BTG Pactual: Esteves brings business back into banking
BTG Pactual’s CEO, André Esteves, says he used its recent IPO to lock in a spirit of entrepreneurialism at the firm. He reckons it is the key to the investment bank’s continued rise. But how far can he take the bank?
André Esteves is often asked if he has political aspirations. So often is he asked that when Euromoney is told by one of the three PRs sitting in on the meeting that the interview will end in five minutes, the idea of asking him if he has any such ambitions is dismissed as a waste of time. After all, how many billionaires have launched political careers in the pages of this magazine?
On reflection though, Esteves could make a formidable politician, and not just for his huge personal wealth, success and access to the great and good. He’s a natural politician. He’s charming, youthful and has a full head of hair. He is able to deliver stock responses in a way that makes them sound fresh, previously unspoken. He answers questions by saying what he wants to say – and no more. He reveals little and yet appears open and engaging. Even when he is encouraged to comment on controversial subjects – and he gives a pretty devastating critique of Wall Street remuneration – it feels premeditated. Some say this blend of charm and control is a product of extensive media training. But perhaps he’s simply a natural at dealing with the press, in the same way that he is undeniably gifted in building a business, making deals, making money.
The bank Esteves is building is entering a new phase. BTG Pactual went public in April this year – providing it with a new capital base that is more efficient for continual expansion. However, it also means Esteves’s management responsibilities now include overseeing quarterly results, participating on equity analyst calls as well as answering to a new stakeholder group of shareholders. If the competition were hoping this new distraction, coupled with the slowing Brazilian economy, would lead to some slowdown in results, they were to be disappointed. The bank has so far exceeded analysts’ expectations – by some margin. In the second quarter of 2012 it reported earnings of R$822 million ($402 million) – R$0.96 a share. The consensus forecast was R$0.63 a share.
The analysts following BTG Pactual are in for a hard time. For example, most of the outperformance of the latest results was in marking to market an equity pick-up of R$316 million within the bank’s principal investments’ real estate unit on its stake in BR Properties. In addition, revenue from the global markets division of the same unit benefited from profitable trades on the back of declining interest rates in Brazil and US mortgage markets. In total, principal investments revenue was R$687 million in the three months to the end of June, up 20.1% quarter on quarter and 3,022.7% year on year.
"Of course beating expectations is always good, but the challenge for us as a public company is not focused too much on the short term," says Esteves. "It’s good to deliver good results but we always told shareholders to expect a long-term high return on equity. We will have natural quarterly or yearly volatility, but in the long run we will provide very good ROE."
So far, so good. "Return on equity was a little over 30% for the first half – 30.4%." The bank doesn’t give guidance on long-term ROE targets and so Esteves avoids specific predictions but says: "It is reasonable to expect that we can provide above 20% return on equity in the coming years."
He adds: "It [will be] a fantastic return on equity and that’s because we have a significant franchise that doesn’t use capital," referring to the bank’s large asset management unit (managing over R$132 billion including the wealth management unit and monies under advisory) and the ‘pure’ investment bank. "People talk a lot about our capital investment, but the ultra-high return on equity that we have on a sustainable basis is related to the size of the fee basis that doesn’t use capital and we expect to keep this model."
As well as struggling to predict the bank’s results within a narrow band of accuracy, part of the analyst’s job is to probe for weaknesses below the headlines. The fear of upsetting the giant of Brazilian banking (who is still just 44 years old) is palpable. One analyst agreed to talk only if his comments were "strictly" off the record. And in the conversation that followed he conducted an unusual two-sided role-play, coloured by self-defeatism about the potential weaknesses he saw in BTG Pactual.
Clearly, Esteves is adroit at managing analysts too. "You could ask him about the proprietary trading [which was a source of the recent outperformance]. Even they can’t keep winning every bet, and there could be risk there," the analyst says, before continuing: "But he’ll tell you that they are not as leveraged as was the case at JPMorgan and they can extricate themselves from their positions without moving the market."
Esteves’s actual response is: "We have partners taking decisions with all of their money, or most of their money, invested in the firm – that’s the most important part of our risk management. It doesn’t mean we won’t make mistakes, we have and we will and we are not ashamed or afraid. But I guarantee we will only make mistakes we can afford."
What other issues does the analyst see? "They are number one in investment bank revenues in Brazil – and there’s only one way to go from there. Itaú and Bradesco are building fast – that could be a problem. But," he again adds without pause, "he’ll say there’s room for everyone and the whole market will grow."
In the second quarter investment banking reported R$129 million, up 158% from the very inactive first quarter and down slightly (by 2.3%) on the second quarter of 2011. Esteves says: "Of course when you have a big market share, growth depends on the market growing but when you see that the ratio of total DCM to GDP is just 15% of that in the US, there is clearly huge potential for growth. So we need to keep the leadership position and develop new products because the growth potential of the capital markets is huge."
Esteves also points to the potential to expand the banks’ leading position in ECM and M&A into DCM, as well as its expansion throughout Latin America, through its acquisition of Celfin in Chile (and with important operations in Peru) and Bolsa y Renta in Chile. The bank has also opened an office in Mexico, pursuing a greenfield strategy in the US neighbour. At the moment the target is regional domination. Possibly, he says, the world could be tomorrow.
|Andre Esteves, chief executive of Brazilian investment bank BTG Pactual|
"We have a very clear strategy to be the regional champion and we have all the tools to execute this," he says, pointing to the international distribution built in New York (office of 100), London (100) and Hong Kong (10). "There will be very few global players in the future of investment banking who compete equally with regional champions such as ourselves. Or perhaps not equally. The regional champions will be ever better positioned than the global players in their own region. It’s always possible we will move beyond [Latin America], but it would need to be a fantastic opportunity because we would assume there would be a very high opportunity cost." Any other key questions? "The new businesses add risk potentially," the analyst replied doubtfully, referring to the newly launched private equity fund for Africa and the new mining company that BTG Pactual has established in partnership with Roger Agnelli, the former chief executive of Vale. Esteves says: "We had the opportunity with Roger Agnelli and we think with China cooling down a little bit, prices are more constructive and there is less competition. The company has a great team and it’s in a core market – Latin America, which is a core player in mining and natural resources. It’s good timing, with good people in the right part of the globe."
"Panamericano?" is the analyst’s final, one-word attempt to identify a worrisome issue. Maybe he’s on to something with this one. After all, the consumer loans bank acquired in 2010 reported a loss of R$98 million in the second quarter, or -6% of revenues, following losses of R$21 million in the first quarter. "We already knew that Panamericano was a very tough turnaround. During the IPO we were very clear with investors that it would take at least one year to complete the turnaround," says Esteves. "The business environment for auto-lending wasn’t great in the first half of this year, which has delayed the turnaround a little bit, but it will take time. You need to be focused and patient – I think it will take another year to take care of Panamericano. We would like to fix Panamericano – having a consumer finance boutique would bring additional, diversified revenues".
BTG Pactual has also been rumoured to be buying troubled Banco Cruzeiro do Sul. Has the Panamericano experience soured Esteves to adding to its investment in this retail sector of banking? "We are looking at Cruzeiro do Sul as a distressed opportunity, not as a strategic transaction like Panamericano by any means. Cruzeiro is even more distressed than Panamericano was, and we are in the middle of analysing the bank under that assumption of a distressed opportunity."
The perennial accusation from the local competition is that the bank, with its very large internal private equity fund, potentially has an inherent conflict of interest with investment banking clients. Esteves denies this: "Clients, society in general and the political spectrum in Brazil are glad that we are an investment bank that invests in the real economy. We are not ashamed of that." Also, BTG’s model has been the same for many years and it has clearly not limited growth and client appeal.
It is hard to draw any other conclusion than that to date the success of BTG Pactual and Esteves is pretty much bullet-proof. It is possible that we are watching the creation of a bank that will one day join the very top tier of financial institutions.
One non-Brazilian banker, looking on from afar as the bank enters his pan-Andean home market, proffers a view that is based on recent research by John Coates, a senior research fellow in neuroscience and finance at the University of Cambridge who previously worked for Goldman Sachs and ran a trading desk for Deutsche Bank in New York.
Coates’s theory suggests that taking financial risks changes the body physically – testosterone is produced. Winners emerge with even higher levels of testosterone and this heightens their chances of winning yet again, leading to a positive feedback loop.
However, according to Coates: "At some point in this upward spiral of testosterone and victory, judgment becomes impaired. Animals with highly elevated levels of testosterone end up starting more fights, neglecting parenting duties and venturing into the open, all of which leads to increased predation. Effective risk-taking morphs into over-confidence and dangerous behaviour, and traders on a winning streak may take on positions of ever-increasing size, with ever worsening risk-reward trade-offs."
Taking the theory to its natural conclusion, the inevitable seeds of destruction are being sown at the same time success is being achieved. Esteves will take increasingly large and risky bets on new business – and within current ones. Blinded by turbo-charged confidence, the bank eventually collapses in an over-extended mess.
But sitting across from a relaxed and beaming Esteves the application of the theory (which is in any case built upon research conducted on traders) to BTG’s CEO seems misplaced. It is not meant as an insult to say that the man in the sun-bathed conference room doesn’t appear to be affected by too much testosterone. He frequently leans back in his chair, wears an open-necked shirt, and speaks in a calm and measured way.
For Esteves, risk and reward is naturally balanced by aligning the partners’ rewards with the bank’s performance and therefore with shareholders. This alignment is a crucial part of the structure of the bank’s recent IPO; the misalignment elsewhere is, according to Esteves, a huge problem for international investment banks.
But before Esteves’s critique, first the proof of how just how critical Esteves sees the need for alignment to be. The bank’s IPO had a very interesting feature. The partners’ shares were not directly part of the listed vehicle but have been placed into a holding company that is 100% owned by the partners. If partners wish to leave the bank, they cannot simply sell their shares on the open market. Partners have to sell their shares back to the partnership at book value, which will then reassign them to existing partners at book value.
"This structure was based on the difficulties that the classic partnerships – like Goldman Sachs, Morgan Stanley and Blackstone – suffered when they went public," says Esteves. "We have moved to a more sophisticated capital structure of a public company that is required for a capital-intensive business – with lower cost of funds, more transparency and better governance, which makes us more competitive. But we have kept the exact same spirit of a partnership. It doesn’t matter if our stock is trading at 2.5x book, if partners are not performing [and evaluation of performance is at the total discretion of the management committee], partners leave and sell at book. And then new partners can come in and be entrepreneurs and become very wealthy by buying at book. This brings us what I consider to be the best possible alignment of interest. We don’t have a date for vesting. We don’t have options. And we don’t have dilution. Partners can only make money by creating high return on equity for the long term. And if we do that we will provide returns for shareholders, so it is a perfect alignment of interest."
Esteves surely stretches credibility when he says that some partners were not disappointed not to be able to sell existing shares at market value, becoming hugely wealthy in the process. But the structure undoubtedly demonstrates Esteves’s shrewdness, his commitment to the long-term success of BTG Pactual, and the strength of his leadership.
And he believes these attributes are currently absent at the international firms: "For many years people on Wall Street received bonuses as if they were entrepreneurs – but they were employees," he says. "They wanted to receive compensation at levels to make them as wealthy as entrepreneurs but also wanted bonus guarantees; they move from bank to bank every few years and they take 30 days’ vacation. If you want to make a lot of money, you need to be an entrepreneur. You need to be obsessive where you invest, stay at your company for ever – not even consider changing your job. If you do that, you can make a lot of money; otherwise you should have a nice career. There is a mis-arbitrage [with bankers’ pay] – it is mispriced and you need to fix that because the shareholders are paying."
Esteves thinks bankers’ pay must fall in European and US firms as these organizations continue to fail to produce sufficient return on equity for shareholders. "It is happening. Bonuses are being reduced – gradually – and you have more strings being attached. We are moving in the right direction. We are not there yet, but it is clear that the model will be changed."
Does this feed into the culture of banking that has led to recent scandals, such as banks rigging Libor? "It’s part of the issue, yes," he replies, while making it clear he isn’t talking about the JPMorgan trading losses, which he describes as "an accident" and says the regulators need to take care not to criminalize mistakes in a risk-taking environment.
"In Brazil I am personally liable [for BTG Pactual]. My house is ready for the creditors [in the event of the organization’s failure], which is a very important statement. And we don’t have that in the US and Europe."