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Banking

Richard Fuld interview: Can Lehman grow and still succeed?

When all around its rivals are spinning off businesses, Lehman Brothers is sticking to a strategy of acquiring rather than relying purely on organic growth. CEO Richard Fuld has exceptional backing inside the firm for this approach. But can the openness and mutual cooperativeness of his managers survive more expansion? Fuld spoke to Euromoney's Antony Currie about Lehman's future.

Awards for excellence - Best investment bank | Awards for excellence - Best credit derivatives house

WHAT DOES LEHMAN Brothers do next? In the 11 years since it split off from American Express the US investment bank has confounded all of its critics to build a top-tier franchise in equities and M&A. More recently the firm, run by CEO Richard Fuld since 1993, has sought to diversify its revenues by expanding into asset management, buying Neuberger Berman in 2003 and a stake in hedge fund Ospraie this year. Fuld is hoping to add more hedge fund stakes in the coming months.

But Fuld wants his firm to achieve much more. "What we focus on in the executive committee is increasing our revenues from around $12 billion to $15 billion or $20 billion," he says. Pointing out that such gains won't come from incremental increases from the business lines he already has, Fuld states that "we are in a position to make a strong acquisition".

What exactly that is he won't say, although he leaves enough clues. "The big meaty stuff for increasing our revenues comes, for example, in building the asset management business," he says. Or it could involve buying a finance company. "It's no secret that we wanted to buy CIT three years ago," he says. "Finance companies are a possibility for us."

It's not just revenues that he wants to increase, but the variety of businesses, in stark contrast to some of his larger competitors, which have started to spin off or consider spinning off less attractive businesses.

There are many who are still concerned that Lehman lacks diversity in its investment-banking products. "Around 60% of revenues comes from the fixed-income business," says one investor. "That's more than Bear Stearns' 50% and Merrill Lynch's 25%." In the second quarter this year just over 63% of revenues came from fixed income.

Implicit in such concerns is a fear that Lehman is more prone to suffer when the debt markets perform poorly. But, as the bank's second-quarter results show, the fixed-income business is one of the strongest and most diversified on the Street, which, combined with the bank's more conservative approach to risk management, helped it to report solid second-quarter earnings in the face of severe dislocation in the markets. Trading results were still down, but not to the extent they were at peers such as Goldman Sachs, JPMorgan and Morgan Stanley that either reported or warned of a significant drop in earnings.

But observers reckon that Lehman has taken a good deal of care with its correlation modelling, and hedged its exposures effectively whether in debt, mezzanine or equity tranches. The downside is the firm earns less in the good times but when events such as May's GM/Ford-related tumult hit, the firm suffers less.

It is this kind of performance that has given Lehman what every investment bank craves: the respect, and envy, of its peers. In the US, CEOs and heads of business at rival firms talk with a mix of awe and grudging respect about what Lehman has achieved under the leadership of Fuld. Some even admit, quietly, to using Lehman as their benchmark when making business presentations to both their bosses and their staff.

It's the result of 11 years' hard work, capped by the bank's performance in the past five years. Throughout the downturn and slow recovery Lehman has consistently delivered results that match or beat the competition. At the same time the firm has managed to invest, successfully, in its equities and mergers and advisory businesses, while others were cutting back, to the point where bankers in both divisions can now rightly claim, in the US if not in Europe as well, that they are now members of the investment banking industry's top tier.

The firm even seems to be devoid of debilitating political battles at the top. Fuld is, without question, in charge. And, according to him, there is no battle to be his successor; Fuld and the board have already chosen Joe Gregory, Lehman's president and COO. Fuld says: "I'm not going anywhere soon, but everyone knows that Joe is the number two man."

But Fuld also instils in his staff a sense that they have as much responsibility for how the firm runs, especially from a risk perspective, as he does: "I expect everyone at the firm to be a risk manager," says Fuld. As for the roles of those on the executive committee: "All 12 of us are focused on all parts of the business. It's all about risk management. If it's just me, then we're in trouble."

Could Lehman put its success in jeopardy by making a sizeable acquisition? It's possible – most of the firm's peers have found digesting acquisitions to be much harder than they expected. And Lehman's culture is one that was born and nurtured in an institution of modest size. Now the bank has 20,000 employees, a small fraction of a Citigroup or JPMorgan but a large increase on the 9,100 when the firm went public in 1994. Some 8,000 of today's total have been added since 2002, many as a result of the acquisition of several mortgage origination platforms and Neuberger Berman.

But it makes Lehman a very different place to manage. Part of the investment bank's strength and appeal came from its being sufficiently small to enable bankers from each division to know colleagues in the others. That has been the case all the way up to the heads of business, who often seem to know as much about what their sister divisions are doing as they do of their own. It's much easier to create a homogenous culture in that kind of environment.

Fuld will be hoping that what has worked in the past will continue to work in the future. And what made it work, he says, is hardly rocket science. "I wish I could tell you there was some magical mix," he says. "It was just straightforward sticking to the plan. And keeping the senior team together was crucial."

There are very few bank executives who can honestly say that.

Earlier this year, after months of rumours that you would increase your 20% stake in London-based hedge fund GLG you bought Ospraie. What's the thinking behind that acquisition?

Simply that we want to increase our asset management business, and our ability to offer clients alternative assets is part of that.

Since the rumours went on for months about your buying a hedge fund, should we assume it was no easy task?

Before making a strategic investment in any company we do a ton of due diligence work. We're focused on strategic fit, price and, importantly, cultural fit. We don't go in with our money until we are happy with management, and are comfortable that they have the same view on risk management as we do. You tried to buy CIT, a US finance company, three years ago before it was spun out of Tyco. Are you still interested in that kind of business?

We are always looking at opportunities which would increase shareholder value but, at the same time, it must be the right cultural fit.  Finance companies and parts of the insurance market are possibilities for us as a complement to our capital markets securitization business expertise.

You've made a great deal of progress diversifying away from fixed income. But you still earn a large amount from these products, to the tune of 63% of revenues in the second quarter. If and when the credit markets cease to be the drivers of investment banking, will you lose out?

Well, look at the first two quarters. Both were tough, yet we performed well. The problem is that so many in the markets believe that an environment of increasing interest rates must lead to a drop in fixed-income revenues.  Our business is much more about day-to-day customer flow and less about proprietary trading and large carry positions.

Why, back when you started as a newly independent company in 1994, did you want to build equities and M&A, though? Was there anything wrong with being just a fixed-income house?

That's a good question. It would have been a very easy route for us to take, as most of us had grown up in the fixed-income business.

We simply felt that we could build a great business here. It was just straightforward sticking to a plan. And keeping the senior team together was crucial.

It's all about building a good, consistent platform, initially in fixed income, equities and investment banking, and more recently in investment management. To oversimplify, we can look at each box as a client, and for each box there are a dozen or so services and products we can deliver.  

Mortgages is one of the businesses that has served you well in recent years. You were already a large underwriter of mortgage-backed securities, but in the last couple of years you've bought mortgage origination platforms and now 55% of your MBS deals come from your own mortgage platform. What's the thinking behind that?

Adding mortgage origination capabilities creates a fully vertically integrated business for us. It gives us a captive source for generating mortgage loans, and allows us to capture additional fees. It also puts in our own hands the quality control of ensuring that loans are underwritten to the appropriate standards.

You've built your business outside of the US to stand at about 40% of revenues. But there are a few countries where your presence is less than it might be. One is Japan, where there's been some furore surrounding your acting as financier to Livedoor, a Japanese company pursuing hostile takeovers.

Yes, Japan is a country where we changed our strategy. We concentrated on distressed Japanese assets in 1997. And then we switched the business to being more focused on corporates three year ago. Our role with Livedoor has been interesting. As a result, we are getting calls from companies we have not spoken with for 20 years. They are saying to us "you're so creative, we want to have you by our side".

Russia and China are two other countries where you are less visible than your competitors, China in part because of the legal disputes with Unipec and Minmetals in the early 1990s.

It's all a matter of value versus risk. We've long since resolved the dispute in China, and are looking for opportunities there. China is overbanked at present, and what they need is not more balance sheet but expertise. Russia is another matter. It is a country in which we feel we do not have enough local expertise at this time to deliver the firm to our clients.

An interesting place you haven't mentioned is India. We opened a new office in Mumbai. Our presence in India enables us to expand our operating capacity to serve our clients as we continue to grow.

You've said in the past that to be a player in M&A takes at least five years of building relationships before you reap much benefit. Where do you stand now?

"Joe Gregory is the president
and chief operating officer
and he runs the firm day to
day. The two of us talk 20 or
more times a day.  I'm not
going anywhere anytime
soon but everyone knows
Joe is the number two man"

We're doing well, as our results show. We've improved our market share, and are getting involved in more and more of the high-profile deals. The philosophy is quite simple, there's no magic to it. First, you need to have the capability so that you can deliver what you promise.

Second, you have to have the right people in place to give the advice.

Third, you have to be consistent and accept accountability.

Fourth, you have to reward those people when they do a good job.

So what is it that will define success for you in M&A?

I think that if we are consistently in the top five in the league tables, that's just fine. But let's be careful with this M&A metric. What we concern ourselves with is how to drive this business going forward. If we did another 20 deals at $10 million in fees each, that's going to help push our revenues up from $11.6 billion a year to $11.8 billion. But it's not going to push revenues up to $15 billion or $20 billion. And that is what the executive committee focuses on.

It's not a matter of increasing the business lines between 5% and 7%. It's having managers in the businesses working out how to double revenues in the next five years.

We've just had our mid-year business reviews. I don't want the executive committee focusing on what their revenues have been year to date. I can read that any time I like. I want them thinking about how they are going to finish the year, what they expect for the next two years, and how all of this has changed since they set their budgets at the start of the year.

So you want to be in the league table game, but also double revenues. That can be a tough call with fees dropping.

Yes, but we have a strategic approach in how we use our balance sheet.  Have the banks been competitive? . . . of course.  Do we lose some business to the banks? . . . of course.  But strangely enough, each year we have increased market share.

How does that approach fit in with expanding your equities franchise, a business that has had to deal with severe margin compression?

As you know, over the past few years, we have made a significant investment in building our equities franchise and have gained significant momentum in the business.  We've been focusing on the quality of our capabilities: sales, trading and research.  And if you look at all of the service quality awards we've won, I think you'll find we can now say we have leading capabilities throughout our equities division.  Now is the time for us to market these capabilities and really drive share.

How do you win clients over? What makes them switch to Lehman?

It's about our approach to the client. When we target clients we'd better be delivering the entire firm to them. If you are only delivering one or two products to them, then you're not delivering on our strategy. So you've won a deal? Whoopededoo. I do not want our bankers simply being in the soup sniffing around for a trade. I want them to build and maintain relationships with our clients over a long period of time. I ask our clients what the five new things are that our team is talking to them about. It's all about innovative ideas and solutions.

What's your biggest concern right now?

I worry that we could get arrogant. I told this to our managing directors at a meeting in London recently. We've made some great decisions, and come a long way in 11 years. But if you get arrogant, you lose your way, and start making mistakes. And we can make enough of those on our own, without the arrogance.

That's easy to say, but difficult to avoid. What checks could you put in place?

It all stems from the philosophy of this firm: when in doubt, fall back and do what's right for the shareholders.

Also, no-one on the executive committee is allowed to wear just their own hat. All 12 of us are focused on all parts of the business. It's all about risk management. If it's just me, then we're in trouble.

David Komanksy, former CEO of Merrill Lynch, used to say that finding one's successor is one of the most important jobs a CEO has, yet few Wall Street firms have done a good job of late. Is your successor chosen?

Joe Gregory is the president and chief operating officer and he runs the firm day to day.  The two of us talk 20 or more times a day.  I'm not going anywhere anytime soon but everyone knows Joe is the number two man.

What continues to drive you professionally?

I'm having a ball. As long as I contribute and the firm wants me here, I'll stay. We like and respect each other here. Without that it's tough to get dressed in the morning. I've been here nearly 40 years; I'll always be tied to Lehman. 

Awards for excellence - Best investment bank | Awards for excellence - Best credit derivatives house

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