Goldman Sachs and Work-Life Balance

Goldman Sachs announced this week that it had instituted ways to improve the work experience of analysts (in its BA program) and reduce the number of hours they work each week. It's the lore of investment banking to hear stories of analysts and MBA associates, too, who work long hours that stretch through the weekend and through holidays and vacation time.

Goldman acknowledges that it is missing out on some top talent, when recruits have selected other finance jobs or industries because of work-life-balance issues. Talented BA's and MBA's will express an interest in corporate finance, will have the aptitude and drive to work on deals and with important clients, but, as Goldman sees it, they back out and accept offers elsewhere. And they may whisper to Goldman and other major banks that it wasn't about the compensation.  Thus, they choose pathways that take them to the shorter hours and better lifestyles offered by hedge funds, smaller boutique firms, and the finance or strategy departments of non-financial companies.

Goldman, for its part, will discourage analysts from working weekends.

Big banks have tried to address these issues over the past 13-15 years, going back to the times when banks risked losing talent to dot-com opportunities. But the slope is slippery. They implement programs and try to change the culture. They make promises to recruits and junior bankers.

Yet in the trenches, old managerial habits surface, and analysts and MBA associates are pushed to extremes to help in deals, to do extensive modeling and research and to participate in elaborate client pitches. No matter how hard banks try to tweak and twist the work culture, mid-level bankers face unbearable pressures to win deal mandates, generate revenues, manage risks and comply with new regulation--without regard to firm rules about working weekends or until midnight. For some middle and senior bankers, there is a little bit of "because I did it, they ought to, too."

Often the messages of improving work experiences, coming from senior managers far removed from deals and clients, are lost in execution or not enforced fairly or properly. The deal, the pitch and the demands of the client becomes the modus operandi.

Still, because this is Goldman, the industry will watch how this unfurls. Goldman has said that, if necessary, it will hire more analysts to compensate for work not getting done during weekends.

The reports, at least what has come out, don't address work-life issues for MBA associates. Therefore, although the firm likely wants to improve work experiences for the older group, it wasn't ready to say they (the associates) can have all weekends off, too.

Tracy Williams

See also:

CFN:  Delicate Balance:  Long Hours and Personal Lives, 2010
CFN:  Is I-Banking Still Hot? 2011
CFN:  Summer-Internship Experiences, 2010

Apple, With All That Cash: Revisited

Billions and billions in cash, still

In corporate-finance circles,  Apple presented a delightful dilemma in much of 2012.  What should it do with its billions of cash, sitting on the balance sheet, earning paltry returns in safe markets, causing restlessness among shareholders who felt entitled to special dividends to get access to it? Should it use cash to repurchase some stock, a few shareholders pressed?

Shareholder activists clamored for cash pay-outs and even devised ingenious financial maneuverings and new equity instruments to get to it.  The current generation of Apple managers, with Tim Cook at the helm as CEO, grew up with Steve Jobs' abhorrence of debt markets and his clinging to a security blanket of hoarded cash if only to endure tough times.

Apple has often countered--in carefully worded ways--that much of the cash it maintains appears in foreign subsidiaries, cash that couldn't be efficiently repatriated back to the U.S. into the hands of shareholders without the company paying onerous taxes on it. This argument may make sense to corporate-finance managers, but wouldn't sit well in the public media.

After shareholders fussed enough in the past year, Apple decided to tap debt markets and borrowed $17 billion to use some funds to give shareholders a gift (via dividends and share repurchases). Apple wasn't desperate for new funding, but appeased shareholders while taking advantage of low rates in the marketplace.

Often at established companies, new-debt funding is channeled into new investments, new acquisitions, or aggressive expansion or into replacing old, more expensive debt.  Apple's borrowing helped quiet teeming shareholders and proved to capital markets it could get comfortable with the process of taking on new loans and issuing corporate bonds, if it ever needed to.

With the debt now in place, what is the flavor and look of Apple's balance sheet today?

1.  Cash reserves.  Funds from the new borrowings might have been a gift to shareholders, but Apple continues to be a formidable cash-generating machine in its global operations.  By late summer, Apple's cash accounts (including some liquid short-term investments and excluding much of what's held abroad) had almost doubled over the past year to amounts above $42 billion.

With debt proceeds, it provided gifts to shareholders, but cash will continue to climb as the company continues to be profitable. The company is operating at a pace of generating about $7 billion in new cash every quarter.

2.   Debt on the balance sheet.  For once, there is long-term debt on its balance sheet, $17 billion. But it's still insignificant.  The closely watched debt-to-equity ratio is still so low (0.13) that it would hardly cause a blip on the analytical screens of ratings agencies and investors. Every bit of that debt could be paid down within days with cash on hand, if it chose to do so.  No need to wait for cash generated from operations.

3.  Debt capacity.  Is there any room for more debt (to help increase ROE, if not fund new projects), now that it has gotten a first bite of it? With cash flow of that magnitude, the company has lots of room to borrow more if it needed to or wanted to.  Interest expense on the new debt each quarter will total less than $200 million--having no burden on a company generating $6-7 billion in new cash quarter after quarter and already with over $40 billion more sitting aside with little agenda.

The company could arguably borrow another $50 billion before investors and ratings agencies might start fidgeting. This assumes Apple will continue at a modest growth pace and the whole globe is at least somewhat infatuated with its product offerings.

These transactions in 2013 were all about tests and gifts for Apple--a test to see if it can become accustomed to debt markets and a gift to get shareholders off its backs. It passed the debt test. Shareholders, however, will become spoiled and will continue to look for more dividends and repurchases, as Apple piles on $5 billion or more of new cash quarter after quarter.

Tracy Williams

See also:

CFN:  Apple's Stash of Cash, 2012
CFN:  What Happened at J.C. Penney, 2012

The Verizon Deal: Big Numbers, Big Debt

When the deal was announced, some surely gasped.  The fact that Verizon Communications decided to purchase all of Vodafone's stake in Verizon Wireless was not a surprise.  Vodafone had decided to sell its stake and units in mobile phones.  What likely caused market observers and headline writers to turn their heads in wonder was the size of the deal, the big numbers. They were huge.

Deals and big numbers excite investment bankers and can spur them to pant and salivate. In the Verizon case, they certainly will, once Verizon gets around to handing out advisory and underwriting checks for fees. Deals and big numbers tend also to cause hiccups and coughs among some investors, research analysts and bank risk managers.

This deal is big, one of the largest ever. Perhaps it sends too many hopeful signals that an era of super-size deal-making has returned.  Verizon Communications announced it will pay a whopping $130 billion for Vodafone's stake. To raise $130 billion to pay Vodafone, it will issue about $60 billion in new stock and tap various other accounts and reserves for billions in cash. It will borrow another mind-boggling $49 billion in bank and debt markets in one of the largest debt deals ever.

While some industry experts applauded this announcement, the stock market gulped, trying to figure out the true impact of Verizon digesting all this new debt onto its balance sheet. Verizon's stock value fell 3% on the day of the announcement.

The deal will probably be approved by regulators, will likely be executed, and will just as likely work--meaning, shareholders will gain value because of it and debt-holders, while crossing their fingers, will receive the regular cash interest payments due to them each quarter.

But some flags emerge. They send signals to investors and credit-risk managers that the deal is not a no-brainer.  It must be assessed carefully.

1.  Verizon already has over $40 billion in long-term debt.  Now add $49 billion in more debt, and that sums up to over $90 billion in total debt.  To manage this mountain of debt, Verizon must generate over $3 billion of year in cash flow to handle just the interest expense.

Is the company capable of handling this burden?  The company operates at a pace today of generating about $10-12 billion/year that can be used to handle debt obligations.

That translates roughly into a Debt/EBITDA ratio equal to about 9.0. MBA finance students know well how this ratio can be used to compute a back-of-the-napkin analysis of whether debt levels are manageable.  It suggests that for Verizon, while the debt is manageable, there may be little wiggle room if cash flows from Verizon businesses fluctuate, as they easily can.

Routine business operations must generate the flow of cash to manage this extraordinary debt load. But there may be periods when something else must take a back seat:  Shareholders, for example, in one quarter may not get all of their entitled dividends, something they've grown accustomed to.  And when substantial new investments are necessary, they will likely be funded by issuing new stock.  The existing financial framework couldn't bear more debt--at least for now.


2.  Verizon's balance sheet spurs a few questions, too.  This is a capital-intensive business, so its nearly $90 billion in plant and equipment is no surprise.  This is also a technology business, so its nearly $100 billion in intangibles and goodwill (from acquisitions, copyrights, patents and more) is not a surprise.  But those assets are supported by "only" $34 billion in equity capital.

After the Vodafone deal, equity capital will increase substantially, but so will the amount of intangibles and goodwill---legitimate assets in the eyes of accountants, but assets that can't be touched and felt, in the eyes of investors and debt-holders (assets that also don't generate a steady flow of cash flow from quarter to quarter).

When analyzing a company, analysts prefer to subtract out intangibles/goodwill when computing the book value of a company (equity account). At Verizon, net tangible equity is computed to be a negative amount before the deal and after the deal. That often implies that debt funds all activities on the balance sheet, and there is little room for error, if the company runs into economic headwinds, and earnings (and cash flow) start to bounce around.

3.  Unlike other large companies with significant cash reserves,  Verizon may not have a comfortable stash of cash to meet unexpected cash shortfalls or required investments.  It would rely on external markets, sometimes in times when external markets wouldn't be kind.

What do ratings agencies think? They are in the ballpark.  Moody's and S&P currently rate the company Baa1 and BBB+, respectively--about what you would expect when there is already a significant debt burden and if bad times could jeopardize paying what's due on debt. With "stable" outlooks, the ratings agencies also observe that Verizon will be able to make investors happy.

Why would investors buy the debt? It's all about the interest-rate returns that investors can't get in other fixed-income investments. One tranche or segment of the new debt will yield 5.22% to investors over 10 years, a return that's not easy to obtain in a low-interest-rate era (even with recent interest-rate volatility and spikes, given uncertainty in Washington). That yield is enticing, and in the eyes of some, worth the risks described above.

Tighten up your belts.  This is a corporate-finance deal that can work, but there could be some bumpy moments along the way.

Tracy Williams 

See also:

CFN:  Libor in Crisis, 2012
CFN:  Why Is Dell Going Private, 2013
CFN:  Merger Mania, Boom Times Ahead, 2013

Now It's Twitter's Turn

Now it's Twitter's turn. It hesitated for the past year or so. This week (Oct., 2013) it bravely stepped into IPO waters, taking the first big step by sharing publicly its SEC filing and letting the financial world see its bottom line.

Twitter's hesitation, like all companies contemplating issuing stock to the public for the first time, results from trying to determine the optimal moment to sell stock in equity markets. That's often tied to market interest in the stock issue, supply and demand for the stock, and general equity-market trends.

Its hesitation may have also resulted from other factors: (a) its being shy about letting the world pore through its true financial performance and (b) its desires to avoid the IPO debacle Facebook experienced last year at Nasdaq with Morgan Stanley as the lead underwriter.

Twitter through the years has had to wrestle, too, with management and organizational issues. Some of those problems have been resolved, and the company has moved on to capitalize on its soaring popularity around the world.  In the filing, Twitter reports 218 million users on average each month this year, up 44% from a year ago.  Not quite Facebook numbers, but sufficient growth to get prospective investors interested and excited. Twitter might argue that the value or meaningfulness of ongoing usage is different than account activity in, say, Facebook or Linkedin. Hence, it's not how many use the site, it could argue as it sells new stock, but who uses it and how it's used. 

Because of the planned IPO, Evan Williams and Jack Dorsey, Twitter founders, can now calculate more accurately their fortunes (over $400 million each). A handful of venture investors will have a nice payday, as well.

Twitter in the filing divulged what many thought was the case. It continues to have losses with no signs those losses will turn into profits in the short term.  Investors in its stock, therefore, will bet that the company will continue to experience stellar growth in users, will find even more effective ways to generate advertising revenues, and will eventually turn losses into steady, growing profits by keeping costs under control.

The company will raise $1 billion in the IPO offering.  Investment bankers advising Twitter have suggested the company today has an implied market value of about $10 billion. How then does the company have such value, the corporate-finance novice asks, when the company reports losses with no expectations of profit in the short term?  SEC documents indicate the company lost $79 million last year and $69 million in 2013 to date.

Investors who will buy the stock are assuming profits are on the horizon. They will come because there are still vast opportunities to grow the number of users, grab more advertising dollars, and, therefore, increase total revenues substantially. They will buy the stock based on expectations, not based on history.

For now, investors and those who assess the value of the firm will value the company based on a reasonable estimate of growth prospects and based on refined projections of users and revenues. Revenues for the six months, 2013, doubled from the previous year, Twitter reports, while number of users continues to grow.

Investors and advising banks have Facebook and Linkedin as convenient benchmarks:  They study and compare current market values of those companies' stocks, their numbers of users, the activity in the millions of accounts and the level of sales and sales growth.  Investors will, too, assume the company, now under the guidance of CEO Dick Costolo, will invest in whatever technology is necessary from year to year to keep the engines going.

Twitter has few competitor threats. No other social network is about to topple it in doing what it does best in those 140 characters. But Twitter, along with Google, Facebook, and Linkedin, all chase after the same pool of advertising dollars. Companies seeking to advertise digitally must decide where they can get the biggest Internet bang without particular regard to the specific roles social networks play.

Goldman Sachs, winners of the investment-banking shoving match, will be the lead underwriter and will be assisted on the front lines by Morgan Stanley and JPMorgan.  The challenge they have as advisers, besides setting precisely the price of a single share, is to form a view of markets in the face of October's U.S. Government shut-down and recent equity-market uncertainty. But that's why they will be paid tens of millions of fees. They must step up and make such decisions and, especially after last year's rough launch, avoid a 2012 Facebook near-catastrophe.

Tracy Williams

See also:

CFN:  Facebook:  The Lucky Underwriters, 2012
CFN: Facebook Stock:  What's Going Wrong? 2012
CFN:  Did Goldman Overpay for its Facebook Stake? 2011

Merger Mania: Boom Times Ahead?

Is this an era of good feeling in mergers and acquisitions?

Time for a break-up or spin-off?

Every other day in the financial media, a deal announcement soars through the headlines.  Dell's founder, Michael Dell, wants to buy back his company, but others bid for the same and "put the company in play" (sort of). US Airways and American Airlines agree to a blockbuster combination that lifts one of the companies out of bankruptcy. Warren Buffett and his Berkshire team decide to purchase Heinz for $23 billion, reinforcing the long-time notion that Buffett has the uncanny knack for extracting value from even the most mature food-products industries.  Sprint Nextel has its eyes on Clearwire. 

In the past week, an aggressive activist investor wants to shake up Sony Corp. and spin out its entertainment division, the unit that includes movies and music labels. Dan Loeb, using his Third Point investment-fund vehicle, prepares to take on the entrenched customs of the Japan financial system, which has always been a guardian of the country's ancient corporate practices and traditions.

Loeb argues that the market is under-valuing the entertainment division because profit margins are not as high as they could be and because performance will improve if its management group "focuses" sufficiently on operations. His argument and his finance logic are not unorthodox.  The daring boldness of his approach toward board members in their country is.

Yahoo, always scrambling to remain relevant and stay on the same stages as Google and Facebook, decides to toss $1.1 billion in the way of Tumblr and acquire it.

Have we wandered back into an era of big deals and industry-shaking merger transactions?  Are the times ripe for companies to stop hoarding billions in cash and start doing something productive with it?  Will we revisit the days of the explosion of deals in the late 1980s or the bubble bursts of the mid-2000s? Will transactions in recent months spur other companies, bankers and investors to do even more?

For a year or two after the financial crisis, companies recovered and conducted business, but they held onto cash generated from operations.  Misers, more or less, they were, in a word, scared. They hesitated to reinvest in new businesses and expansion. They worried about the coming of yet another crisis. They stuffed cash into safe, low-yielding assets because they worried they might not be able to tap debt markets to borrow, even if they could borrow at absurdly low rates. (Apple's billion-dollar stash in 2012 was the stuff of headlines and editorials--until this year when shareholders started pleading with the company to do something with it.)

Companies sat on the financial sidelines--not sure what was looming ahead, not sure of the impact of Washington political winds, not sure when the recovery would ever resume. With stock markets crumbling and volatile and with nobody able to project an economic turnaround, companies weren't eager to make acquisitions, do deals or do much of anything--except wait it out. 

As markets have recovered and business confidence has surfaced, companies with mountains of cash are deciding they must do something. They have begun to feel the pain of purchasing U.S. Treasury securities that accrue virtually no return. With equity markets on a roll--at least in early, 2013--companies can comfortably elect to do cash or stock acquisitions in the way they couldn't rationalize a few years ago. 

But does that explain recently announced big deals?


Statistics actually show merger activity in 2013 running at about the same rate as last year--in number of transactions in the U.S., around the global, in fees generated, and in the aggregate value of deals. Hence, the industry and market celebrate the fact that spikes of last year are not necessarily spikes, but perhaps signs of a new trend.

Through April, according to Factsheet, there have been about 10,000 announced corporate mergers, acquisitions, takeovers, or buy-outs involving U.S. companies over the past 12 months, slightly less than in the previous 12-month period.  The aggregate value of transactions is slightly higher. Certain industries have experienced more significant growth the past year:  broadcasting, real estate, computer hardware and retailing. 

The leading banks in advising companies tend to be the familiar crew of top investment banks:  JPMorgan, Goldman Sachs, Merrill Lynch, Credit Suisse, Barclays and Citi. Despite having withdrawn from much of investment banking, UBS is still booking remnant merger business.

Over the past few years, a couple of boutique banks, Evercore and Centerview Partners, have slipped through the back door to join this elite club. Evercore nudged its way in 2012-13 with key roles in deals involving Dell, Kraft Foods, and Ally Financial. It ranked 10th among global banks in the aggregate value of deals done in the first quarter, 2013, according to the Financial Times.


The stir around Sony will be intriguing to watch. Gather and get a front-row seat.  You have an irascible investor who likes to get his way and who has a sound track record. He bursts into Sony's offices in Japan to demand that the board respond to his request to spin out the entertainment group. (This week, the board agreed to ponder his demands.)

This kind of corporate jockeying and board-room maneuvering is nothing new in the U.S., but Loeb and Third Point are taking on a different culture, a country not accustomed to takeover tactics or threats from billion-dollar investment funds based in the U.S. However, these are better times even in Japan. Its economy has escaped doldrums under its new prime minister Shinzo Abe, who has taken the right steps to give it a swift kick. Japanese companies and investors might be open to Loeb's ideas--especially if they result in improved returns for all shareholders and two stronger companies.

Yahoo will be watched, if only to see if it can finally get one right. Yahoo is known for errant strategies and botched acquisitions and lagging behind the Internet-eyeballs race . With a new CEO (Marissa Mayer), who has injected hope, energy, and discipline into the company, the market might give it the benefit of doubt and treat the Tumblr acquisition as something that makes sense.

The deal numbers, the league tables, and merger statistics don't point to these being the best of times for merger bankers and private-equity investors. It's not 1986 or 2005 all over again.  Brisk, consistent activity, nonetheless, suggests we are far beyond the deal paralysis of the crisis, even with some large companies still paranoid and protective of some of their stashes of cash. 

The best of times? No. Better times than before? Yep.

Tracy Williams

See also:

CFN:  Boutique investment banks, 2009
CFN:  Today's Bulge Brackets, 2012
CFN:  Outlook, 2013
CFN:  Apple's Stash of Cash, 2012

What Will Dimon Do?

WWJD. Not what would Jamie Dimon do? But what will Jamie do?

Waiting Anxiously for the Shareholder Vote

In a matter of days, JPMorgan Chase shareholders will find out the results of a crucial vote to determine whether Chairman and CEO Jamie Dimon should relinquish  his role as Chairman of the bank holding company. In a similar vote last year, 40% of shares outstanding voted for him to give up the role as Chairman.  A year later, Dimon and JPMorgan have had to digest continual impact from the billions in trading losses in the infamous "London Whale" credit-derivatives debacle. They have endured stiff criticism from regulators for how JPMorgan managed those losses and for how regulators perceived the bank was behaving in response to inquiries.

Dimon has already been penalized for "Whale" mistakes when his 2012 bonus was reduced, even as JPMorgan continued to generate extraordinary earnings last year and in 2013's first quarter. His inner circle of senior managers (operating committee members) has changed faces substantially with some departing, some nudged out, and others promoted.

(JPMorgan reported record income of $21 billion in 2012--good enough for a 15% return on equity. It earned $6.5 billion in the first quarter, 2013. By year-end 2012, the bank reported assets exceeding $2.3 trillion supported by an equity base of over $200 billion.)

Some shareholders, who have large stakes and have stepped into activist roles, want to make sure such trading losses or astounding surprises in mismanagement will never occur again. They want to reorganize board membership, juggle risk-management oversight, and put more checks in the checks-and-balances of Dimon's power over the organization.  In effect, some contend that JPMorgan-related mishaps might not have occurred if Dimon had a chairman peeking over his shoulder.

As the vote counting winds down, the question for the moment is not what should Dimon do or what would he do.  The question? What will he do if the role of Chairman is seized from him?

His storied banking resume' indicates he doesn't like playing second-fiddle. He's comfortable biding a little bit of time as he awaits a top spot, but he fidgets and fumes if the wait is prolonged. Moreover, certainly he wouldn't want to give up power, authority and influence he has had for eight years or more.

Since he has been JPMorgan's head, he has not had a formal second in command, a president waiting in a green room for him to retire.  When JPMorgan purchased Bank One ten years ago, where he had been Chairman and CEO, he agreed to be President and CEO-in-waiting.  Typical of Dimon, he itched to assume full control of the bank sooner than he was supposed to. From the moment he arrived in New York from Chicago, he aggressively pushed his agenda of expense-control and balance-sheet strengthening, while then-CEO Bill Harrison was still in office.  Back then, Dimon urged the board to make him Chairman and CEO months ahead of schedule. That was no surprise.

Before JPMorgan and Bank One, Dimon had made his mark at Citigroup. As Sandy Weill's long-time protege' when the two of them built a financial-services behemoth during the 1990s, Dimon, over time, agitated his boss, even undermined him. Eventually a power struggle and some fiery situations caused Weill to fire his favorite deputy. Dimon might have been the CEO of Citi today (and Citi might be a much different organization), if he were willing to play fair and square with Weill.  Weill had the last word, and Dimon went on to make financial history elsewhere.

What will Jamie do if he's no longer chairman of JPMorgan?

Will he remain as CEO and proceed to manage the bank in the way he has since the financial crisis--expanding in all areas, controlling costs and operations, restructuring the mortgage businesses, and hustling to keep a trillion-dollar bank under control? Will he be willing to subject his strategy, actions, and every managerial move to the second guessing of a non-executive chairman--especially when Dimon hasn't been accustomed to such in the past decade?

Or will he agree to finish out the year or two as CEO and opt to retire sooner than he expected? Will he cooperate, manage the global business, and assist in selecting a CEO successor and grooming him or her? Will he cooperate, too, if only to ensure his own shareholder stake in the bank (over hundreds of millions in ownership) is not jeopardized?

Amidst this debate of corporate governance, many have taken sides. Some have pointed to studies that show the impact of separating the two roles.  Many of the studies indicate little, if any, favorable impact on a company's revenue or earnings growth or stock price when the roles are separated.

Jeff Sonnenfeld, a senior associate dean at Yale's School of Management, a Consortium school, in The New York Times this week called the shareholder vote at JPMorgan a "Jamie Dimon Witch Hunt" and reminded readers that some of the most scandalous companies in the last century, including Enron and Worldcom, had separate Chairmen and CEOs.

Other experts point out the decision to separate should not be determined by previous studies, but by the particular challenge or issue that confronts the company. Case by case, they say. In the case of JPMorgan, the challenges are to (a) manage the complex risks and operations of a financial institution almost too big to fail, (b) respond to, report, and manage the escalating requirements of regulators, and (c) meanwhile, continue to grow revenues, earnings and a stock price that seems to have trouble eclipsing the $50/share threshold. Some of the proponents in the shareholder vote think JPMorgan can overcome these kinds of challenges with two people in charge.

But what happens to JPMorgan and its ability to confront these issues if one of the two is not Dimon? Is Dimon about to bolt out the door?

Here are a couple of scenarios.

1.  Shareholders vote to keep Dimon as Chairman, but the vote is close, say 51%-49%.  Dimon, therefore, won't linger or care how close it was. With a short memory, he will proceed along his recent course--cooperating with regulators, gearing up for Dodd-Frank and Basel III, reshaping his inner circle, and driving his bank leaders crazy, pushing them to increase revenues, manage all risks imaginable, and control costs.

Several recent scoldings from regulators and all the attention in the press about confrontations with lawmakers and regulatory bodies will keep Dimon focused on issues of risk, regulation and compliance.  The bank is re-engineering its organization from front to back to ensure compliance and help comfort outsiders to show Dimon has things under control in the way it seemed he didn't--momentarily--during the "Whale" crisis.

Events of the past year will encourage him to be more forthcoming with the public about his intentions for succession.  He might even quietly support the effort that his successors be a separate Chairman and CEO. In recent months, with the shuffling among those in the inner circle and by appointing people into the roles of COO, he has offered clues. But in the past, he offered hints of who were the designated favorites one year, yet changed the slate quickly a year or two later.

2.  Shareholders vote to take away Dimon's Chairman title, but permit him to remain as CEO as long as he wishes. Dimon will be wounded. However, he would be a professional, uttering the right remarks about his support for the new structure. He would also likely regroup and contemplate next steps. He would not be comfortable taking directions regarding strategy and the deployment of capital from a part-time Chairman, especially if he feels confident his sole leadership is the best course.

As an experienced professional and an investor who will not want boardroom turmoil to inflict unnecessary volatility in the stock price, Dimon won't pout and play spoilsport. However, the thrill and energy of running JPMorgan won't be the same. The power he wielded within the organization may not be the same, because the buck won't any longer stop with him.

He would likely plan a retirement over the period of a year or two. Following the footsteps of former CEOs, like GE's Jack Welch, known for being accomplished, premier business managers, Dimon will review his achievements, reflect on them, and will likely want to write about them (or teach them to a business-school finance class). He won't sit still and will pursue something bold. He'll want to advise future bank leaders on what went right, what worked, how it all worked, and what went wrong.

And it's likely then he'll insert the last word to say that separating the roles of Chairman and CEO at JPMorgan might have been something, in his case, that didn't work as well as the status quo.

Tracy Williams

See also:

CFN: JPMorgan and Its Trading Losses, 2012
CFN: Jamie Dimon on Regulation, 2012
CFN:  Jamie Dimon's Message to Shareholders, 2011

What Happened at JCPenney?

Waiting for the invitable b-school case

Eventually this will become an intriguing business-school case, particularly for those concentrating in marketing and general management.  Activist investors push hard to re-engineer, restructure and revitalize JCPenney, the old retailing outfit--languishing in modern times, struggling to expand, and suffering with losses and a tanking stock price in the post-recession recovery.

The old CEO resigns, and the company figures it has found the solution in a dynamic new CEO, who would swoop in and radically change JCP by casting upon it magical dust from Steve Jobs and Apple.  JCP, amidst fanfare, hires Ronald Johnson after he helped spawn and lead Apple's broadly successful and wildly popular store expansion.  Apple, Jobs and Johnson had transformed the branch-store and electronic-purchasing experience into in-store theater.

JCP succumbs to the nudges from shareholder activist and prominent investor William Ackman. They reason that Johnson would similarly transform the low-retail customer experience into something resembling an Apple store in over 1,000 JCP stores across the country.

Johnson was supposed to bring the secret code to the magic of Apple. He brought revolutionary transformation to JCP, eliminated traditional discounting pricing, and altered the buying experience by setting up stores within stores. He instituted change in Apple-like ways.  Just as Jobs would do, he avoided detailed, quantitative marketing research and analysis.  Just like Jobs, based on experience and hunch, he decided that he could determine what customers want and decide how stores should be designed and structured. Jobs used to say customers aren't sure what they want, so he should determine that. Johnson approached JCP's customer base similarly.  

Two years later, JCP seems to be in a financial quagmire, a retailing mess.  The stock price fell from about $37/share to less than $14/share in the past year.  Sales last quarter fell over 20%, and the company has announced losses and management change. The bleeding had to stop immediately. It even decided to invite back former CEO William Ullman, as if it will contemplate a reversion back to the old JCP.

Marketing gurus and analysts will ponder this in the time to come and try to figure out what happened, why Johnson's strategy crashed, and why consumers who flock to whatever is new at Apple were turned off by Johnson's store changes and redesign. Business-school professors will decide this is a timely, significant case to study retail strategy, marketing management, and consumer behavior.

But there is a finance element to what happened.  The change was triggered by a large equity shareholder, activist Ackman.  He thought complete, rapid transformation was the best way to boost sluggish shareholder value. The company had--at that time--manageable debt loads, substantial amounts of liquidity and cash, and sufficient amounts of cash flow from the 1,000-plus stores to plow back into the business. Sales growth seemed to have stalled, mostly a result of consumers' reluctance to spend during and immediately after the recession.

The best way to get sudden boosts in stock price, he likely figured, was to make substantial changes in management and business strategy, while keeping the balance sheet stable.   The best and most popular choice would be someone who had that Apple magic.

Now with recurring losses and dwindling levels of cash, corporate-finance advisers may need to step in to determine clever ways to manage what could turn out to be a bothersome debt burden.

(Some will argue the company was distracted by current litigation related to Macy's and Martha Stewart. This might have been a thorn in management's efforts in the short term, but would not likely have proven to be the difference between soaring growth and sorrowful losses.)

JCP, Ackman, and Johnson all combined to take a significant business risk. Perhaps they should be and will be applauded for that. But somehow it didn't work. Or for the first two years, it didn't work.  Given time, it might have taken off later, or it might have eventually "clicked" with customers, or the company might have discovered a new, different customer segment to enjoy the different, more flamboyant in-store experience. 

Perhaps it pushed too hard, too fast. For now, marketing MBA students will have a chance to scrutinize what went wrong and why.  Finance MBAs may get a chance to study whether the strong voices from large activist shareholders can steer an old company that needs a swift kick, but does so in the wrong way.

Tracy Williams

See also:

CFN: Apple's Stash of Cash, 2012
CFN: Dell Going Private? 2013

Why He Left Goldman

It was the culture, he contends

Recall about a year ago. It was the op-ed piece heard all around the business world, when Goldman Sachs vice president Greg Smith dared to announce his resignation on the pages of the New York Times. After an 11-year stint in its institutional sales unit, Smith announced he had had enough and it was time to depart. He decided to share publicly why his disappointments in the business culture led to his decision to leave a fairly lucrative position.

(See  CFN: Goldman Sachs and the Letter, Mar-2012)

At the time of his departure, Smith was head of U.S. Equity Derivatives in Goldman's London office. (In London, he was an "executive director," which at Goldman was equivalent to a U.S. "vice president.") He had progressed swiftly through the ranks and was highly regarded for his expertise in markets, clients and derivatives in his special perch. By most accounts, he was not a difficult employee and colleague. He had made meaningful contributions in many ways--building a new business in Europe, preparing  market insight in the form of frequent, written commentary to Goldman salesmen around the world, and agreeing to transfer to the London office, when he didn't want to.

The revered culture of clients coming first had evolved, he said, at Goldman in ways he felt uncomfortable. The crisis was partly at fault.  Every partner, managing director, vice president, and associate, he observed, was out for him- or herself. Survival was the mission of the day.

It boiled down to this, he observed:  The trading culture had evolved into a massive mission of accumulating "GCs"--gross credits, sometimes at the expense of doing the right thing for the client.  The value of the employee to the firm was determined by the total amount of GCs he or she accumulated during the year.

Mindful of this, the employee overlooks teamwork, partnership, and support for other colleagues and focuses singularly on maximizing GCs and, therefore, the year-end bonus, even if it means swiping GCs rudely and unfairly from colleagues or being willing to unload "toxic waste" securities onto unsuspecting or unknowing clients. 

So after he had his apocalyptic moment (on a business trip to Southeast Asia while Goldman executives had been summoned to a Congressional hearing), he decided to quit. As many expected, after the  op-ed blast in the Times, Smith went into hiding. He emerged from a  self-imposed rest when he published a book last fall to recount his experiences at Goldman and explain his well-publicized departure more thoroughly.  The book, Why I Left Goldman, received lukewarm reviews.  Reviewers and industry-insiders, and perhaps Government regulators, were looking for something more, perhaps a hint of scandal, a more detailed account of mishaps and fraudulent business practice. He presented none of that.

The book is similar to other detailed accounts of a young banker or trader's venture onto Wall Street. They are views from the ground up, from the trenches, from entry-level positions as the novice tries to adapt to the ways of a zoo-like trading room.  Smith's book reminds us Michael Lewis' Liar's Poker."

Smith is fresh out of Stanford and thrust onto a derivatives-sales desk.  Lewis had just graduated from Princeton and encountered the bowels of Salomon Brothers' legendary trading floor and lived to write one of the most spectacular, humorous accounts of Wall Street ever.  Smith's book is also similar to a lesser known, recent book, A Colossal Failure of Common Sense, by Lawrence McDonald of Lehman, an up-and-coming fixed-income trader, who viewed his last days at Lehman, not with sarcasm and humor, but with anger and humiliation.

Notwithstanding the so-so response to a book we knew he would write, for the newly minted MBAs, those who contemplate career paths in sales & trading at major banks, those who are considering institutional sales, the book has its strengths. It is an invaluable introduction to the trading floor, describing the environment, work pace, client groups, and specific roles.  Institutional sales will have an important role at big banks, as regulation prohibits much of proprietary trading.

Reform and new rules, whenever they are finally implemented in full, will permit the big banks (from Goldman Sachs to Bank of America and Citigroup) to engage in trading on behalf of clients, not necessarily on behalf of themselves.  Proprietary trading is being eased out of existence. Trading for clients will be permissible.  (Trying to distinguish between the two will sometimes be a nightmare for banks and regulators.)

Some will argue that as technology advances and clients get more comfortable with it, electronic trading and execution will replace sales professionals.  But as the book shows, sales professionals will be necessary to bring clients on board, help them with best execution, guide them through rough markets, and present new trading ideas.

Thus, the book provides a day-to-day overview of institutional sales and explains a conventional career path from analyst to managing director.  It describes the structure of a sales & trading organization, the management, and the relationship among sales professionals, traders, researchers, and floor brokers. It shows how the firm generates revenues from trades, the more difficult or exotic trades generating the largest commissions or mark-ups.

The book is a reflection on firm culture from the vantage point of the trading floor. Firm culture is important, but what is more critical is how the culture penetrates all activity, roles, relationships and transactions in the firm. Smith, in the book, contemplates firm-wide goals vs. personal goals, how the two intersect, but how they sometimes collide. And he shows how bad, selfish personal goals can be inferred from vague firm-wide goals.

Especially in the wake of the financial crisis, he highlights how personal goals sometimes became a higher priority than firm goals. In a vivid, poignant scene in the days after the collapse of Lehman Brothers as markets nose-dived, Smith watches a senior managing director on the trading floor glued in a silent trance to the computer screen, studying his personal portfolio of assets, having no care in the world with what was going on elsewhere with his clients or with Goldman.

Thirdly, Smith demonstrates the impact of corporate politics on a personal's career success. He had learned quickly, perhaps in his first few weeks, that success at Goldman or at any large financial institution would not be a result of effort, hard work, and time commitment. To get promoted to vice president or managing director, to have the opportunity to work abroad (in London, in his case), or to transition into a different role all required special networking skills. He would either have to learn those skills or rely on buddies, mentors or managers to guide him.

In his case, Smith wasn't a schmoozer. He was, however, fortunate to have advocates nearby on the trading floor, champions on his behalf, people who liked him and were willing to grant a favor or speak up on his behalf.  Generating "GCs" (or client-related revenues) could lead to a big bonus, but finding someone to spread the word about him could lead to a promotion. Over time, he learned to win favors in bars, accompany managers on business trips and bachelor parties, attend social functions and farewell receptions, and even allow clients to look good in parlor ping-pong games.

Diversity. Smith's book hardly touches the subject.  He had the opportunity to address it, because he describes himself as an outsider trying to find his way within a powerhouse firm. (He is a foreigner who grew up in South Africa before coming to the U.S. to go to college.)  He might have been so consumed by his frustration with how he perceived Goldman had evolved that there was much he couldn't get to. (For example, he barely discusses other parts of Goldman, including its investment-banking machine or its sectors in asset management, private equity or private banking.)

It appears, nonetheless, that women in sales & trading have had scattered chances to reach the highest rungs.  A handful of his bosses or senior colleagues, over the decade, are women. And he observes how they have had to evolve to survive or change to battle the machismo ways of trading-room trenches.

The fanfare around the op-ed piece book will likely fade into memory and become a mere, colorful chapter in the history of Goldman. Smith will likely move on beyond Wall Street. He learned a lot about global markets, clients, derivatives, financial products, exchanges, and business management. You can bet he has another book in mind. He highlights the foibles of certain banking cultures in this one. In the next, he'll probably present solutions.

Tracy Williams

See also:

CFN: How Does Goldman Do It? 2010
CFN:  Goldman Tweaks the Ladder, 2012
CFN:  The Role Goldman's Board, 2010
CFN:  Morgan Stanley Tries to Please Analysts, 2012
CFN:  The Volcker Rules, 2011

Why is Dell Going Private?

Many know the story already. The story about how Michael Dell formed his own company in his college dorm room to sell personal computers. The story's plot soars toward an apex. Dell eventually took his company public, seized substantial market share, and eventually became a billionaire. His stake in the company today exceeds $3 billion (while he has maintained substantial wealth outside the company).  But the story is far from over.

In recent years, the company has struggled to maintain market share and has suffered ups and downs in earnings and share prices.  It has reached a pivotal point, where it must decide what it wants to be, who its customer base should be, and what products, beyond conventional desktops, should it sell.  In recent days, founder Michael Dell decided it's time to buy back the company from the public and take it private with investments from himself and the private-equity firm Silver Lake. While reviewing alternatives (remaining a public firm or seeking higher bids from other groups or Michael's group), the company's board is near an agreement to permit Michael Dell and his group to purchase Dell, Inc. for $24 billion.

Fans of private-equity can't help but emit a cheer in unison, as they see this as a signal that the era of big deals (big buy-outs in the billions) is back. That era has not yet returned, partly because big deals require mammoth financing, especially from banks, who have been shy in recent years about stepping up to provide funds to support leveraged buy-outs.

Meanwhile, why has Michael Dell decided that it makes sense to go private via a buy-out?

The proposed deal is not too complex. Michael Dell has found a way to raise $24 billion.  He will contribute the $3 billion-plus stake he already has and will add more (up to $1 billion) from his own investment fund, the fortune he extracted from Dell and runs separately.

Silver Lake will invest $1 billion. Dell, Inc., the company, will repatriate as much as $3 billion in cash in overseas subsidiaries to repurchase stock of existing shareholders. And then comes a mountain of debt:  $14 billion from a bank group and $1 billion from Microsoft. Microsoft still yearns to work with Dell in partnership, perhaps to ensure Dell will continue use its software. But Microsoft elected to invest in the form of a loan, not in equity. (Microsoft's loan suggests, too, it desires an exact cash return on its investment and a fixed time horizon.)

Nevertheless, the deal shoves three times the amount of its existing debt burden onto the Dell operation and onto its balance sheet.  That is essentially the traditional impact of private equity--the rearrangement of a company's capital structure such that debt has a prominent role and operations must generate a consistent flow of cash to meet higher levels of interest and principal payments. Deal-doers and industry analysts had already determined the company is capable of generating a stable flow of cash from current operations from quarter to quarter to service debt. But more debt  requires the company to meet sometimes onerous financial covenants and requirements.

Michael Dell had likely decided the following:

a) Under a different ownership and capital structure, he could implement a different company strategy to achieve earnings growth and, therefore, a substantially higher company value to the new owners.

b) With the new structure, he can make changes more quickly and easily without having to encounter many constituents, including other major shareholders, the public markets, research analysts, a board of directors he has less control over, and a band of other naysayers.

c)  As a private company, he could take more risks with new ventures, ideas and products without the laborious task of vetting public markets, ratings agencies and research analysts.

d) And as private company, he won't have to present a quarterly scorecard of earnings projections, targets to meet, and overall performance and be routinely scolded or penalized for not meeting targets.

A typical private-equity investor has a goal of going private, stripping down the company to reduce costs, increasing cash flow and re-emerging as a more valuable public company. Founder Michael Dell has yet another fundamental objective. He must determine and then implement that relevant strategy. That strategy will likely rely less on a consumer client base and seek to tap into a corporate client base.  It wants to escape desktops and laptops and venture more deeply into corporate systems, data storage and cloud computing. Dell, its founder reasons, must become less like Apple or H-P, more like IBM.

It will be easier to engineer such a transformation beyond the sneering eyes of public markets. Reporting requirements will be less strenuous. Moreover, it will easier to digest a quarterly loss, while the new company funds new investments or a radically different structure. 

Not having to pay a dividend will help, too. Cash normally paid out in dividends will be diverted to meet interest and principal payments on the debt load. The burden of debt will seem to be more bearable than the burden of meeting research analysts' expectations four times a year.

There are still risks in a different approach and risks in implementing a substantially different strategy. But as Dell and Silver Lake see it, there are risks in the status quo.

There will also be the challenge in managing the expectations of three large stake-holders:  Silver Lake, Microsoft as lender, and the bank group.  Silver Lake will not want to be a permanent investor. It will want out and seek to enforce a five-year plan.  Banks will impose somewhat strict financial requirements, will require approval of certain business strategies, and might choose to be difficult in a downturn. 



The deal is not yet done, but will likely proceed as announced. Dell, Inc., the company, not Dell the founder, will be permitted to explore other offers and strategic options to be fair to current shareholders. (There could be another suitor interested in offering more than $24 billion.)

Michael Dell gets five years to prove going private was the best move for current shareholders, for Silver Lake, and for himself.

Tracy Williams

See also

CFN:  What Should Apple Do With Its Stash of Cash? 2012

Today's "Bulge Brackets"

Who comprises the Bulge Brackets of 2013?

"Bulge brackets" in investment banking was once an acclaimed list of investment banks that dominated most of the activity in the industry--from staid, conventional bond underwriting to mergers-and-acquisition advice to flamboyant IPOs.  "Bulge bracket" signaled dominance and prestige. It implied a bank was a major player. Statistics and market share determined who made the list or not, and it was often a moniker awarded to banks that finished in the top five in most finance categories.

Say "bulge bracket" and those who trade and do deals and those who follow the industry think immediately of Goldman Sachs and Morgan Stanley.  Just a few years ago, Lehman Brothers and Merrill Lynch were "bulge bracket" mainstays.  Go back decades, and banks such as Salomon Brothers, Drexel Burnham, First Boston, and DLJ might have squirmed their way into a top-5 listing. Often they did, back then. Today, they don't exist or were absorbed into oblivion long ago.

Over the years, MBAs in finance with eyes toward Wall Street often wanted to work at "bulge brackets," because they were movers and shakers, the behemoths that shaped, dominated and influenced corporate and municipal finance. They were the firms that generated the most revenues, carved out the greatest market shares, swept up much of the prestige in doing deals, and--to the delight of MBAs wanting to work there--paid the biggest bonuses.

The term is not used as much today. Some still use it, but the financial media don't flaunt it as much, if it all. That's likely because of (a) the disappearance of some of those storied names in American finance (Salomon and Lehman, e.g.), (b) the dominance of banks with commercial-banking heritages on current lists (JPMorgan, Citi, Bank of America, Deutsche and UBS, e.g.), (c) the continuing blending of traditional investment- and commercial-banking roles, and (d) the ongoing uncertainty of who will survive rapid changes in the industry. 

In the past and even today, if there were one list bankers wanted to dominate, it was often the list of M&A advisers. Mergers and acquisitions in investment banking has often been the heart, soul and core, not because they generated the most revenues, but because M&A bankers have a direct line to CEOs of the client companies.

M&A bankers strive to be the conscience guiding the CEO and board members on corporate strategy, business expansion, new investments and significant acquisitions. They steer CEOs, knowing that CEOs, too, can direct other business to the bank--business including bond underwritings, project finance, new equity offerings, and corporate lending.

The "bulge brackets" in M&A activity today include the same, familiar names (Goldman Sachs and Morgan Stanley). Meanwhile, institutions with traditions in commercial banking or foreign operations have shoved their way to spots near the top. After they decided in the late 1990s to exploit their large capital bases and balance sheets and thanks to loosened regulation, these institutions (the JPMorgans and Citis) earned lead roles in underwriting activity (especially in bonds and loans) and found a back door into strategic M&A. It also helped, too, when they raided other investment banks for top talent or acquired other established investment banks to propel them through M&A doors. 

In 2012, Goldman Sachs and Morgan Stanley were the top two M&A banks (according to Thomson Reuters), based on total deal value.  Not a surprise.  JPMorgan and Citi rounded out the top 5. Also not a surprise.  Barclays emerged as no. 3--a surprise leap, spurred mostly by a surge of activity in the U.S.  The M&A unit at Barclays, remember, includes bankers with old Lehman ties after Barclays acquired Lehman's U.S. broker/dealer during the financial crisis, 2008.

At Bank of America, its Merrill Lynch unit seems not to have had a similar influence--at least in M&A.  BoA slipped to 8th in recent lists.

Some juggling and repositioning should continue into 2013, because all of the above are scratching their heads figuring out the impact of regulation and straining to squeeze more revenue out of an uncertain business model. Even this week, Morgan Stanley hinted that it needed reduce the scale of its fixed-income unit.

All of the above, as well as Credit Suisse, Deutsche, and UBS (three more names also in the top 10), are major financial institutions, subject to tough capital and liquidity reforms called for by Basel III and Dodd-Frank. Hence, in 2013, all activities in investment banking--from trading to underwriting and strategic advisory--are on the table, subject to revamping if necessary to reach return-on-capital targets.

UBS is in a peculiar place. It claims to be doing now what other banks will need to do over the next two years--withdrawing from any investment-banking activity it can't rationalize. Nonetheless, in 2012, it ranked as a major investment bank--at least based on league tables. It placed 9th in M&A activity--garnering a notable share of deals, especially in Asia.  In late 2012, it made prominent announcements about vast reductions in investment-banking staff--especially in fixed-income markets.

It may still choose to support its mergers team, because M&A requires less capital and hardly needs use of the balance sheet. But trends today suggest that being big in all other investment banking units (including corporate lending, mezzanine financing, bond underwriting) helps drive M&A--not necessarily the other way around.

Meanwhile, don't discount the "boutiques."  They lack capital. They can't swing for the fences with big balance sheets, nor can they provide bridge loans or mezzanine financing to clench deals or get them done quickly. (Lazard and Evercore rank in the top 13 among M&A advisers.) Their bankers are the ones who whisper to CEOs they do deals without the blatant conflicts of interests the "bulge brackets" often have.

And just as important, because they are organized in simple structures without trading arms, lending units, and armies of industry teams, "boutiques" are not subject to the vast amounts of regulation, reform and re-engineering "bulge brackets" will encounter this year and the year after and the year after that.

Tracy Williams

See also:

CFN:  Morgan Stanley: Can It Please Analysts? 2012
CFN:  UBS Throws in the IB Flag, 2012
CFN:  Goldman Sachs: How Does It Do It? 2010
CFN:  Banking Boutiques: What Are the Advantages? 2009

Bring on 2013: Cliffs, Reforms, Recovery

What lies ahead in finance?

After a long haul and after markets watched and studied the results, we've jumped the hurdle of the presidential election. We now head toward a year-end where sound bites and gurgles of noise from Washington scream "fiscal cliffs" and a possible end-of-world scenario if legislators don't reach an agreement and unveil a fiscal plan before January 1.

Often in an election year, capital markets and finance managers go through pauses, starts and stops. They gauge the political winds that will affect economic recovery, interest rates or the tendencies for companies to invest in growth, merge with others, borrow long term or issue new stock.

The election is done, and it's time to bring on 2013, of course, after legislators cease jousting with each other. What lies ahead for professionals in finance? What is the outlook for those who manage portfolios, trade derivatives, underwrite securities,  borrow funds, invest in big projects, advise clients on retirement planning, and advise companies pondering a merger?

In the post-financial-crisis era, finance professionals are accustomed to volatility and uncertainty.  The two terms are portrayed as variables, statistics and concepts in theoretical finance. Today, they are a way of life. Just when signs point to a full-fledged economic recovery, from around the corner come a momentary slowdown or unsettling gyrations in markets--caused by factors or events previously unaccounted for:  Mideast uprisings, Greece, bipartisan politics, Spain, Italy, China, and the lingering reluctance of U.S. Congressmen to agree on anything. Markets become volatile because they can't handle, measure or project uncertainty or the impact of unforeseen events.

It has become the new normal for finance professionals, complicating how they manage portfolios, assets, balance sheets, funding needs, and foreign currencies. To be prepared, they must brace for the next startling event that unleashes itself to cause havoc in capital markets.

Some events, nonetheless, aren't uncertain in the year to come. They will occur, and bank managers and traders will spend much of 2013 and beyond wrestling with them.

New bank regulation and reform is for real. It's about to happen. The politics, debating and fretting over Dodd-Frank and Basel III are diminishing. The implementation has become. Large banks, broker/dealers and trading firms are hustling to prepare for a new world of restrictive rules of capital requirements, leverage, and trading.

Hence, new regulation will dictate how financial institutions do business, generate revenues, organize their global operations, and expand.  Most of the new rules require banks to hold more capital now, more capital next year, and even more capital in the years to come.  The new rules restrict proprietary trading and require extensive vetting, analysis and approval of new financial products.  Gone are the days when banks could amass large trading positions in options or commodities or when a coterie of bankers with math doctorates could design a derivative one month and trade it profitably with hundreds of counter-parties the next.

With increased amounts of capital set aside to support the same business, they can't generate or reach targeted levels of return on equity. If banks have an ROE (NPAT/Equity) target of 15%, then new capital above the old capital implies (a) they can't borrow as much to support existing business levels and balance sheets, (b) they must squeeze out more revenues from the same business model and/or (c) they must wring out costs from existing businesses.

This week, with revenue growth uncertain, Citigroup decided it needed to slash costs to address the same issues. It announced major plans to cut businesses and trim staff by 11,000--partly to bolster its ROE while meeting the growing capital requirements. 

With the new normal of uncertainty and the periodic slowdowns in recovery, like Citi, other financial institutions, too, are zooming in on cost control and business efficiencies to meet ROE targets. No business line or activity, it seems, is exempt from a revamping, a re-engineering, or a shut down. Some are selling off or closing businesses to meet performance targets; some are choosing to redeploy resources, attention and hiring toward business units already above ROE targets.


Fixed-income.  These business units (corporate bonds, mortgage bonds, structured finance, public bonds, high-yield debt, leveraged loans, etc.) at many financial institutions are under the gun right now. With thin profit margins on trading and lending activity and low fees from underwriting, some banks can't rationalize existing business. Not being able to make it work, many are withdrawing from fixed-income businesses or reducing their scope or capital deployed to support it.   

UBS announced this fall that it was virtually shutting down activities in this sector, while it contracts in investment banking overall. Other banks, too, are painfully making fixed-income decisions. A few more will persevere with hopes of gaining market share from banks exiting the business.


Asset management. New regulation won't overwhelm asset-management sectors as much.  They don't require substantial amounts of new regulatory capital (not much beyond the capital required to support infrastructure).  Financial institutions are, therefore, swarming to the apparent benefits of this sector:  less-onerous regulation, stable revenues, and everybody's projections regarding savings habits among consumers or corporations hoarding cash.  Even this month, Goldman Sachs announced plans to push this segment harder in global frontiers.  

For these reasons asset management--and variations of it (from private wealth management to investment management and institutional client management)--will get attention from bank senior management. Because of such attention, financial institutions will find ways to expand, grow assets under management, offer new products and hire researchers, investors, portfolio managers and client managers.


Risk management. In the years after the crisis, financial institutions everywhere beefed up their risk-management units to prepare for the next black-swan event or Lehman-AIG-Bear-Stearns collapse.  Many had units, people and systems in place, embedded in much of the trading and banking organization.  Risk managers were already detecting, managing, approving and projecting risks (and the exposures, defaults, non-performing assets that arise from those risks).  In recent years, however, financial institutions have tweaked governance and increased the authority of risk managers--given them more institutional power to act, make impactful decisions, raise flags and stop bad banking behavior. 

In the last year or two, risk management now incorporates a bit of compliance, arguably a growth industry in finance these days.  Banks and broker-dealers, now more than ever, require professionals who must interpret the thousands of pages of Dodd-Frank, decipher Basel II and III, and help build systems to monitor capital, leverage and liquidity. Opportunities abound for those who can master the rules, have the discipline to monitor them, and can explain their precise impact on business activity.

Compensation for experts in risk management and compliance sometimes lags that of those on the glamorous front lines.  Some institutions have taken proper steps to close these differences. Others need to. 

Equities.  Equity units aren't suffering as much as fixed-income units, partly because profit margins and fees on equity activity (trading, market-making, underwriting and investing) are higher, despite the worrisome volatility in markets, the anxiety of retail investors and the hesitancy of some client companies to issue new stock. Higher margins and fees explain how banks with equity prowess and market share can rationalize the business and keep in humming--in hopes volumes will once again reach pre-2008 peaks.


Corporate Banking.  Renewed  emphasis in corporate banking has surged in recent years, as major banks see value in old-fashion corporate lending, corporate cash management, custody and processing.  Managing corporate relationships from day to day results in satisfied clients, who provide a steady flow of business and revenues--in good times and downturns. Corporate banking, if risks are managed and harnessed, can meet the ROE hurdles, even with Basel II and III rules keeping tabs on corporate-loan volume.

Derivatives.  "Derivatives" has been the ugly word of finance since the finance crisis. Since then, derivatives have resurfaced in different forms and ways.  They (interest-rate swaps, credit-default swaps, options, warrants, etc.) are still useful corporate hedging tools and weren't legislated out of existence by new reforms.  New regulation now requires that most of them should no longer be traded "over the counter," "by appointment" or at the whims of large institutions.

New reforms will require they be traded and cleared more transparently on exchanges and at approved clearing organizations, so trading participants can see prices, volumes and counter-parties. This upends the trading and market-making models at big banks, which for years gushed at high margins and their ability to strong-arm markets in the way they could. New reforms will slash those margins and profits.

The new trading schemes for derivatives are still under review and subject to vast restructure. Banks, trading firms, broker/dealers, hedge funds, exchanges and clearing firms remain at the drawing board planing how interest-rate swaps and credit-default-swaps and other derivatives will trade going forward. Nervous, they are still unsure how they'll generate sufficient profits to meet ROE targets.

Some banks and firms will retreat; others will try to pick up the slack and make money from volumes and technology efficiencies. For most, it will still be a question mark for 2013 and forward.


Hiring and recruiting.   Financial institutions still hire with the same recruiting habits--massive hiring when the market picks up, massive reductions when threats of a downturn appear. Amidst the profitability challenges and cost-control campaigns, there will be reductions or limited recruiting in some segments (fixed-income, sales/trading, e.g.). They are offset by opportunities in areas where banks are confident earnings will be stable and expansion less risky:  asset management, corporate banking, consumer banking, e.g. Better opportunities exist, too, for those willing to go abroad (Southeast Asia, Brazil, e.g.).

In good times and bad, amidst market bubbles or threats of a system collapse, financial institutions still make their appointed rounds on campus at top business schools. They make their corporate presentations, identify students they covet, and hold interviews. Actual hiring tends to be erratic, but they maintain relationships, always hoping for that sustained market turnaround.

Compensation.  Compensation is always tricky, sometimes bewildering, often one grand puzzle. Media stories dare to project compensation in financial services (bonuses, first-year base salaries, total packages for senior bankers, etc.). Often the stories reflect the sentiments of one or two institutions and are based on quick interviews with a handful of executive recruiters.

For the most part, bonus packages in current times tend to (a) be as volatile and as uncertain as markets, (b) reward those designated as top performers, and (c) be a grab bag of cash, stock, deferred arrangements and even debt securities these days. Many large banks in the past five years have reduced bonus payouts substantially, but have offset that with significant increases in base pay.

Compensation overall may have trailed off, but most packages have been and will likely continue to be attractive for the best of the lot.

Diversity

Markets are volatile, and so is the emphasis financial institutions place on diversity--whether that's diversity at entry levels or diversity at the most senior rungs.  Most institutions devote more attention at the lower professional levels and neglect it at the senior levels. At levels above vice president, they tend to allow the numbers to be whatever they are.

As 2013 approaches, diversity (no matter how it is defined or what it encompasses) has forged its way back onto corporate priority lists at most financial institutions.  During the crisis, diversity initiatives, programs and targets became a forgotten agenda item shoved into the back of the drawer. Today, with a bit of optimism, the major institutions see and feel the benefits of a more inclusive organization. Smaller firms (hedge funds, private-equity and venture-capital outfits, e.g.) haven't quite bought the benefits.

In 2012, diversity highlights culminated with Goldman Sachs' fall announcement that 14% of its new partners were women. Even in 2012, people applauded the 14%, a figure that hints at notable progress when compared to numbers from other years. But 14% still suggests that we still have a long way to go.

In all, whatever is happening in Washington will keep the industry from storming out of the starting gates, as 2013 launches. But most in the industry sigh and feel comfortable 2013 won't be 2008 or 2009.

Tracy Williams

See also:

CFN:  Approaching 2012, Dec-11
CFN:  Opportunities in 2012, Dec-11

Jefferies: Comfortable in its Niche

In finance circles, Jefferies, the mid-sized, New York-based investment bank, is a "tweener"--too big and mature to be a young upstart, but not  large or imposing enough to earn the label "bulge bracket" or "too big too fail." Like a Knight Capital or MF Global, if Jefferies were in danger of sliding into oblivion, government regulators and market counterparties would let it go.

Amidst all the post-election squabble about "fiscal cliffs" and recent stomach-churning market volatility, Jefferies quietly slipped into the business news this month. It agreed to be acquired by its minority owner, the conglomerate holding company Leucadia.  The transaction won't shake the broker/dealer world. It may hardly move anybody in any way.

But it brings to mind the consistent, stable performance of a niche investment bank, one that has always been too small to be a threat of any kind to behemoths Morgan Stanley, Goldman Sachs and JPMorgan. Yet it is one that is a bit too large to be called a specialized boutique (like Greenhill or Evercore) and too broad in scope to be a Lazard.  The quiet acquisition reminds us how one firm through decades of incarnations and shake-ups has survived when others (bigger and better known) like Bear Stearns and Lehman couldn't.

MBA students interested in banking and finance usually don't know the firm as well as it should. Jefferies is not widely known to criss-cross the country to visit top business schools and make flashy corporate presentations, hungry to recruit the best MBAs. And some might rate its diversity  record slightly less than satisfactory.  Bankers and traders across the globe are from various ethnic groups, many backgrounds and countries. The board of directors and executive committee, however, appear to be a club of long-time Jefferies executives--with virtually no representation from under-represented groups (women and minorities).  

The firm, which used to promote itself the go-to investment bank for the "middle market," has endured its share of troubles, problems and scares. When the dust often settles--whether they were insider-trading problems years ago or European-debt turmoil of a year ago, Jefferies appears to wipe itself off and proceed with its normal course. Or it sometimes swoops in to purchase the valued pieces left behind by other firms that failed.

The acquisition by Leucadia will come with synergies and provide a resource for more capital, if and when it needs it. (Leucadia, known also to be a "Baby Berkshire," manages private investments in multiple industries.) Jefferies will continue its business as usual. In times when capital is king, Jefferies likely decided that it should have a parent that could provide capital at a moment's notice--without it having to fall into the hands of the big boys like JPMorgan or Credit Suisse. Jefferies can now have access to capital, but still be Jefferies after all.

The bank manages a diverse array of businesses (sales & trading, investment banking, equities, fixed-come, precious metals, and brokerage) with a $3.3 billion capital base--too large to be called a pure-advisory boutique like Greenhill or Moelis, too small to be in the league of Goldman or Morgan Stanley.  To its credit, it has never aspired to go head-to-head with Morgan Stanley in most of its business lines.

Years ago it pronounced itself as the favorite investment bank for middle-market clients, seizing upon a niche that even the boutiques and bulge-brackets often ignored.  Growing, middle-market companies are enterprises that issue modest amounts of new equity and high-yield debt to support growth. Jefferies elected, too, to tap aggressively into the high-yield niche, when boutiques couldn't do so and the bulge-brackets wavered about their commitment to "junk bonds."

The bank has certainly withstood its share of storms. Its founder, Boyd Jefferies, got caught in the whirlwind of insider-trading scandals of the 1980s. At the time, the firm was better known as a "third market" trading firm, making markets in equities after normal trading hours. More recently, as the financial crisis unfurled, the firm got caught with excessive amounts of high-yield and mortgage securities on its balance sheet (just like its larger peers). 

Last year, when the whole world watched the crumbling state of finances in Greece and Spain, market watchers turned suddenly to Jefferies and wondered whether the firm was overloaded with European debt or other related exposures.  Rumors swirled, and its stock price tanked. When MF Global collapsed, partly because of excessive Europe exposures, financial markets wondered if Jefferies would be next. Markets always play a guessing game of who's-next. Some made unfair, ungrounded accusations about what toxic waste might be hiding on Jefferies' balance sheet.

Somehow Jefferies escaped that tumult and pulled through to have a stellar, profitable year in 2011.  In 2012, it's on its way to a $250-million-plus earnings year (good enough for a respectable 8-10% ROE).

Every other year, there are industry shake-outs. While firms like DLJ, Drexel Burnham, A.G. Edwards, Alex Brown, Hambrecht & Quist, Montgomery Securities and L.F. Rothschild have disappeared to the back financial history books, Jefferies plods along. Richard Handler is its CEO, who roared often when others claimed the firm was overloaded with Greek exposure, and will also become the head of Leucadia.

A strategy of remaining comfortable and aggressive within its niche, allowing itself to seize pockets of opportunity when they arise, has probably made the difference. It would, however, be nice to see it do better in diversity at its top rungs.

Tracy Williams

See also

CFN:  MF Global and Its Collapse, 2011
CFN:  Knight Capital's Darkest Day, 2012

UBS Throws in the IB Flag

UBS, the Zurich-based global financial institution, announced last week that it plans to dismiss 10,000 employees as it continues, like most big banks, to review, revamp and re-scale its business units around the world.  That's not an unusual news item. In financial services, that's a news blurb we see almost every other day.

UBS provided more details.  Most of the dismissals will come in its investment-banking group.  More specifically, its fixed-income businesses will suffer the most.  The dismissals, the down-scaling and shrinkage are unfortunate. The announcements are, nonetheless, not shocking, since they are a common event in the business press.

This might, however, be the first wave of dismissals in finance, where the bank stepped up to admit  blame solely on its inability to justify business lines because of hefty capital requirements from the new wave of regulation. UBS says new regulation (in Switzerland and from the reforms of Basel II, II.5, and III, and new Dodd-Frank and Volcker rules) will require substantial increases in its equity capital base just to continue doing existing business. And barring any spectacular periods of revenue growth, the increases in capital will push down returns on equity to levels that can't be explained to shareholders.  About as simple as that.

(See CFN on Basel III, 2010 for more background on Basel regulation. In effect, the combination of Basel and Dodd-Frank would virtually double the capital requirements at large banks (those commonly thought to be "too big to fail") between now and 2019. The requirements will step up in increments over the years.)

For all practical purposes, UBS has decided to withdraw from huge-scale investment banking after having decided years ago to attempt to be a bulge-bracket bank.  It has decided it can't make the numbers make sense for it to be a Top-10 investment bank.  Sure, it will continue in certain niches--equities, research, brokerage, and investment management.  But it will not try to compete head-to-head with Goldman Sachs, JPMorgan, Deutsche Bank, and Morgan Stanley.

UBS, through the years, had built up its investment-banking practice through acquisitions, corporate-banking relationships, the reputation of its investment-management and private-banking businesses and the heft of its capital base. Some may recall how in two decades it penetrated U.S. borders by acquiring the well-known retail brokerage Paine Webber and the boutique firm Dillon Read. It absorbed those operations years ago and used them as a base to compete in the U.S. in many areas.

UBS's rationale makes some sense.  It articulates that it seeks to generate a return on equity (ROE) from 12-17 percent. That varies with business cycles and market volatility. On average, it strives to seek returns of 15 percent.

New regulation throws a thorn into its side.  The bank must, as it has done the past year or so, reduce leverage, get rid of bad assets, and push costs down significantly. It also had to deal with the $2 billion loss of a rogue trader, repair risk management and trading operations and improve controls.  While sprucing up controls and balance sheet, new regulation comes along and adds the burden of boosting capital and taking leverage down even more.

If it decides that it must boost capital by 10-20 percent, then ultimately it would need to increase net earnings by 20 percent or more. Increasing net earnings in the current environment--one of uncertainty, volatility and fierce competition from the other big banks--might be near impossible, unless UBS decided to cut costs vigorously.

So where do you cut costs? You do so in businesses where regulation will require big increases in capital, where profit margins are already slim or vulnerable and where costs can be cut swiftly.  Its fixed-income businesses (corporate bonds, municipal bonds, government bonds, interest-rate derivatives, corporate lending) became the first target of deep cuts. This includes (within fixed-income units) corporate-advisory activity, underwriting, trading and market-making.

Senior management may have deduced that, at best, ROE would hover around 5-7 percent in those businesses. ROE in the range of 0-5 percent for a business that already uses up significant amounts of capital would be a certain drag on the bank's overall ROE.  An unsatisfactory result for shareholders, who too dream of earnings growth, stock-price increases and a nice, reliable dividend.

UBS Investment Banking won't go away. It requires a certain amount of investment banking (underwriting, market-making, securities distribution and equity research) to complement other profitable or growing business lines:  investment management, private banking, brokerage, and corporate banking. Yet with massive departures in London and in fixed-income activities, there will be minimal activity in corporate bonds, short-term instruments, mortgage securities, structured securities, private placements, subordinated debt, mezzanine debt, interest-rate swaps, and any of the products and activities that fall under the fixed-income spectrum.

UBS in its announcements hints this is not a cowardly business act. It claims to be making a tough business decision (at the expense, unfortunately, of thousands who must seek employment elsewhere) that all of its old peers must inevitably make over the next few years. It is patting itself for making that decision now.

Tracy Williams

See also:

CFN:  Basel III and Capital Cushion, 2010
CFN:  Big Banks and Dreadful Downgrades, 2012
CFN:  JPMorgan Chase and Regulatory Rants, 2012
CFN:  Big Banks and Where Do We go from Here? 2010

CFN:  The Volcker Rule, 2010
CFN:  The Volcker Rule, Part 2, 2011