A year of restructurings: investment banks decide what they want to be
Bank restructurings come in two flavours — the kind where the business stays pretty much the same, and the kind where it doesn’t. 2015 was the year of the latter, as new chief executives, new business models and a pervasive sense of existential doubt hung over investment banking. Owen Sanderson reports
The doubts set in as Europe’s better banks started to look wobbly. The Qatari-backed trio, Barclays, Deutsche Bank and Credit Suisse, all escaped the crisis with fixed income divisions intact, capital ratios which looked adequate to the regulatory environment of the time, and no state shareholding. HSBC and Standard Chartered were heavily exposed to emerging market growth, the rise of China and the safer parts of investment banking.But in 2015, the confidence crumbled. “The belief that you can cut 5%-10% from the cost base and that will be enough is ebbing away,” says Bill Michael, head of EMEA financial services at KPMG.
James Gorman of Morgan Stanley has shown the way, culling 25% of his FICC division in December, after the worst quarter for bond trading since the financial crisis. Others will surely follow in 2016. Banks will be forced to choose: are they one of the big flow houses that can eke out a living in this business, with its dire returns on equity, or should they give up?
Barclays outlined a turnaround strategy in May 2014, but in 2015 its board, impatient with progress, fired Antony Jenkins. Officially, the strategy remains, but new boss Jes Staley is widely expected to shake things up on March 1, the bank’s strategy day.
Standard Chartered was next up — after rumblings of discontent in 2014, fantasy bid rumours, and the departure of the chief financial officer, Richard Meddings, 2015 saw a full-on boardroom coup in February.
Peter Sands, the chief executive, stepped down in June and the chairman, Sir John Peace, will make tracks in 2016, accompanied by a clutch of non-execs. Bill Winters, former boss of JP Morgan’s investment bank, took over in the summer, and began rolling out his new strategy in the autumn.
Credit Suisse also switched CEO, with company man Brady Dougan swapping out for Tidjane Thiam, former CEO of Prudential. This sent the shares up 8% on announcement, and Thiam has delivered so far, with a punchy new plan that involves shutting the European government bonds business and leaning more on Asia.
Deutsche Bank, meanwhile, has no new strategy. The official corporate line is that Strategy 2020, ex-CEO Anshu Jain’s scheme to boost the bank’s capital base, sell Postbank, and keep it in the investment banking game, is still in place. The details, however, are a little different, especially for the 6,000 staff that will lose their jobs under the revised version.
John Cryan, the Deutsche Bank board member who took over from Jain as co-CEO, has lost no time in stamping his mark on the firm, especially on the investment bank.
Gone are the products of internal empire-building, and in their place is a po-faced org chart, a public disdain for bonuses and the removal of major players.
Spot the restructuring
In the other camp — bank restructuring where nothing much changes — are HSBC and UniCredit, both of which are working on transformations. HSBC announced, in a strategy update in June, that it would allocate more capital to Asia, sell less profitable loan books in Europe, cut costs and boost efficiency.
UniCredit’s changes mean big cuts in retail and the back office, and not much in the investment bank, except a desire to do more business at lower cost. The bank wants to ditch low earning assets and focus on more profitable business — but doesn’t everyone want that?
Meanwhile, the European banks which went through this pain a few years earlier are doing better — while the US firms, rescued and recapped early, are riding high.
In Europe, the standout example is UBS, trading on the highest earnings multiple of any big bank, despite a torrid court case exposing its role at the centre of the Libor rigging scandal, and a home regulator with the toughest capital regime in the world.
Moving early undoubtedly helped. UBS’s first restructuring came in 2011, a dark time for banks — but one which was followed by a rally.
“In 2011, we modelled exit costs and losses, and there were fairly chunky numbers involved, with severances on top of the losses on positions,” says Tom Naratil, group chief financial officer at UBS. “But we had a little bit of luck when we started executing in 2012, as it was a real risk-on quarter, with a strong bid for legacy, high risk weighted assets. The losses we’d modelled turned out to be gains, and it gave us momentum.”
Running out of optimism
But it’s not just coincidence that has made 2015 the year of restructuring. It was also the year that banks ran out of optimism about regulation, and about interest rates.
“There’s a growing realisation that the business model is running out of runway, and there’s more clarity on the direction of regulatory travel,” says Michael at KPMG. “Lots of the big regulations have yet to take effect, but the global structural reform agenda is approaching its last stage.”
Michael Reuther, CEO of corporates and markets at Commerzbank, says: “Regulations that will impact the banking industry as well as Commerzbank include the fundamental review of the trading book, meaning more capital for market risk, the standard floor for credit risk, which will impact banks that have a well rated loan book, and interest rates in the banking book, leading to capital requirements designed to eliminate regulatory arbitrage between banking book and trading book and prepare banks for rising interest rates.”
Reuther continues: “Most of these don’t come in until 2018-2019, but you need to be ahead of the curve, even though some of the rules aren’t always clear yet.”
Quantitative easing might have jacked up asset prices, and soothed the markets for the first half of the year, but it has flattened the yield curve, and meant maturity transformation is less profitable than before.
KPMG’s Michael says: “Banks are also realising that the underlying economic environment isn’t friendly, and isn’t changing any time soon. Low interest rates are a killer for banks full stop, and there simply isn’t much growth in Europe, for example.”
That means restructuring plans that imagined a rate rise and a return to normality have been revised downwards repeatedly.
“Until recently, restructuring to a simpler business model provided meaningful upside to a number of stocks,” wrote Matt Spick, a bank equity analyst at Deutsche, in a client note. “This process seems to have stalled, with the sector now apparently reaching the point where restructuring is hard, messy and time-consuming.”
Spick charted consensus earnings estimates for European banks since 2010, noting: “Sell-side analysts (as well as management teams) have consistently erred on the positive side.”
Where’s the growth?
Banks are seen by the stock market as leveraged bets on economic growth, and there isn’t much growth in large portions of the world. Where there is growth banks exposed to it are using the outsize revenues to invest in their businesses elsewhere and take market share.
“The US cross-border banks have benefitted from a better regulatory response — realising it’s all about capital from the beginning — but also benefit from exposure to growth, and a system which is led by the capital markets, not by bank lending,” says KPMG’s Michael. “The geographies you operate in and the business you do determines the glide path and how the new environment shapes the business.”
But perhaps geographic success is skin deep. Deutsche Bank, Credit Suisse and Barclays, all with big restructurings in progress, are widely seen as three European firms that successfully bought exposure to the US. But this could be precisely what is powering the re-orientation of all three firms. Credit Suisse’s restructuring, for example, features re-commitments to wealth management, and to leveraged finance, credit and securitization — in other words, the core business of Credit Suisse, the Swiss wealth manager, and DLJ, the US leveraged finance house.
Still, banks without the geographic setup to grab hold of growth have some hard thinking to do. Either buy growth from somewhere, or cut costs. The problem is, in the post-crisis environment, the first route is blocked, with good reason.
“There’s no appetite among regulators, bank boards, or management for banks to be any bigger,” says Michael. “The regulatory agenda hasn’t solved too-big-to-fail, but has put limits on how big you can be. But as organisations transform, there is definite potential for realignment, simplifications, separations and integrations. It’s not going to be classic consolidation M&A, but there could be quite a lot of asset disposals, exchanges and so on which will make banks simpler.”
So with buying growth through M&A off the table, that means cost cutting. But cutting front office staff will always, at first, cut revenues faster than it cuts costs. Competitors will gladly seize on signs of weakness and step in, and the juicy business will disappear first.
So restructurings end up focussing on which businesses to ditch, or offices which can be shut outright.
RBS is the champion of this approach, ever since it sold equities to Jefferies, shut down M&A and passed big bits of business to Mizuho, BNP Paribas, and others.
But other restructurings have been specific: Credit Suisse will not be a primary dealer of European government bonds; Deutsche is to quit 10 countries; and StanChart will shut down Hong Kong project finance.
“Across the banking industry, we’re no longer in a one size fits all situation — banks are concentrating on their particular strengths, and that means more variation between investment banking results each quarter,” says Commerzbank’s Reuther.
Deutsche’s Spick says: “The problem at this point seems to be one of management teams still aiming at too broad product provision and also the environment being less supportive for running off non-core assets and businesses.”
Restructuring means not just pain for staff, but a period of endurance for management and a period of faith for shareholders. Bold targets do not mean much without detail, and confidence that management can deliver.
“Everyone focuses on the big sexy strategy story, but that only meant a little pop in the share price,” says UBS’s Naratil. “The multiplier compressed and meandered around, and we only earned the expansion [in earnings multiple] when it was clear we could execute. You earn the multiplier in the trenches of execution, not on the stage of strategy, and we didn’t really get it until year three, after quarters and quarters of constructive execution.”
KPMG’s Michael says: “Banks need to be clear about what they’re giving up on, and demonstrate each quarter that they’re delivering on strategy changes. It only makes sense to come up with big disposal or RoE targets when you’ve done the work in detail and it’s obvious where you have fat.”
Selling shareholders on the project requires art and delicacy — and, ideally, a stream of other income to support the institution through an overhaul.
“We had around $5bn a year coming in from wealth management, wealth management Americas, asset management, retail and corporate — if we didn’t give that back to shareholders, that’s up to $5bn a year to change the business model,” says Naratil. “Firms with a very strong investment bank making up a large percentage of total revenues don’t necessarily have that flexibility.”
Deutsche Bank, under the stewardship of Cryan, Naratil’s predecessor as UBS CFO, has opted to boost its firepower for restructuring with a cut to the dividend, while Credit Suisse and StanChart are pinning their hopes on substantial rights issues.
What is a bank for?
Banks not only need to figure out which banking activities they ought to get out of, they also need to consider which activities shouldn’t be done by banks at all. The large universal banks typically combine dozens of entities subject to different regulatory regimes, and figuring out which parts to keep and where to book business is a major task.
“Banks need to ask why they do what they do, and whether it needs to be done in a bank,” says Michael. “Every bank does client onboarding, know-your-client and antimoney laundering, but there’s nothing differentiating about it. Why do we need more than one per country? Why does settlement infrastructure need to be in a bank?”
Michael’s point is that banks are duplicative and wasteful. In the past, banks have worked together on projects such as clearing houses, standard documentation, credit event determinations and indices. Even now, banks are funding joint initiatives like R3, a blockchain project, and Symphony, a secure chat and electronic communications system. So why not go further?
The merger of ICAP and Tullet Prebon’s business points the way. It gives one firm decisive scale in a particular, regulated industry, while the other, ICAP NewCo will escape the regulatory perimeter. That frees it to concentrate on services like clearing, e-trading and indices, profitable niches which, right now, are often carried on within investment banks or brokers.
Today, it is regulation that defines what an investment bank is and how that will change in the future. Banks in 2015 faced up to their future regulatory challenges, but we don’t know whether the overhauls the banks have promised will work. Will 2016 see successful turnarounds, or more banks in existential crisis?