How investment banks shape up after crisis
By Megan Murphy, Justin Baer, Francesco Guerrera, Patrick Jenkins, Jeremy Grant, Martin Arnold and Sam Jones
In the past decade the investment banking world was hit by a virus. Known as “Goldman envy”, it prompted the likes of Morgan Stanley,Merrill Lynch and UBS – and the now-defunct Lehman Brothers and Bear Stearns – to ratchet up risks to try to replicate Goldman Sachs’ strong profit growth.
With few exceptions, the spread of Goldman envy meant that, in the boom years that preceded the financial crisis, most investment banks had similar strategies.
Lending funds to facilitate leveraged buy-outs, investing in private equity and hedge funds, selling mortgage-backed securities and trading on their own account became the favourite game plan on Wall Street.
Some $1,000bn in losses and thousands of job cuts later, that model has been exposed as a costly disaster. Along with profits and jobs, the financial crisis wiped out investment banks’ faulty strategies.
As a new era of tougher regulation, greater oversight and less accommodating markets beckon, FT writers explore the strategies adopted by the world’s largest investment banks to fit this new climate.
Goldman Sachs confident in ability to adapt
Whether it was trading securities, advising companies or placing bets with its own capital, Goldman Sachs spent much of the pre-crisis era on Wall Street a step ahead of its peers.
Those that tried to chase the bank’s strategy did so at their own peril, and often with catastrophic results – a post-mortem on any one of Wall Street’s biggest failures, including Merrill Lynch andLehman Brothers, will find traces of Goldman envy.
Thanks in part to a relentless focus on risk management and a culture that eschews individual stardom, Goldman led the industry heading into the crisis. And, as the downturn subsided in the spring of 2009, the bank went on to post record profits.
But as the industry steps gingerly into the post-crisis period, and new regulations and capital requirements threaten to crimp profits at many of the risk-taking businesses on which Goldman thrived, the bank must prove itself all over again.
The landscape has shifted just as Goldman seeks to reverse a bitter backlash against its business practices during the crisis, which culminated in July when the bank paid USD550m to settle Securities and Exchange Commission charges that it misled investors. But Lloyd Blankfein, Goldman’s chief executive, appears confident in the bank’s ability to adapt.
“We continue to see structural developments that remain unshaken,” he says. Among them, Mr Blankfein identifies the importance of technology, and the growth of capital markets throughout Asia and South America.
Mr Blankfein is betting that Goldman has not lost the edge on its peers in these growth opportunities, or others.
When given the chance last month to lower investors’ expectations for the bank’s future return on equity, which has hovered above 20 per cent for more than a decade, he passed.
Credit Suisse aims for more stable returns
Credit Suisse emerged as one of the winners of the financial crisis in part by zigging while everyone else was zagging. Led by Brady Dougan, its American-born chief executive, the Swiss group began closing its riskier proprietary trading operations and exiting complex structured products in the summer of 2007, well before many rivals, in favour of a less volatile model.
Three years on from implementing that strategy, which spared Credit Suisse from the worst ravages of the subprime mortgage market downturn, Mr Dougan remains convinced the group has the right model in place. Getting the most out of the bank’s huge footprint in private banking as well as its asset management business, Credit Suisse aims to provide more stable returns without the peaks and troughs of the typical investment banking cycle.
Whether analysts and investors are convinced is a different question. Credit Suisse’s trading revenues dipped more than some rivals this year as clients stayed on the sidelines amid fears of a full-blown sovereign debt crisis in Europe. Senior executives insist they will remain disciplined – but in a model that is focused on client flows rather than proprietary business, low volumes of activity will hit the bank’s bottom line harder than some competitors.
Credit Suisse believes, however, that after the crisis, clients will prefer a less capital-intensive, more conservative approach. Mr Dougan is aiming to deliver a consistent return on equity of about 20 per cent, with deviations between quarters but without the huge swings of past bubbles. Crucial to delivering on that target will be continuing to exploit the ties between the investment bank and Credit Suisse’s wealth management business.
The bank also needs to keep a tighter lid on costs, after adding hundreds of staff over the past year in anticipation of a stronger recovery.
JPMorgan Chase focuses on international growth
After taking advantage of the financial crisis to buy rivals and poach clients, JPMorgan Chase is the institution to beat in the investment banking stakes.
In the first nine months of the year, the US group earned USD3.5bn in revenues from equity and bond underwriting, loans and mergers and acquisitions – more than any other bank in the world, according to Dealogic. With its trading businesses – helped by the cut-price acquisition of Bear Stearns in 2008 – JPMorgan’s strategy seems to be paying off.
Jamie Dimon, chief executive, was never a great fan of exotic products such as collaterised debt obligations. He was proved right, after relatively small losses on CDOs helped JPMorgan come out of the turmoil stronger than most and position itself as a haven for clients and investors.
The bank’s plans to maintain its prime spot are concentrated on international growth. JPMorgan wants to expand overseas and better link its commercial bank and payments businesses to the securities unit in order to sell more services to multinationals. Challenges abound. Rivals such as Bank of America/Merrill Lynch, whose share of investment banking revenues is just behind JPMorgan’s, are back to full strength. Banks with large international networks, such as Citigroup and UBS, are also deepening their focus on emerging markets. A couple of well-publicised mishaps in JPMorgan’s commodities unit have not helped matters. The latest quarter was the least profitable for JPMorgan’s investment bank since the last three months of 2008, which were marked by Lehman Brothers’ failure.
JPMorgan’s executives profess confidence in a model and a suite of services that has captured significant market share in the past few years. But the question for Mr Dimon, now that his bank has reached the top, is whether it can remain there.
Barclays Capital faces choppier waters
When Bob Diamond, the man who built Barclays’ investment banking arm, becomes chief executive of Barclays group next year, he will look back at a business that now competes head-to-head with Wall Street groups such as Goldman Sachs and Morgan Stanley.
Barclays Capital’s growth over the past 15 years can be partly attributed to its ability to trump competitors in areas such as fixed-income and foreign exchange, but even senior executives admit the firm has dodged a few bullets along the way. Mr Diamond’s audacious move to acquire the US operations of Lehman Brothers at the height of the financial crisis gave the bank size and scale on both sides of the Atlantic.
But BarCap was also known to be circling a weakened UBS, and narrowly missed what would have been a disastrous tie-up with ABN Amro, the Dutch bank that nearly sank Royal Bank of Scotland. Barclays may have avoided having to be bailed out by the UK government but it did not sidestep the boom in risky structured products – BarCap has written off billions in toxic subprime assets.
BarCap, which is now headed by two of Mr Diamond’s long-serving lieutenants, Jerry del Missier and Rich Ricci, faces choppier waters than some of its competitors. A UK government-commissioned panel is examining the future structure of the banking industry, and still could recommend a forced separation of investment banking and retail banking operations.
On the business side, BarCap has invested heavily in building its advisory and equities franchises in Europe and Asia. But its progress continues to be constrained by volatile markets and weak M&A activity. Moving Mr Diamond, arguably the UK’s most famous banker, into the top job could also further intensify political and public scrutiny of BarCap’s operations, especially if it continues to deliver the lion’s share of the group’s profits.
Nomura’s challenge is winning market share
Building a global investment bank in the aftermath of the worst financial crisis in generations would probably be viewed as a step too far for most institutions. Not, however, for Nomura, the Japanese securities group that snapped up most of Lehman Brothers’ European and Asian assets when the US investment bank collapsed in September 2008.
At the time, analysts and investors queried whether Nomura, as a Japanese house, would be able to bed down an acquisition that added 8,000 people accustomed to operating in Lehman’s no-holds-barred culture virtually overnight. Two years on, with the integration having gone better than many senior executives expected, Nomura’s challenge is winning market share and delivering revenues.
At the time of the Lehman purchase, Nomura’s management believed there would be big opportunities for a “pure play” investment bank, as several big US and European rivals faltered or were forced to accept government handouts to survive. But many of those institutions, such as UBS and Bank of America, recovered far more quickly than expected, limiting Nomura’s ability to gain share in areas such as equity and debt capital markets – especially when it still lacks critical mass in the US.
Having tried and failed to crack the US market several times before, Nomura has spent the past 18 months adding hundreds of staff to its North American business. The group now employs nearly 2,000 people there, up from just 650 two years ago.
Some executives would like to boost that number dramatically, potentially through the acquisition of a mid-tier US investment bank – although Nomura is quick to stress that no suitable target has been identified, nor is any deal in the offing. Investors are increasingly clamouring for the bank to deliver on an international growth strategy that continues to drag on profits.
Bank of America face steep competition
Bank of America has not hesitated to lay out its strategy for the post-crisis era. “We are going to be your everyday banker as well as your big deal banker,” Brian Moynihan, who succeeded Ken Lewis as BofA’s chief executive a year ago, recently told investors.
To fulfil its aspiration to join the ranks of the top investment banks the Charlotte-based lender agreed to buy Merrill Lynch in September 2008 in an all-stock deal then valued at USD50bn. The move was a bold one, but also brought a spate of lawsuits and cost top executives their jobs.
Two years later, the idea of melding BofA’s massive consumer and commercial banking operations with a global investment bank and the industry’s top retail brokerage still makes sense to many. But, while the controversies stemming from the Merrill deal have now receded, new ones have emerged. This year the bank has endured an industrywide scandal on US foreclosure practices, as well as widespread expectations that mortgage securities investors will force BofA to buy back billions of dollars in loans that failed to meet underwriting standards.
Meanwhile, though, Mr Moynihan and his deputies have stitched together a corporate and investment bank that surprised peers last year with its ability to produce steady results. Up until November this year, BofA trailed only JPMorgan Chase in global investment-banking fees, according to Dealogic.
While BofA ranks first in US fees, the bank’s presence outside its home country remains low; it has a less than 5 per cent share of the non-US market for merger advice, debt and equity underwriting. BofA has hired 800 bankers and traders outside the US, half of whom work in Asia, to help round out its footprint. But it will face steep competition from virtually every other bank with global ambitions, some of whom have deeper ties to fast-growing economies than BofA.
UBS charts aggressive course
Few institutions have faced a greater challenge in investment banking than UBS, the Swiss group that was forced to write off USD50bn in subprime mortgage losses at the height of the financial crisis.
Having long touted the benefits of an “integrated” model that was supposed to profit from synergies between its three main businesses – investment banking, wealth management and asset management – UBS’s securities division was exposed as a teetering house of cards built on toxic assets.
With senior bankers leaving in droves and an outraged Swiss public demanding fundamental changes, many competitors wrote off the bank, expecting it would be broken up and sold off in pieces.
Against the odds, however, UBS has staged a renaissance over the past 18 months. Led by Oswald Grübel, the former Credit Suisse chief executive brought in to turn the group around, UBS has managed to rebuild its business in crucial areas while boosting capital and shrinking its balance sheet.
Like many of its rivals, UBS believes tighter global capital and liquidity requirements will benefit those banks who trade predominantly on behalf of clients, rather than for their own “proprietary” desks. The group has added about 750 people across its fixed-income and equities divisions during 2010, boosting capacity but also driving up the cost-to-income ratio in its investment bank to 80 per cent.
The group needs to hit its medium-term targets of SFr20bn ($20.7bn) in revenues and SFr6bn in profit before tax – targets it will fall far short of this year. Is ratcheting up risk in an expanded investment bank the answer?
Investors were repeatedly told at a conference in London last month that UBS, in contrast to some rivals, will be more aggressive with its bets over the coming months. Its next chapter may be just as interesting as the last.
Morgan Stanley in a transition period
Few survivors of the financial crisis had a more harrowing 2008 than Morgan Stanley.
The US investment bank came close to the same fate that befell Lehman Brothers and Bear Stearns – Lehman filed for bankruptcy protection, while Bear Stearns was bought by JPMorgan Chase as it neared collapse.
However, a timely capital raising from Mitsubishi UFJ, along with an intervention by the US government, helped assure Morgan Stanley would live on.
Two years later, Morgan Stanley has attempted to revamp its focus to be less dependent on volatile securities businesses, winding down riskier bets with its own capital and rebuilding client-facing trading desks.
The centrepiece of the new strategy was revealed last year, when Morgan Stanley folded its retail brokerage business into a joint venture with Citigroup’s Smith Barney. The bank, which owns 51 per cent of Morgan Stanley Smith Barney, has options to buy out Citi’s remaining stake in several tranches. A revamp of the company’s asset-management arm is also under way.
Morgan Stanley has hired about 700 traders, salespeople, bankers and support staff in the past year to beef up a securities arm that had lost numerous employees during the course of the crisis.
The bank has retained its core strength in mergers advice and equity capital markets. It has been Washington’s adviser of choice on a number on high-profile bailout-era deals, including stock sales by General Motors and Citigroup.
Nevertheless, the bank’s trading results have remained uneven.
“We are in a transition period,” James Gorman, who succeeded John Mack as chief executive at the start of the year, said during an October conference call with analysts.
Deutsche Bank’s Jain relying on Project Integra
Deutsche Bank can credibly claim to be moving into the post-crisis world in a better position than most European rivals. However, the picture did not look so bright when Deutsche’s investment banking operations plunged to a €7.8bn ($10.2bn) loss in 2008, dragging the whole group into the red.
Since then, the investment bank – now led exclusively by derivatives trader Anshu Jain, who has added equities, advisory and transaction banking to his original fixed-income franchise – has derisked its profile significantly.
Mr Jain, whose strength in developing exotic derivatives fuelled outperformance in the boom years – before causing some of those 2008 losses – has turned his back on many higher-risk operations.
In the third quarter of the year, Deutsche closed its equity proprietary trading desk – which used the bank’s own money for equity bets – after having closed its other prop desks.
It has beefed up its focus on steady transaction banking businesses, which rely on regular fee income, recently buying the old ABN Amro transaction banking operation.
For this year the investment bank looks on track to make a pre-tax profit of about €6.1bn, up 42 per cent, in spite of a sharp dip in performance over the summer. The question now is whether it can hit publicly set targets for next year – generating €7.6bn out of a €10bn group-wide profit target.
Mr Jain will be relying in part on his latest efficiency drive, Project Integra, which aims to connect the businesses he is now responsible for.
That will involve cross-selling where possible, for example, foreign exchange services as part of an M&A deal; “streamlining” staff so that duplication in different teams is stripped out; and expanding into undercovered areas, such as natural resources advisory work and trading US equities and commodities.
Citigroup sticks to game plan
Compared with the recent past, these are glory days at Citigroup, which nearly collapsed during the financial crisis.
The US government has sold its 34 per cent stake, the shares are up nearly 40 per cent since January and investors have enjoyed three consecutive quarters of profitability. The investment banking unit – built on the foundations of the once-mighty Salomon Brothers – played an important part in the recovery.
Vikram Pandit, Citi’s chief executive, has taken the group back to basics, where clients, and not the company’s own investments, come first. This has involved advising companies and trading securities on behalf of investors while shrinking the in-house hedge funds and private equity activities that, alongside huge bets on subprime securities, almost caused Citi’s downfall in 2008.
However, the performance of its investment bank is set to come under closer scrutiny. In the first nine months of the year, Citi ranked seventh in terms of revenues among investment banks, according to Dealogic, behind most of its rivals except for UBS.
The 13 per cent yearly fall in revenues at the unit will not have pleased its upper echelons but executives stress they will not be derailed from their game plan.
John Havens, who runs the investment bank and is a close lieutenant of Mr Pandit, says Citi should play to its strengths – its international reach and the huge roster of companies and governments that use its banking and cash payment services.
Even rivals envy Citi’s large network of international offices and concede that it has excellent access to boardrooms, but say the company is still reeling from the crisis. Mr Havens does not seem concerned. “Our goal is simple,” he says. “We want to be the operating system for our clients. Once we are embedded in them, we can serve them with a huge variety of services.”
What did I say then?
Goldman excluded from ICBC mandate | FT (7 years 10 weeks ago): Goldman excluded from ICBC mandate - Goldman Sachs has been excluded from the USD15bn-plus listing of Industrial and Commercial Bank of China, the country's biggest equity offering, because of Beijing's concerns about a possible conflict of interest with the US firm's role in another deal. [Financial Times - Financial Services]