "Boston mafia" within the bank. This refers to the board members who once worked at Fleet Bank, which Bank of America acquired in 2004. That might be true. I find it intensely ironic that before Moynihan’s appointment in December 2009, Kelly was one of the external candidates rumoured to be in discussions with the board about succeeding Ken Lewis. Wall Street is a small place. However, less than two years’ later, I doubt Kelly’s name would be in the frame to succeed Moynihan.
Market histrionics and rioting hooligans are an indigestible combination. The August riots in London were an unwelcome backdrop to the bungee-jumping stock markets. I was intrigued by commentators’ attempts to link the two. "There’s still a lot of rage against the banks," one talking head expounded. "That’s why today’s disaffected youth are on the rampage." This is nonsense. The looters were greedy criminals who realized the police had lost control of the situation. We’re talking "yobbo summer" rather than "Arab spring".
The YouTube video of a Malaysian student mugged by thugs posing as good Samaritans has gone viral. Ashraf Haziq won a scholarship to study accountancy in London. While cycling to a friend’s house to break the Ramadan fast, he was attacked by rioters who stole his bicycle. As he lay bleeding, other youths helped him to his feet and then robbed him. The story contrasts Haziq’s quest for education and his religious values with the amorality of his attackers. The bigger issue, however, is the gaping hole between the comfortable majority and a disenfranchised minority who are largely illiterate and have no hope of employment. As one commentator puts it: "Whereas we go from school to university, they go from school to prison."
The turmoil on international markets and the pressure that is being exerted for governments to cut spending can only lead to more social unrest in the developed economies. Meanwhile, markets abruptly came round to the Abigail with attitude viewpoint and saw that things were bad on many different fronts. The fact that Bank of America’s share price swooned 20% in one day in early August is eerily reminiscent of the dark days of 2008.
In April, my colleague, Peter Lee, wrote a great article called "Banking isn’t working". The thrust of his piece is that in an era of higher capital requirements and lower leverage, banks might not be able to earn a return on equity that is higher than their cost of capital. One quote from an unnamed banker sums up the dilemma: "When [banks] are borrowing three-year money at 150 basis points over and lending it out for five years at 40bp over to corporates with similar credit ratings to their own, then banking has simply stopped making sense."
Many senior bankers are deluded. They somehow believe that although the world has changed, their life has not. Perhaps this is because for those who kept their jobs and didn’t have too much invested in bank shares, the standard of living has remained the same: cosseted and gilded.
For years, I have wondered how long the hefty pay structure in investment banking can continue. Surely compensation compression looms? I was one of the first journalists to point out that increasing base salaries in an attempt to lessen the pain of lower bonuses was foolhardy. I was also one of the first to highlight that there would be banking lay-offs this year. Investment banking is an oligopoly. There is no justification for compensation levels where 50% of revenues go to pay employees while investors receive negligible dividends. However, if the bosses squeeze the pay of the lower ranks, their own pay levels will be questioned. Would you ask the inmates to act as the wardens in a prison system?
Second-quarter bank profits released in late July and early August were patchy, with some surprises. I don’t want to drone on about events in the rear-view mirror – but some nuggets caught my eye.
The most startling was the disappointing results from Goldman Sachs. The firm reported lower than expected earnings of $1.1 billion and announced 1,000 job cuts. Goldman attributed this underperformance to a reduction in market risk. FICC revenues were down 53% year on year, at $1.6 billion, although revenues in the investment banking and equities divisions rose. The quarterly return on equity was a measly 6%, yet 44% of revenues were set aside for employee compensation.
What will we see in Goldman’s third-quarter results? We now know that low risk was the way you wanted to be positioned for the tempests of July and August when the US markets fell nearly 20% in three weeks.
Goldman is no longer the pristine prince it was a few years ago. Its star has sunk dramatically, not faded gracefully. A recent article in New York magazine reveals that Lloyd Blankfein, Goldman’s chief executive, is an introvert with a wry sense of humour, bemused by the public’s antipathy towards his firm’s "vampire squid" reputation.
Morgan Stanley’s reputation might be on the up however. The firm produced a good set of results even though it announced a loss because its largest investor, Mitsubishi UFJ Financial, converted its preferred stock to common stock.
Total revenue rose 16% to $9.3 billion, year on year, while revenue also climbed in the institutional securities business, which produced a creditable profit of $1.46 billion.
Chief executive James Gorman is battling to reinvent Morgan Stanley as a turbo-charged Rolls-Royce with resilient trading revenues and a market-leading wealth management business. A source muses mysteriously: "Gorman will either be the last CEO of Morgan Stanley as we know it or a great hero."
He may be doing a good job but the overall environment is tough. On the day of the firm’s second-quarter profits announcement, the share price rallied some 11% to close above $25. The bounce didn’t last long. By early September, the stock was languishing below $16.
Another bank where investors must be keeping a wary eye on the stock price is Credit Suisse. In my July column, I wrote that the Credit Suisse share price was wasting away, heading towards its crisis low of SFr24.
My gloom proved timely. During the second week of August, that low was breached. Sources whisper that the low share price is affecting morale at the Swiss bank. I am unclear why investors have lost faith although, given the strength of the Swiss franc, foreign investors have a layer of protection.
It might be that for a while the shares were simply too highly valued on price-to-book, so they have had to slither into line with their peers. Credit Suisse shares today trade at roughly 1.2 times tangible book value – better than many other European banks.
In 2009, Credit Suisse adopted a more client-driven approach in its investment bank, lessening its dependence on proprietary trading. This does not seem to have paid off; results from the investment bank were weak.
Net income was down by 31%, year on year, to SFr231 million ($291 million), and the investment bank’s cost-to-income ratio was terrible at 90%. Credit Suisse is promising SFr1 billion of cost reductions and a 4% headcount cull.
Credit Suisse’s chief executive, Brady Dougan, needs to prove he has the right strategy in place for this new era. Otherwise the words of a mole might be correct: "Dougan won the war of the 2008 financial crisis, but he might lose the peace." I have a premonition that equity markets could get much worse next year. Will bank investors continue to accept their role as second-class citizens for much longer?
I suspect that now might be a shape-up-or-ship-out moment for bank chief executives. They need to cut investment banking compensation savagely. I don’t want to see meagre reductions that amount to little more than a fat man trying to lose weight by cutting his toenails.
Amid all this uncertainty, it’s nice to welcome back Charlie Berman to a new seat at Barclays Capital. Berman is one of the original debt buccaneers who came to prominence in the heyday of the Eurobond market in the early 1990s. Berman was at Salomon Brothers for many years and then Citi. He was always associated with the sovereign, supranational and agency sector.
Berman left Citi in 2009 during the dark months after the financial crisis. He quickly reinvented himself as an entrepreneur when he founded with a former colleague, Jeremy Amias, Amias Berman, an independent, fixed-income agency broker.
I was intrigued to learn that Marex Financial recently took a stake in Amias Berman, and Amias will head Marex’s operations in Asia. Marex is owned by the JRJ group, which was founded by former senior Lehman bankers Jeremy Isaacs and Roger Nagioff.
Anyway, Berman, despite having his name over the door at Amias Berman, feels that now is the right time to return to his roots. So in early September, he joined Barclays Capital to run the public-sector team within the bank’s EMEA global finance group.
Berman will report to Barclays’ senior bankers, Richard Boath and Jim Glascott. I wish Berman success in his new role. One thing is certain: he will be at the centre of the action over the next 12 months as international markets remain fixated on the fate of overly indebted European sovereigns.
How was your month? Please send news and views to Abigail@euromoney.com