Koji Nagai, the stony-faced chief executive of Asia’s biggest investment bank, finally has a reason to start smiling.
As of late February the bank’s stock price had doubled since the beginning of August 2012, when Nagai became CEO in the midst of an insider-trading scandal. The last time the Japanese investment bank’s shares recorded such a leap was in 1986, the beginning of Japan’s asset bubble that made Nomura the world’s mightiest brokerage for a few wild years.
On this occasion most of the credit for Nomura’s stock resurgence lies with Shinzo Abe, Japan’s new prime minister. His inflation-targeting promises weakened the yen and sparked a bull market in Japanese equities.
Still, the reason Nomura’s stock was in a position to enjoy such a rebound was due to drastic actions taken by Nagai. In the seven months he’s been in charge, Nagai has staunched the haemorrhage of cash from Nomura’s global wholesale operations that resulted from it acquiring the European and Asian arms of Lehman Brothers in 2008 at the height of the global financial crisis.
“They’ve made substantial progress with cost-cutting and are doing a good job with it,” says Graeme Knowd, associate managing director at Moody’s Japan. “They are trying to lower their breakeven point, so that even in bad markets they won’t lose money.”
Every region is now profitable for Nomura for the first time in more than three years. The star performer is Asia outside Japan, where in the three months to the end of December, revenue jumped 76% from the previous quarter.
Despite this admirable performance, the bank continues to make the most international money from the US and Europe, where it has pared back operations to a mostly fixed income focus.
Nomura’s ambition to stay profitable through a smaller array of businesses is laudable, and stands in contrast to the ambitious goals of Nagai’s predecessor Kenichi Watanabe and his chief operating officer Takumi Shibata. When buying the lion’s share of the bankrupt Lehman Brothers’ international businesses in October 2008 they discussed becoming one of the world’s top-10 investment banks.
But even this narrower strategic direction is beset by obstacles, primarily tougher capital rules that are particularly sceptical about fixed income businesses. Nomura needs to demonstrate that even its newly modest ambitions are attainable.
Lehman losses
Nomura’s recent difficulties largely stem from the Lehman acquisition.
The bank reasoned that employing proven top investment bankers in Asia and Europe in the midst of the global financial crisis would allow it to finally build the international presence it desired.
It was not to be. Nomura became notorious for offering lucrative compensation guarantees to its foreign bankers, only for them to generate scant returns.
“Nomura has never really understood that while they walk the Japanese financial earth like gods, overseas they are just seen as [being] willing to pay the wrong money at the wrong time,” a cynical foreign banker in Tokyo, who asked not to be identified, tells Asiamoney.
Worse, the core business model of Lehman Brothers was almost instantly obsolete upon purchase.
“Nomura thought that there was an opportunity to use the weakness of their rivals to become a player. They didn’t realise that regulators were determined to kill the low-equity, highly leveraged business model, particularly for fixed income. That was Lehman’s business and the business has gone,” says the senior analyst in Tokyo.
Battered by the global financial crisis and its new Lehman business costs, Nomura’s wholesale businesses suffered a huge pre-tax loss of ¥717.3 billion (US$7.67 billion) during the financial year ending March 2009.
Wholesale revenues recovered to a pre-tax profit of ¥175.2 billion by March 2010, but by the end of September 2012 it had lost a further ¥52.7 billion, despite cutting US$1.2 billion from its costs between July 2011 and June 2012.
Shareholders, and Nomura’s Japanese staff, were furious. Jasjit Bhattal, the former CEO of Lehman Brothers Asia who was in charge of Nomura’s wholesale business, resigned in January 2012.
Knowd of Moody’s believes much of the criticism of the Lehman acquisition is unwarranted.
“Nomura was one of the few institutions in a position to buy something back when they did. I don’t think anyone else would necessarily have been any better,” he says.
“The question is how long should you give it to work? Give it another couple of years and the market might pick up again and it will be seen to be genius. A lot of it is timing.”
Leaky ship
Nomura might have been willing to display such patience had everything else remained stable. But it didn’t.
In March 2012, shortly after Nagai was made head of Nomura Securities, the Japanese business, Nomura was slapped with the first of several sanctions from Japan’s Securities and Exchange Surveillance Commission, part of the Financial Services Agency (FSA), for leaking confidential information about share offerings in 2010 by oil explorer Inpex, Mizuho Financial Group and Tokyo Electric Power.
“Very large international long-only, buy-side players complained vehemently to the FSA in 2011, because there were so many public offerings and they got stitched up every time,” recalls a senior analyst in Tokyo, who asked not be named. “They told the FSA, ‘We will need to re-evaluate our investments in the Japanese stock market if you don’t do something about insider trading with public offerings’.”
The Ministry of Finance tried to hatch a compromise with Nomura but such plans were nixed by the FSA, whose then head, Ryutaro Hatanaka, thought the legacy of the Lehman deal was damaging the health of a key player in Japan’s financial markets.
Instead, Nomura lost a succession of mandates for bond and equity offerings by government agencies or state-owned companies. It was dropped as joint global coordinator with Daiwa from the ¥663.3 billion (US$6.95 billion) IPO of Japan Airlines and excluded altogether from the forthcoming sale of 333 million shares of Japan Tobacco by the Ministry of Finance.
As its isolated status became clear, Nomura’s market share in capital markets plummeted. The bank had enjoyed an ECM bookrunner market share of 41% in the five years to 2011. This halved to just below 20% in the year to late February, according to Dealogic.
The pressure on Watanabe and Shibata became overwhelming. They resigned in July 2012.
Belt-tightening
Under Nagai’s austerity regime, the mantra at Nomura is simple: cut costs and make money.
In September 2012, the new chief executive ordered an additional US$1 billion in cost reductions by March 2014, half from personnel, the rest from integrating IT systems. Europe has borne the brunt of reductions (46%), followed by the Americas (21%), Japan (18%) and Asia outside Japan (15%).
Further big acquisitions are off the table, even if that means missing some choice assets sold by shrinking European banks, such as Rabobank’s asset management unit Robeco, bought in February by Japanese financial services rival Orix for €1.94 billion (US$2.53 billion).
At Nomura’s Investors Day on December 3, Nagai betrayed emotion only once, when dismissing any expectation that Nomura would back its enthusiasm for doing deals in Southeast Asia with substantial cash flows.
“We will not pursue reckless growth in these areas,” he said in a raised voice, bringing his hand down on the table for added emphasis.
“As Nagai-san has made pretty clear, we think our priorities are elsewhere at this point, principally sustainable profitability and returns of financial resources,” says deputy chief financial officer Jonathan Lewis, the most senior Nomura staff member Asiamoney was permitted to speak to.
Such plans are necessary in part because the government’s previous sanctions have cut Nomura’s lucrative market share of Japan’s primary equity market, perhaps forever.
“We definitely expect and can see from the pipeline that’s building that we will regain more of that [Japanese primary equity] market, though I can’t predict that it will recover to 40%,” says Lewis.
Adapt or die
Nomura’s need to shrink and adapt has left it as a curious hybrid: a full-service investment bank inside Japan, but one increasingly powered by fixed income outside the home territory.
The bank expects most of its growth over the next three years to come from Japan, the opposite of what it intended when buying into Lehman.
Nomura has a ¥125 billion goal for wholesale pre-tax income in 2015/2016, of which ¥75 billion is to come from Japan. Its core Japanese retail operation is meant to generate ¥100 billion in annual pre-tax income, chiefly from managing ¥90 trillion in client assets.
Internationally, Nomura’s dramatic cutting has left it looking far more fixed income-focused. Its global fixed income business, which includes rates, credit, structured products and foreign exchange, has been a key driver for its wholesale division. In the last quarter of 2012 for instance fixed income accounted for 59% of revenues, its strongest quarter for three years. And the bank’s global fixed income market share increased from 2% in 2009 to 4.2% in 2012, according to internal figures.
The bank is big in arranging leveraged finance for financial sponsors in EMEA too, topping the league tables for such deals last quarter. The bank has also targeted profitable market niches. For example, mortgage-backed securities (MBS) origination and trading has become a main business line for Nomura in the US, where it has a chequered history of securitisations. Former employee Ethan Penner pioneered commercial MBS for Nomura in the US in the mid-1990s but the market he created blew up in 1998. Nine years later, Nomura had to close its residential MBS business in the US, just before the subprime crisis.
Lewis stresses that this time it will be different.
“This is pure agency [trading] now. We are not originating loans. We are not securitising ourselves. It’s in that area that we had the challenges historically. In addition, the risk-management department now has close to 200 people. We are very, very focused on the speed of turnover of portfolios, and on minimising inventory.”
In Europe Nomura has been supplementing its banking business, which includes helping recapitalise Spain’s struggling cooperative banks, with select asset sales.
Cost of capital
One very senior Japanese financial analyst working for a US bank in Tokyo is unconvinced Nomura’s fixed income emphasis can sustain its international profit growth.
He points out that under Basel III, capital charges will increase for trading securitised products. A spokesman at Nomura counters that this will encourage more banks to quit the business, creating more opportunity for those that remain.
Nomura faces an even bigger challenge when the cost of funding starts to rise.
“At this moment everyone is enjoying a low funding cost,” says the financial analyst. “But once funding costs normalise, the margin on fixed income trading will be squeezed, and you have to have a high credit rating, then you will have to have bigger capital, and return on equity will start to decline.
“If you want to be reasonably profitable in fixed income, you will need a big balance sheet with a cheap funding source, and there is no question that a retail deposit base is the cheapest.”
Team up?
The inescapable logic is that if Nomura wants to be big in fixed income it will have to tie up with a deposit-taking bank.
Partnering with a Japanese lender to ensure its long-term viability seems most logical. The idea has been seriously discussed behind closed doors at Nomura and other banks in Tokyo.
The potential match most frequently cited is with Bank of Tokyo-Mitsubishi, the core bank of Mitsubishi UFJ Financial Group (MUFG). MUFG owns a sizeable stake in Morgan Stanley and has deployed its balance sheet to help the US investment bank win advisory mandates in Japan.
Katsunori Nagayasu, the current CEO of MUFG, and his predecessor Nobuo Kuroyanagi have both publicly mentioned the theoretical possibility of a strategic tie-up or merger with Nomura, a well-informed source tells Asiamoney.
Masaaki Tanaka, deputy president of MUFG, is sceptical of the advantages to MUFG of its investment in Morgan Stanley and Japan joint ventures, and favours a merger with Nomura instead, according to the source. “Tanaka was appointed to the board of Morgan Stanley in the hope this would shut him up,” the source adds.
MUFG spokesman Shinya Matsumoto did not respond to a request for comment.
Observers think that MUFG would be most interested in Nomura’s Japanese operations.
“What MUFG primarily is interested in at Nomura is the retail business,” a veteran foreign banker in Tokyo explains. “You could provide a proper Japanese platform to go with Morgan Stanley as your international arm...and Nomura the domestic.”
Alternatively Nomura could seek to join with Resona, a failed bank rescued by the Japanese government in 2003. Resona has since repaid 72% of its debt, and become a successful retail bank. It also is the successor to the old Osaka Nomura Bank founded in 1918, and from which Nomura Securities was spun off in 1925.
Nomura has “no plans to form an alliance with a bank”, says a Nomura spokeswoman, citing a statement by Nagai in September.
Daring to dream
Nomura will require capital and commitment if it is to make international operations that centre around fixed income a force for growth again. But expanding international wholesale once more risks the ire of its Japanese shareholders.
It could choose instead to merge with a deposit-taking bank, exchanging its own prized retail business and 80 years of independence for deeper pockets.
Either way, Yasuyuki Kato, a former senior managing director at Nomura, is sure his former employer will take the plunge.
“I think Nomura’s ambition to be among the global top-10 still exists,” he says. “It’s kind of [in their] DNA.”
