Ian Kerr: 2004 — a one-legged race

  • 14 Jan 2005
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Fixed income carried the investment banking industry again in 2004, but there was precious little money to be made from underwriting bonds. Proprietary trading was the hot spot, but as Ian Kerr writes, prop desks can lose a ton if the wind changes.

Was 2004 one of the dullest years in recent financial history? Not if you worked in an investment bank, because bonuses, which are the happiness barometer of every employee, were around the same as in 2003. Some earned more. Some earned less. As always in the investment banking industry, it depends whether your face fits when the bonus cheques are being distributed. Doesn't that sound slightly unfair? Of course, but if you want total equality and a square deal, go and work for a toothpaste manufacturer or in Disney World's Magic Kingdom.

On one of the London radio stations, a firm of solicitors we've never heard of advertises its services to workers who believe they have been unfairly dismissed, or who have failed to be rewarded with promotion because of sexist, ethnic or minority bias.

In the new year, can we expect the same solicitors to sympathise with workers who are unhappy with their bonuses? Don't bet against it would be our advice, and we think the legal firm in question may have discovered an attractive market niche.

So, was it really such a dull year? Speaking as a financial writer and a veteran observer of the financial services industry, it was excruciating.

Markets were going nowhere. If markets went two steps forward, they immediately went two steps back. The smartest hedge fund managers were starting to whinge about the lack of volatility, which is their lifeline.

Time after time we opened the Wall Street Journal or the Financial Times and our heart began to bleed for the struggling columnists, who were reduced to writing pure fluff.

It wasn't totally their fault. Banks suddenly became too timid to try and merge with each other. Industrial chief executives suffered from similar bouts of stage fright and seemed to be terrified of their own shareholders' shadows.

Titans of industry and finance were not toppled over like ducks at a fairground shooting gallery.

John Mack at Credit Suisse First Boston may go down as the biggest scalp of the year, but would that have impressed Geronimo or Chief Sitting Bull on the war path?

The fall of John Mack enlivened an otherwise torpid early summer and then, thank heavens for multi-billionaire Philip Green, who added some much needed sparkle to Royal Ascot and the Chelsea Flower Show by ruffling Marks & Spencer's undies in public.

What a pity that his first bid was miserly, but we were treated to a new side of Goldman Sachs, with bare-knuckle M&A tactics in Philip Green's corner and finally, the total ringcraft mastery of Cazenove's David Mayhew, who saved the day for M&S, as well as his dignity.

Perhaps the surprise is that in a year when many major markets were becalmed, the investment banks managed to make so much money. How did they accomplish this without using sleight of hand or pulling rabbits out of a hat?

In such dreary markets you would expect two or three houses to fall by the wayside but in the end, only Commerzbank Securities bit the dust, after the departure of its cavalier leader, Mehmet Dalman.

However, that was always on the cards, because the Commerzbank Vorstand in Frankfurt, which never had much stomach for securities trading, couldn't see what Dalman might have achieved.

Dalman may have been over-exposed to equities and underweight in fixed income, but that balance could have been adjusted. Commerzbank has now gone back to basics, just when its leaders in Frankfurt should have been asking themselves how Deutsche Bank, just across the street, makes so much money in investment banking.

What is the future for Commerzbank now? From the outside the prospects look truly dismal and the bank's totally decent and hard-working chairman, Klaus-Peter Müller, might consider a visit to Lourdes to pray for a miracle.

Ladies of the night
Investment banks wanting to realise their maximum potential start each year by praying for favourable conditions in fixed income, equities, corporate finance advisory work and asset management. These are the four main revenue producing cornerstones.

Fixed income also includes trading in currencies and commodities. Derivatives and proprietary trading are part of both equities and fixed income.

Some investment banks have thriving clearing and settlements businesses or divisions which specialise in tax savings structures. Investment banks are not unlike ladies of the night. They are not proud, and go wherever the money is.

But in 2004, two of the four legs of investment banking were essentially hors de combat and another walked with a limp. Equities struggled all year and mergers and acquisitions, despite much huffing and puffing in the press, was a wet blanket.

Many investment bankers were seriously under-employed in 2004. Even the very best in the business, Goldman Sachs and Morgan Stanley, didn't make much money out of pure investment banking after allowing for their sky-high costs.

And because global stock markets mainly drifted sideways, asset management could make only a modest additional revenue contribution.

Thank heavens, therefore, for fixed income, currencies and commodities. Once again, these operations carried the investment banks on their shoulders.

The conventional wisdom at the beginning of the year was that interest rates would climb and fixed income would consequently lose its momentum. ?Don't worry,? said the market strategists, because equities and corporate finance would pick up the baton and all would be well.

As usual, the strategists were talking through their trousers. After a scorching first quarter, fixed income slowed, but it never stopped, while equities and corporate finance ran out of puff after the first lap.

In fixed income the name of the game changed. Traders had to adapt. As the yield curve flattened, they had to say goodbye to those lovely carry trades which had been their bread and butter for three years.

Prop trading saves the day
What did they do? They simply pressed the proprietary trading pedal to the floor.

Surely this would have showed up in increased value at risk (Var) exposure? Not really. The investment banks only disclose what they want you to see and Var figures may be little more than a token gesture to persuade shareholders that they have not invested their money in a casino.

The reality is that some houses took proprietary trading risks in 2004 which would have made the shareholders' hair stand on end.

Luckily, the dice mainly rolled in their favour. When it didn't, it was possible to lose more than half a billion dollars on a directional trade, as Morgan Stanley demonstrated in the third quarter.

The houses which had a serious advantage over their competitors in 2004 were those which had extensive interests in commodities trading. Indeed, 2004 will be remembered for the boom in commodity prices.

The two market leaders in commodity trading, Goldman Sachs and Morgan Stanley, made billions. Barclays Capital and Deutsche Bank increased their market share. Merrill Lynch, which had developed cold feet after being mugged by rogue traders, finally saw its mistake and threw its hat back into the commodities ring.

Goldman Sachs raised the ante by buying physical power stations to ensure electricity supplies, but then Goldman is always one jump ahead.

Experienced commodities traders were bid, not offered and became among the highest paid people in the financial services industry.

Shareholders in Citigroup and JP Morgan Chase should ask why these banks have not become powerhouses in commodities. There is really no excuse.

What was the secret in making money out of commodities? In fact, it wasn't that difficult. All you had to do was see what China was buying in bulk and then fill your boots.

It wasn't just oil and raw materials. Even formerly stodgy gold had a good year, and some food prices soared. Speak to your favourite Italian restaurant owner and he or she will confirm that the price of mozzarella cheese rose by almost 60% in 2004. Don't order an extra sprinkling of white truffles unless you have won the lottery.

How did the investment banks fare in their currency trading? Volumes were huge, but unlike most commodities, trading in currencies wasn't a one way street. Back in January, who would have guessed that the US dollar would start to crumble and then fall like a stone after President Bush was re-elected?

Turn the clock back five years and how many global economists would have predicted that the world's foremost superpower, the United States, could be told to put its financial house in order by the world's largest Communist country, China?

How many US fixed income investment managers with their reference currency in dollars produced dazzling returns by simply buying nothing but bonds denominated in euros?

Probably not even the legendary Bill Gross of Pimco, but then the American attitude towards currencies has always been insular.

Hedgies howl
Was 2004 a year the hedge funds would prefer to forget? Yes, indeed. Suddenly, those former masters of the universe were scrabbling around to make nickels and dimes.

Our favourite telephone call of the year told us, ?Short Man Group and buy Man United.? Not only should we have listened, but we should have immediately executed the trade.

Man Group shares plunged in the short term because they were being unceremoniously shorted by other hedge funds, who saw that an easy killing would be made. Meanwhile, Manchester United shares rose as a sporting chancer from Texas thought he could buy the club on the cheap.

But for many hedge funds, 2004 was the year when the chickens came home to roost. There just weren't very many good trading opportunities similar to shorting Man Group.

Volatility, which is the hedge fund's oxygen, almost disappeared. There were few merger arbitrage opportunities because there were relatively few big mergers, and at least half of those announced failed to reach the finishing line.

The old, reliable standby of playing clever games with convertible bonds became less attractive as convertible issuers, knowing that hedge funds were buying up to 50% of every offering, made their deals more expensive. Increasingly, the hedge funds resorted to plain old-fashioned punting and abandoned their black boxes and state-of-the-art computer systems.

Botín steals Barclays' thunder
What happened to all of those bank mergers which were supposed to take place in 2004? In the previous year you at least had Citigroup playing footsie under the table with Deutsche Bank, while Bank of America, having decided that Barclays was too hot to handle, acquired FleetBoston in a transaction which Wall Street initially pooh-poohed, but which is now looking rather good.

But in 2004 there was very little excitement in the banking sector. The world's two smartest serial acquirers, HSBC and Royal Bank of Scotland, attended some financial car boot sales and picked up tiddlers.

Why did HSBC walk away from the Japanese sub-prime champion, Takefuji? It seemed to be tailor-made for HSBC, but Sir John Bond may have bigger fish to fry.

Once again, all eyes in the United Kingdom were on Barclays Bank. Having shimmied out of Bank of America's reach surely Barclays, which still makes mountains of money, even with its mortgage business slowing down, would make a significant move of its own?

But it was not to be, except for the possibility of buying back into South Africa. (Does any of the current generation of Euromarketeers remember the glory days of Barclays DCO, when regional DCO managers drank pink gins on their verandas and quite regularly died from malaria?)

The UK banking thunder ? or was it more a small paper-bag pop? ? was stolen by Luqman Arnold's Abbey, which announced a merger with Emilio Botín's Banco Santander Central Hispano.

When the news broke that the two groups were talking about a full Spanish takeover, you would have thought the year was 1588 and the Spanish Armada had been sighted off Land's End. The small Abbey shareholders were up in arms.

They may pour down to the Costa del Sol on package holidays with their horrible children, but why would they want to accept shares in a Spanish bank with an unpronounceable name? Worse still, the Spanish bank's shares were quoted not in pounds, but in those difficult to understand euros.

Because Abbey was one of the last prizes left in the UK retail banking sector, the bookmakers immediately quoted odds against Abbey falling to the Spanish. And the bookies seemed to be on the right track.

Hadn't Abbey exchanged visiting cards with Citigroup in the previous year? Despite being the largest bank in the world in terms of market capitalisation, Citi had missed the boat in the UK. Abbey wasn't big, but it would have been a useful entry point for Citigroup into the UK market.

And surely Lloyds TSB and HBOS were also interested in Abbey? Indeed, Lloyds had tried to buy the old Abbey National at a price which was far too high, but had been luckily refused permission by the regulators.

In 2004, Lloyds appeared to be going precisely nowhere, and a new bid for Abbey might convince its long-suffering shareholders that the senior management had not succumbed to an attack of sleeping sickness.

Then there was HBOS, with James Crosby in charge. Four years on, HBOS is still indignant about the way Bank of Scotland, which made the first move for National Westminster, was brushed aside with contemptuous ease by Royal Bank of Scotland.

That acquisition made Fred Goodwin's RBS into a global super-bank. HBOS, by comparison, is a minnow. Buying Abbey would therefore help HBOS both to upgrade and to save face.

But HBOS dropped the Abbey catch and in 2004 may only win prizes for being the most indecisive bank of the year.

Santander Central Hispano now had the field to itself and the Abbey acquisition was duly completed, notwithstanding some last protests from the small shareholders.

This was a victory for Abbey's chief executive, Luqman Arnold, who had always preferred the Spanish bid, and the estimated £15m he will receive seems a very reasonable reward for turning Abbey round and saving the bank from an early grave.

Speak to Arnold and his senior managers and they will confirm that when they arrived they had serious doubts as to whether Abbey National could be rescued.

Thanks to Arnold, the shareholders received a very good price and the small investors who complained so bitterly are likely to find that Santander Central Hispano is actually a more efficient bank than the old Abbey.

Deutsche's distractions
In continental Europe, there was a great deal of banter and hot air about cross-border acquisitions, but very little action.

The recent talks between Dexia and Sanpaolo IMI seem to have lasted about five minutes before being abandoned. However, even if neither bank ever played in the premier league, it didn't seem a bad idea, and didn't you also get the impression that Dexia would do almost anything to avoid being rolled over by the French?

Deutsche Bank has always been the innovative leader in continental Europe, and in securities trading and investment banking it is streets ahead of the European competition.

Deutsche would like to grow to ensure that it is among the 10 largest global banks in terms of stock market value, but it didn't help that the bank's chief executive, Josef Ackermann, had to spend many months in Düsseldorf facing silly charges which were eventually thrown out of court.

The case should never have been brought to court in the first place, and it unnecessarily deprived Deutsche Bank of its leader at a crucial stage of the restructuring process, which Ackermann had himself initiated.

To make matters worse, Ackermann had problems at home in Deutsche's Frankfurt HQ. For reasons which even German psychiatrists have found difficult to explain, there was a renegade minority group of grizzled Deutsche veterans and assorted yesterday's men who didn't approve of progress, which was at the core of Ackermann's new business plan?

The renegade minority would have preferred to return to the bad old days when the bank went round and round in circles, it was almost impossible to be fired and Deutsche seemed to enjoy lending money to companies that didn't want to pay it back.

Deutsche Bank shareholders can count their lucky stars that the wacky minority was finally booted into touch and that the leaders of the group have been gently escorted away to rest homes by the Baltic Sea, or in the tranquillity of the Black Forest.

What are Deutsche's plans for 2005? We are not privy to Josef Ackermann's secrets, but you may be sure that this isn't the European bank which is going to stand still and gather moss.

Can Ackermann rely on a sustained high level of earnings from the securities trading and investment banking businesses, run by Anshu Jain?

These divisions have now carried the bank for several years, with fixed income providing most of the momentum. Some analysts in the UK and Germany say that Deutsche is too reliant on fixed income, where it is the best in the industry by a substantial margin, and does not receive sufficient support from equities and investment banking.

That may have been the case in the past, but will we see some improvement in 2005, now that Jain has taken over equities as well as fixed income?

Ackermann himself may be hoping that the new year will bring a further recovery in Deutsche's share price to provide him with a stronger acquisition currency.

Spitzer's shadow
A reasonably well respected London securities lawyer suggested that we should make Eliot Spitzer one of the personalities of the year. Sorry, but we have little sympathy for regulators and especially those who clearly enjoy leading a public witch-hunt.

The reality about Mr Spitzer is that he was out-foxed and short-changed by Wall Street and that his cleansing of the US mutual fund industry died a death and is now largely forgotten. His exposure of the insurance broking industry was well timed, because there are more bandits and cowboys in that business than in a spaghetti Western.

But that attack has also run out of steam, which is exactly Eliot's style. Probably because he is understaffed, he picks some easy targets, extorts a few heavy fines but then rides away with the job not even half-finished.

Because he wants to become governor of New York State, he uses all the media resources at his disposal to project the personal image of a crusader and a champion of the little people. When he finally becomes governor, his lion's roar may turn into a whimper.

Goldman leads the superstars
Which banks and investment banks performed best in 2004? Who were the laggards? Who might make a significant move in 2005?

Although the firm doesn't go out of its way to make friends, there is no question that Goldman Sachs was the investment banking superstar of 2004.

Goldie didn't drop any serious catches in fixed income, it made squillions in commodities and its name was in the frame in almost every important M&A deal.

Just look to Asia to see some of Goldman's smartest and most profitable transactions. Goldman is simply very good at identifying and then acquiring cheap financial assets.

The chairman and CEO, Henry Paulson, may not be a stand-up comedian, but he is a much better leader than some of his Wall Street counterparts. Goldman's share price is back above $100. If, as seems likely, 2005 will be a challenging year, wouldn't you also bet on Lloyd Blankfein's traders at Goldman being able to read the direction of markets better than their competitors?

Who also deserves a round of applause? We have heard consistent praise for Lehman Brothers throughout the year. In 2004, respected commentators have been saying that Lehman is one of the best managed investment banks in the world. Ten years ago, in 1994, we would have voted it one of the worst. Hasn't the world turned full circle?

Royal Bank of Scotland and HSBC have made huge strides in fixed income securities trading. Barclays Capital is, at least in our opinion, the outstanding bond house of the year, and UBS has the investment banking blue-print which many lesser houses would like to find in their Christmas stockings.

Citigroup in the doghouse
And which house lost face more times in 2004 than Liz Taylor or Cher's make-up artists?

Come in Citigroup, which spent so much time in the dunce's corner that it might have been a prison sentence.

What is Citi's problem? Is it that, with around 300,000 employees, it has simply become too large? Does the legacy of the inspirational Sandy Weill encourage Citi managers to maximise profits at any cost, even if this means risking a brush with the regulators?

Surely not, as this would remind us of Credit Suisse First Boston in its most swashbuckling days under Allen Wheat.

Citigroup's chief executive, Charles Prince, would probably argue that the bank was simply unlucky in 2004 and that it is not possible to exercise total control over 300,000 staff.

Only very recently, Hank Paulson said that Goldman could not be responsible for every member of its 20,000 payroll when he commented, ?in every town of 20,000 there is a gaol?.

How very true, Hank, but that's not the point. If Citigroup continues to make silly mistakes, the shareholders will hold Prince accountable.

Who, therefore, wants to be a chief executive, you might ask? Well, apart from the sky-high pay, the prestige, the round-the-clock limos and private jets at your beck and call, the job may not be as attractive as it once was.

Isn't the real problem that many employees, especially on the proprietary trading and structuring desks, are smarter than their chief executives?

Think about it. Chuck Prince may rant and rave about that now infamous government bond trade in Europe which blindsided its competitors and made the bank a cool Eu20m in a few hours.

Of course it wasn't quite cricket, and the opposition duly howled with indignation. However, the fact is that even if the traders had asked Prince's permission, he wouldn't have understood the transaction anyway.

Once again, HSBC's chairman, Sir John Bond, was right on the button when he was asked why some key HSBC line managers in North America were paid multiples of his own earnings. Sir John's response was: ?Those people have different skill-sets to you and I.?

2005 ? the year of Armageddon?
What are the prospects for the financial services sector in 2005? The banks and investment banks have nothing to be ashamed about in their share price performance this year ? even Credit Suisse has shown that there is life after near-death.

If you read global strategists such as Stephen Roach of Morgan Stanley, we would advise you to either wear brown trousers or have a bottle of absinthe close at hand. Roach thinks that Armageddon is not an outside bet. He draws attention to the disappearing dollar, horrendous and probably unmanageable consumer debt in North America and the developed European countries and an imminent collapse in house prices.

Of course, he is right, but these problems didn't surface overnight. Share prices should probably be lower and dollar bonds in a tailspin. However, they are not.

The markets have, in fact, been remarkably resilient and if Armageddon was really around the corner, would Morgan Stanley shares be close to their year's high?

Almost certainly, 2005 will not get away to the flying start which we saw in 2004. What we need are more Google-type IPOs and a wave of mergers similar to K-Mart and Sears Roebuck.

Banks and investment banks may finally get off their duffs and pair up ? and please may we not have another year when Santander Central Hispano's purchase of Abbey was considered to be one of the highlights. 

  • 14 Jan 2005

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 415,838.72 1590 9.03%
2 JPMorgan 379,647.36 1732 8.25%
3 Bank of America Merrill Lynch 359,324.90 1302 7.81%
4 Goldman Sachs 267,102.04 920 5.80%
5 Barclays 266,010.35 1070 5.78%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 44,979.63 190 6.68%
2 Deutsche Bank 37,125.85 136 5.51%
3 BNP Paribas 36,403.69 206 5.41%
4 JPMorgan 33,752.71 110 5.01%
5 Bank of America Merrill Lynch 32,865.23 106 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,398.41 104 8.72%
2 Morgan Stanley 18,608.72 99 7.25%
3 Citi 17,768.49 110 6.92%
4 UBS 17,372.80 70 6.76%
5 Goldman Sachs 17,228.66 97 6.71%