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
Showing posts with label Risk management. Show all posts
Showing posts with label Risk management. Show all posts
Sunday, October 13, 2013
Thursday, December 6, 2012
Bring on 2013: Cliffs, Reforms, Recovery
 |
| What lies ahead in finance? |
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
Wednesday, May 23, 2012
"Where Was the Risk-Management Unit?"
Once the world of finance (and the world beyond, too) learned about JPMorgan's earth-shaking $2 billion-plus trading loss from credit derivatives, the finger-pointing and the blame-gaming started. Where were the risk-management units? How and why weren't the risks of these large positions properly managed? How could what began as efforts to manage credit risks with portfolio hedges end up as shocking market losses and a three-headed monster out of control?
In financial institutions, in stable times, when profit engines hum and business is brisk, risk-management units remain quietly out of view. They aren't glamor-seeking or aren't permitted to be. You won't see risk-management "stars," as much as you do among the deal-doers in investment banking, particularly in M&A, venture capital or private equity.
Nonetheless, if they are doing their job, senior managers in risk management in normal times are as busy as ever. They touch all aspects of the institution's business. They are charged with managing risks of all kinds--including those related to exposures, counter-parties, borrowers, portfolios, trading positions, and balance sheets.
They are also responsible for anticipating unforeseen risks, "tail" or unexpected scenarios, or even catastrophic events. They must unveil plans to manage these scenarios. They must implement programs or procedures to reduce or minimize existing risks (positions, exposures, borrowings, etc.), if they conclude it is necessary.
When you read about a financial institution involved in a big deal, large transaction, an IPO, or a notable underwriting or learn about its revenue increases, new clients, and expansion to foreign sites, risk-management units are hardly mentioned, even if they are intimately involved in reviewing and approving all such business activity. On the other hand, when you hear about the sudden losses at or demise of such institutions as Washington Mutual, Lehman Brothers, or Bear Stearns, everybody--from pundits to regulators--asks, "Where was the risk-management unit?
"Why couldn't it have prevented the collapse or loss? Who approved the transaction, trade, client, counter-party, or deal? Why didn't it reduce the portfolio of loans or hedge the trading positions or notice the operations hiccups or problems in the documentation?"
Often in these upsetting moments, risk management becomes the scapegoat, and the problems, errors or flaws tend to be related to one or more among the following:
1) Lack of sufficient authority to enforce policies, procedures, limits, and approvals, because risk managers aren't empowered to hold the line with investment and corporate bankers, salesmen and traders.
2) Lack of proper information or delays in sharing details about borrowers, trading positions, balance sheets, and risk exposures (sometimes caused by a reluctance of business lines to admit to errors in judgment or by problems in systems in collecting and summarizing information quickly)
Risk-management units in many places sometimes spend as much time gathering data about clients and trades, ensuring the information is correct and up to date, as they do in analyzing counter-parties, markets, exposures, and portfolios and making the right decisions.
3) Inability to anticipate unforeseen or unusual risks, because of lack of understanding of markets and borrowers, because of too-complex trading and risk models, or the naive conviction that the worst cases won't happen.
4) Over-reliance on complex risk models, familiar techniques and conventional approaches. A reluctance to assess risky scenarios in new, unconventional, more appropriate ways.
5) Inability to quantify the true, actual scope of risks because of flaws or failures in some of the above and in information and analysis. Risk managers may not know the exposure, loan, or trade is as large as it is, because they can't quantify it properly.
6) Neglect because certain risks or risk functions were not prioritized, checked or given proper attention. Risk managers put the issue on the shelf and dismiss it until it is too late--after the big trading loss or after the client files for bankruptcy.
7) Errors in judgment, caused by inherent biases in decision-making or conflicts of interests. Risk managers are not able to assert themselves (and make decisions) independently because they are "trying to help" business and marketing managers achieve profit goals or are also trying to maximize revenues, returns and profits to get a share of bonuses.
8) Fraud
At Lehman and Bear Stearns, risk managers weren't empowered or authorized to hold up the stop sign or call time out when their balance sheets grew to excessive levels of leverage or piled on too much in mortgage-related assets. Or risk managers, too, were delusional in their perception of mortgage markets or what they deemed were adequate levels of capital. Refco, the futures and commodities firm that went bankrupt in 2005, was a victim of accounting fraud by one of its own senior managers. At AIG, risk managers didn't have control over the activities of its financial-products subsidiary and made blatant errors in the analysis of mortgage-related risks.
At Merrill Lynch, we learned, risk managers simply lacked authority to control undisciplined trading activity. At Long Term Capital, traders acted also as risk managers and stubbornly believed in their models ("relative-value trading") without acknowledging the worst-case scenarios or "tail" events. At JPMorgan, it's too early draw conclusions. Risk managers, we know now, attempted to manage other portfolio risks. But it elected to use complex trades. In the process, overall risks spiraled out of control, partly because they didn't project extreme cases in the credit-derivatives markets.
The risk-management function at large financial institutions has evolved in many ways the past two decades. Once, risk management at banks and broker/dealers meant credit analysis, credit approvals, and reviews of counter-parties. Somewhere along the way (the early 1990s perhaps), risk management assumed responsibilities for credit and loan portfolios, trading-related counter-parties, collateral risks, country and political risks, and all forms of market risk from trading positions.
Today, at the largest institutions, risk management's domain is as expansive as the organization's business--touching almost all functions and expanding to all regions and businesses. In recent years, experts say risk managers must approach the role as "managers of enterprise risk" (the entire organization and all its functions), not just isolated credit and market risks in certain business areas.
Risk managers today and going forward will be asked to oversee, analyze, project, manage and reduce (if necessary) risks related to the following.
1) Credit and counter-party risks, which include the risks of lending money, doing any kind of business with corporations, individuals and government entities, and executing and maintaining securities and derivatives trades with the same. This includes long- and short-term risks, collateralized and unsecured risks.
2) Market risks, which include all forms of risks from trading and/or maintaining positions in all securities and derivatives transactions. This includes risks from positions related to market-making, brokerage, specialist, clearing, and proprietary-trading activities. And it includes long- and short-term trades or mere settlement or clearing activity.
3) Operations, systems, and processing risks, which include risks arising from executing trades, doing money transfers, collecting and sending out data, processing and clearing securities, accepting and holding collateral, and systems glitches.
4) Documentation, regulatory and compliance risks, which include all risks tied to legal and regulatory issues and the documentation behind all business activity.
5) Reputation risks, which was popularly added to the lists of risk management's responsibilities the past decade and includes reputation issues that arise from doing business with questionable clients or in certain areas around the world or doing business in a questionable way.
6) Country and political risks, which include risks in conducting businesses in certain countries and geographic regions.
7) Collateral risks, which include risks of accepting certain types of collateral in transactions (including securities, cash, and hard assets) and risks that the collateral is under-valued or not transferable in certain cases.
Risk-management units juggle all of these responsibilities, try as hard as they can to grasp, scope and quantify these risks, do all they can to project and anticipate worst cases, and are expected to have a plan for how to manage and reduce them. Miracle workers, some say, who must also have a solution, a game plan, an alternative, or simply a way out.
Over the past two decades from Drexel Burnham to Washington Mutual, we've seen it all, or always thought we saw it all, until the next shocking loss by another big institution. But through it all, while fingers pointed directly to risk managers, the role of risk management always emerged as important as ever.
Tracy Williams
See also CFN: Dimon and Bank Regulation, May 2012
CFN: Risk Management: Opportunities in 2012
CFN: Risk Management and MF Global's Demise, 2011
In financial institutions, in stable times, when profit engines hum and business is brisk, risk-management units remain quietly out of view. They aren't glamor-seeking or aren't permitted to be. You won't see risk-management "stars," as much as you do among the deal-doers in investment banking, particularly in M&A, venture capital or private equity.
Nonetheless, if they are doing their job, senior managers in risk management in normal times are as busy as ever. They touch all aspects of the institution's business. They are charged with managing risks of all kinds--including those related to exposures, counter-parties, borrowers, portfolios, trading positions, and balance sheets.
They are also responsible for anticipating unforeseen risks, "tail" or unexpected scenarios, or even catastrophic events. They must unveil plans to manage these scenarios. They must implement programs or procedures to reduce or minimize existing risks (positions, exposures, borrowings, etc.), if they conclude it is necessary.
When you read about a financial institution involved in a big deal, large transaction, an IPO, or a notable underwriting or learn about its revenue increases, new clients, and expansion to foreign sites, risk-management units are hardly mentioned, even if they are intimately involved in reviewing and approving all such business activity. On the other hand, when you hear about the sudden losses at or demise of such institutions as Washington Mutual, Lehman Brothers, or Bear Stearns, everybody--from pundits to regulators--asks, "Where was the risk-management unit?
"Why couldn't it have prevented the collapse or loss? Who approved the transaction, trade, client, counter-party, or deal? Why didn't it reduce the portfolio of loans or hedge the trading positions or notice the operations hiccups or problems in the documentation?"
Often in these upsetting moments, risk management becomes the scapegoat, and the problems, errors or flaws tend to be related to one or more among the following:
1) Lack of sufficient authority to enforce policies, procedures, limits, and approvals, because risk managers aren't empowered to hold the line with investment and corporate bankers, salesmen and traders.
2) Lack of proper information or delays in sharing details about borrowers, trading positions, balance sheets, and risk exposures (sometimes caused by a reluctance of business lines to admit to errors in judgment or by problems in systems in collecting and summarizing information quickly)
Risk-management units in many places sometimes spend as much time gathering data about clients and trades, ensuring the information is correct and up to date, as they do in analyzing counter-parties, markets, exposures, and portfolios and making the right decisions.
3) Inability to anticipate unforeseen or unusual risks, because of lack of understanding of markets and borrowers, because of too-complex trading and risk models, or the naive conviction that the worst cases won't happen.
4) Over-reliance on complex risk models, familiar techniques and conventional approaches. A reluctance to assess risky scenarios in new, unconventional, more appropriate ways.
5) Inability to quantify the true, actual scope of risks because of flaws or failures in some of the above and in information and analysis. Risk managers may not know the exposure, loan, or trade is as large as it is, because they can't quantify it properly.
6) Neglect because certain risks or risk functions were not prioritized, checked or given proper attention. Risk managers put the issue on the shelf and dismiss it until it is too late--after the big trading loss or after the client files for bankruptcy.
7) Errors in judgment, caused by inherent biases in decision-making or conflicts of interests. Risk managers are not able to assert themselves (and make decisions) independently because they are "trying to help" business and marketing managers achieve profit goals or are also trying to maximize revenues, returns and profits to get a share of bonuses.
8) Fraud
At Lehman and Bear Stearns, risk managers weren't empowered or authorized to hold up the stop sign or call time out when their balance sheets grew to excessive levels of leverage or piled on too much in mortgage-related assets. Or risk managers, too, were delusional in their perception of mortgage markets or what they deemed were adequate levels of capital. Refco, the futures and commodities firm that went bankrupt in 2005, was a victim of accounting fraud by one of its own senior managers. At AIG, risk managers didn't have control over the activities of its financial-products subsidiary and made blatant errors in the analysis of mortgage-related risks.
At Merrill Lynch, we learned, risk managers simply lacked authority to control undisciplined trading activity. At Long Term Capital, traders acted also as risk managers and stubbornly believed in their models ("relative-value trading") without acknowledging the worst-case scenarios or "tail" events. At JPMorgan, it's too early draw conclusions. Risk managers, we know now, attempted to manage other portfolio risks. But it elected to use complex trades. In the process, overall risks spiraled out of control, partly because they didn't project extreme cases in the credit-derivatives markets.
The risk-management function at large financial institutions has evolved in many ways the past two decades. Once, risk management at banks and broker/dealers meant credit analysis, credit approvals, and reviews of counter-parties. Somewhere along the way (the early 1990s perhaps), risk management assumed responsibilities for credit and loan portfolios, trading-related counter-parties, collateral risks, country and political risks, and all forms of market risk from trading positions.
Today, at the largest institutions, risk management's domain is as expansive as the organization's business--touching almost all functions and expanding to all regions and businesses. In recent years, experts say risk managers must approach the role as "managers of enterprise risk" (the entire organization and all its functions), not just isolated credit and market risks in certain business areas.
Risk managers today and going forward will be asked to oversee, analyze, project, manage and reduce (if necessary) risks related to the following.
1) Credit and counter-party risks, which include the risks of lending money, doing any kind of business with corporations, individuals and government entities, and executing and maintaining securities and derivatives trades with the same. This includes long- and short-term risks, collateralized and unsecured risks.
2) Market risks, which include all forms of risks from trading and/or maintaining positions in all securities and derivatives transactions. This includes risks from positions related to market-making, brokerage, specialist, clearing, and proprietary-trading activities. And it includes long- and short-term trades or mere settlement or clearing activity.
3) Operations, systems, and processing risks, which include risks arising from executing trades, doing money transfers, collecting and sending out data, processing and clearing securities, accepting and holding collateral, and systems glitches.
4) Documentation, regulatory and compliance risks, which include all risks tied to legal and regulatory issues and the documentation behind all business activity.
5) Reputation risks, which was popularly added to the lists of risk management's responsibilities the past decade and includes reputation issues that arise from doing business with questionable clients or in certain areas around the world or doing business in a questionable way.
6) Country and political risks, which include risks in conducting businesses in certain countries and geographic regions.
7) Collateral risks, which include risks of accepting certain types of collateral in transactions (including securities, cash, and hard assets) and risks that the collateral is under-valued or not transferable in certain cases.
Risk-management units juggle all of these responsibilities, try as hard as they can to grasp, scope and quantify these risks, do all they can to project and anticipate worst cases, and are expected to have a plan for how to manage and reduce them. Miracle workers, some say, who must also have a solution, a game plan, an alternative, or simply a way out.
Over the past two decades from Drexel Burnham to Washington Mutual, we've seen it all, or always thought we saw it all, until the next shocking loss by another big institution. But through it all, while fingers pointed directly to risk managers, the role of risk management always emerged as important as ever.
Tracy Williams
See also CFN: Dimon and Bank Regulation, May 2012
CFN: Risk Management: Opportunities in 2012
CFN: Risk Management and MF Global's Demise, 2011
Wednesday, December 21, 2011
Getting Real: Opportunities for 2012
Let's get real. As we turn the corner and head toward an uncertain 2012, where are the real opportunities for MBA finance professionals?
What's the real scoop? In an environment where some tip-toe when they project better scenarios next year, but where every other day large banks announce lay-offs by the thousands, what's the real story?
Who's hiring? Who's promoting solid performers? Who's luring those interested in finance and promising long-term career paths? Where are the sectors or institutions that will harbor finance pros and allow them to grow, contribute and thrive over the the next few years?
Let's take a glance and gauge vibes and signals across the sectors.
1. Investment banking, corporate finance. From now until about mid-2012, you know banks won't commit. Uncertainty forces them to be hesitant. They'll want to see sustained trends in an economic recovery. Until then, banks will resort to old-time habits of firing rashly and excessively, but hiring too aggressively when signs point to more deal flow. Some banking sectors (Asia, financial institutions, e.g.) are thriving more than others. But even those change from quarter to quarter.
But old habits mean when the tide picks up (or when deals rush through the door), the doors of banks open, and they welcome new contributors at all levels.
2. Investment banking: equities, fixed-income. Who knows? Groupon, Facebook, Zynga, and Linkedin IPOs or projected IPOs were supposed to kick-start the equities sector. Low interest rates were supposed to encourage companies to refinance and get comfortable with debt levels. But regulation (especially from the new Dodd Frank rules) is forcing banks to restructure their trading desks and the complementary role investment banking plays.
Some analysts project fixed-income sectors will diminish in importance because of the lingering damage from the mortgage castastrophe and banks not being able to offset declines in fixed-income revenues with fixed-income banking fees. Some project equities units will soar and thrive, when markets improve, because of higher fees from deals.
2. Investment banking, mergers & acquisitions. Read between the lines or current deals. All depends on the industry sector. Many industries wait for entrenched signs of growth before they acquire companies or merge with a peer. Other industries, because of business conditions, must consolidate, restructure, or sell off divisions to survive. M&A groups stand ready to advise on any kind of corporate reorganization that exists.
New regulation won't tarnish this business too much, since it's fee-based and doesn't often require banks to use too much of their balance sheets. Opportunities for M&A pros in selected areas will always exist, as long as they're comfortable with a lifestyle of few holidays and weekends and arduous travel.
3. Bank sales & trading. Expect few opportunities. Profit opportunities are disappearing. Regulation, compliance, and market volatility have combined to become an avalanche. And banks, after careful analysis, are choosing to get out of the way. Expect gradual reductions in staff across the board. Some are deciding that trading requires too much effort, pain and compliance just to squeak out a few basis points of revenues or tiny profit margins.
Banks are restructuring their trading desks, because they must. Some will depart from all trading activity, except from bare-bones customer-flow transactions. Many (J.P. Morgan, e.g.) have already reduced staff in commodities substantially. The new Volcker Rules will change the game, guidelines and profit dynamics. Some will rationalize maintaining a presence in certain trading areas if they can offset declines with gains in business elsewhere, if that's possible.
They know their best traders will flee for hedge funds and take entire desks with them, and there's not much they can do about it.
4. Risk management. Right after the financial crisis, this was the "growth area" in most financial institutions. Banks, firms, and funds hurried to ensure they had experienced, wise risk managers in place. They reviewed governance policies and rewrote them to give risk managers sufficient authority to confront the next crisis.
They even re-branded risk units to attract and keep talent. Risk management would be a destination unit, not a temporary stop-off between corporate finance assignments. Since then, the rush to reorganize and re-emphasize risk management has slowed down, but few institutions will want to be seen as reducing risk staff or risk support during challenging times.
At many firms, you seldom hear about drastic cuts in risk staff. Risk management, you can argue, is the glue that keeps Goldman Sachs in order. The lack of a strong risk organization, some argue, is why MF Global failed.
5. Corporate banking. Corporate banking, or old-fashioned relationship banking and corporate lending, regained prominence in recent years. Big banks, fatigue from the ups and downs of investment banking, rediscovered the benefits of corporate banking: a stable revenue base from lower-risk products and a loyal, committed client base that rewards banks for service, not for dramatic board-room pitches.
Many banks continue their renewed emphasis on corporate banking and project hiring experienced bankers. They are also designing new paths for new MBAs, especially for those who never contemplated such a career while in business school.
6. Bank treasury services, funds transfer, custody and cash management. The other half of nuts, bolts, blocking and tackling of service banking. Big firms re-emphasizing corporate banking must also have superior service products, too. Banks in the past were often careless in their efforts to attract strong product managers or marketing experts from the outside or from within.
Lately, however, some (J.P. Morgan, e.g.) have successfully convinced former investment bankers to transfer into these areas to energize mature (and sometimes moribund) business units. Banks, nonetheless, haven't yet rationalized a comparable compensation program for those ex-investment bankers and may not be able to.
7. Corporate treasury, financial management, financial analysis. Ah, breaths of fresh air. Amid all the market turmoil and difficulties at financial institutions, blue-chip companies are quietly reporting strong earnings, investing in new markets, and projecting reasonable growth. The finance units in these companies continue to recruit aggressively at business schools; some have convinced top graduates to by-pass Wall Street.
They promise more stability, opportunities to work in foreign countries, and worthwhile management experience. A financial analyst job at Ford or General Motors (popular destinations for many Consortium graduates) might have become fashionable again. Or a position in corporate strategy at Eli Lily or Pepsico is a desirable first job.
8. Private wealth management. Almost every bank in the country has decided to devote capital and attention to this sector. Almost every bank is attracted to a business model of aggressive accumulation and gathering of client assets, which lead to stable revenues, steady growth, and fewer headaches from market risks, regulatory threats, and an uncertain corporate clientele.
At least for now, before too many banks chase too few clients or too little in assets (or clients get too frustrated with market performance), everybody agrees this is the hot hiring growth spot in the year or two to come.
9. Community banking and development, retail banking. Some institutions see long-term growth in brick-and-mortar banking. Some don't. J.P. Morgan Chase and Bank of America have seen it. Citi sees it overseas. HSBC or BNY Mellon didn't see it.
Those that do will continue to acquire branches, hire more managers and staff, and provide more face-to-face banking services, even if it's not always easy to justify the efficiencies of such expansion. As long as they attract more and more customers (especially those who prefer a personal touch) and as long as those customers bring their deposits and their ongoing personal needs (mortgages, car loans, credit cards, e.g.), they can justify it.
Not many MBAs from top schools (including many from Consortium schools) have conventionally expressed interest in retail or community banking, but many with experience have eventually turned toward these sectors when opportunities arise.
10. Hedge funds. Hedge funds stumbled through a tough 2011. They have admitted to their investors they were caught off guard with troubles in Europe and U.S. budget-deficit fuss. But funds tend to forget the past. Or at least they try to.
Others close up shop and reopen in a different incarnation. They move on and start anew. They know, too, they'll benefit from banks being forced to downsize proprietary trading. There will be opportunities, but the industry, as always, will still be difficult to break into. Hedge-fund managers hire cronies, classmates, former colleagues from other trading experiences, graduates from the schools they attended, and sons and daughters of classmates.
11. Venture capital and private equity (financial sponsors). This is the industry of home-runs and American-dream stories of earning millions inside the proverbial five-year window. Opportunities for firms and funds to make money exist in good times (new markets and mature markets) and in bad times (distressed assets, bargain-basement prices, and restructurings). There are some (KKR, e.g.) who have even discovered ways to make investments in battered Europe. But the doors to get inside this industry are difficult to penetrate. Now, next year, and for years to come.
Some (Blackstone comes to mind) have tried to be open-minded about opening their doors to a wider array of talent and backgrounds, partly because a few have become public institutions or have been contemplating going public.
12. Asia, Europe, South America, China. Of course, Europe is in turmoil, and experts project the likelihood of continued problems. Banks there are besieged with issues and capital challenges. Few European institutions (UBS, RBS, Deutsche Bank, HSBC, e.g.) are heralding opportunities while the continent tries to right itself.
Meanwhile, financial institutions everywhere continue to have expansion eyes on parts of Asia, South America (especially Brazil), and China.
13. Diversity initiatives. When institutions struggled to remain alive after the Lehman collapse, many initiatives and much enthusiasm for diversity slipped. You could hardly get a CEO or sector head to discuss the topic, much less attend a meeting or conference call on the topic.
Some enthusiasm has revived since then, partly because some institutions see the long-term benefits and genuinely believe it's a way to hire top talent.
We've reached the corner and are headed toward the new year. Uncertainty prevails, but the mood isn't one of hopelessness or disenchantment. It's about caution and picking the right spots, the right places, and the most optimistic and resourceful institutions.
Tracy Williams
What's the real scoop? In an environment where some tip-toe when they project better scenarios next year, but where every other day large banks announce lay-offs by the thousands, what's the real story?
Who's hiring? Who's promoting solid performers? Who's luring those interested in finance and promising long-term career paths? Where are the sectors or institutions that will harbor finance pros and allow them to grow, contribute and thrive over the the next few years?
Let's take a glance and gauge vibes and signals across the sectors.
1. Investment banking, corporate finance. From now until about mid-2012, you know banks won't commit. Uncertainty forces them to be hesitant. They'll want to see sustained trends in an economic recovery. Until then, banks will resort to old-time habits of firing rashly and excessively, but hiring too aggressively when signs point to more deal flow. Some banking sectors (Asia, financial institutions, e.g.) are thriving more than others. But even those change from quarter to quarter.
But old habits mean when the tide picks up (or when deals rush through the door), the doors of banks open, and they welcome new contributors at all levels.
2. Investment banking: equities, fixed-income. Who knows? Groupon, Facebook, Zynga, and Linkedin IPOs or projected IPOs were supposed to kick-start the equities sector. Low interest rates were supposed to encourage companies to refinance and get comfortable with debt levels. But regulation (especially from the new Dodd Frank rules) is forcing banks to restructure their trading desks and the complementary role investment banking plays.
Some analysts project fixed-income sectors will diminish in importance because of the lingering damage from the mortgage castastrophe and banks not being able to offset declines in fixed-income revenues with fixed-income banking fees. Some project equities units will soar and thrive, when markets improve, because of higher fees from deals.
2. Investment banking, mergers & acquisitions. Read between the lines or current deals. All depends on the industry sector. Many industries wait for entrenched signs of growth before they acquire companies or merge with a peer. Other industries, because of business conditions, must consolidate, restructure, or sell off divisions to survive. M&A groups stand ready to advise on any kind of corporate reorganization that exists.
New regulation won't tarnish this business too much, since it's fee-based and doesn't often require banks to use too much of their balance sheets. Opportunities for M&A pros in selected areas will always exist, as long as they're comfortable with a lifestyle of few holidays and weekends and arduous travel.
3. Bank sales & trading. Expect few opportunities. Profit opportunities are disappearing. Regulation, compliance, and market volatility have combined to become an avalanche. And banks, after careful analysis, are choosing to get out of the way. Expect gradual reductions in staff across the board. Some are deciding that trading requires too much effort, pain and compliance just to squeak out a few basis points of revenues or tiny profit margins.
Banks are restructuring their trading desks, because they must. Some will depart from all trading activity, except from bare-bones customer-flow transactions. Many (J.P. Morgan, e.g.) have already reduced staff in commodities substantially. The new Volcker Rules will change the game, guidelines and profit dynamics. Some will rationalize maintaining a presence in certain trading areas if they can offset declines with gains in business elsewhere, if that's possible.
They know their best traders will flee for hedge funds and take entire desks with them, and there's not much they can do about it.
4. Risk management. Right after the financial crisis, this was the "growth area" in most financial institutions. Banks, firms, and funds hurried to ensure they had experienced, wise risk managers in place. They reviewed governance policies and rewrote them to give risk managers sufficient authority to confront the next crisis.
They even re-branded risk units to attract and keep talent. Risk management would be a destination unit, not a temporary stop-off between corporate finance assignments. Since then, the rush to reorganize and re-emphasize risk management has slowed down, but few institutions will want to be seen as reducing risk staff or risk support during challenging times.
At many firms, you seldom hear about drastic cuts in risk staff. Risk management, you can argue, is the glue that keeps Goldman Sachs in order. The lack of a strong risk organization, some argue, is why MF Global failed.
5. Corporate banking. Corporate banking, or old-fashioned relationship banking and corporate lending, regained prominence in recent years. Big banks, fatigue from the ups and downs of investment banking, rediscovered the benefits of corporate banking: a stable revenue base from lower-risk products and a loyal, committed client base that rewards banks for service, not for dramatic board-room pitches.
Many banks continue their renewed emphasis on corporate banking and project hiring experienced bankers. They are also designing new paths for new MBAs, especially for those who never contemplated such a career while in business school.
6. Bank treasury services, funds transfer, custody and cash management. The other half of nuts, bolts, blocking and tackling of service banking. Big firms re-emphasizing corporate banking must also have superior service products, too. Banks in the past were often careless in their efforts to attract strong product managers or marketing experts from the outside or from within.
Lately, however, some (J.P. Morgan, e.g.) have successfully convinced former investment bankers to transfer into these areas to energize mature (and sometimes moribund) business units. Banks, nonetheless, haven't yet rationalized a comparable compensation program for those ex-investment bankers and may not be able to.
7. Corporate treasury, financial management, financial analysis. Ah, breaths of fresh air. Amid all the market turmoil and difficulties at financial institutions, blue-chip companies are quietly reporting strong earnings, investing in new markets, and projecting reasonable growth. The finance units in these companies continue to recruit aggressively at business schools; some have convinced top graduates to by-pass Wall Street.
They promise more stability, opportunities to work in foreign countries, and worthwhile management experience. A financial analyst job at Ford or General Motors (popular destinations for many Consortium graduates) might have become fashionable again. Or a position in corporate strategy at Eli Lily or Pepsico is a desirable first job.
8. Private wealth management. Almost every bank in the country has decided to devote capital and attention to this sector. Almost every bank is attracted to a business model of aggressive accumulation and gathering of client assets, which lead to stable revenues, steady growth, and fewer headaches from market risks, regulatory threats, and an uncertain corporate clientele.
At least for now, before too many banks chase too few clients or too little in assets (or clients get too frustrated with market performance), everybody agrees this is the hot hiring growth spot in the year or two to come.
9. Community banking and development, retail banking. Some institutions see long-term growth in brick-and-mortar banking. Some don't. J.P. Morgan Chase and Bank of America have seen it. Citi sees it overseas. HSBC or BNY Mellon didn't see it.
Those that do will continue to acquire branches, hire more managers and staff, and provide more face-to-face banking services, even if it's not always easy to justify the efficiencies of such expansion. As long as they attract more and more customers (especially those who prefer a personal touch) and as long as those customers bring their deposits and their ongoing personal needs (mortgages, car loans, credit cards, e.g.), they can justify it.
Not many MBAs from top schools (including many from Consortium schools) have conventionally expressed interest in retail or community banking, but many with experience have eventually turned toward these sectors when opportunities arise.
10. Hedge funds. Hedge funds stumbled through a tough 2011. They have admitted to their investors they were caught off guard with troubles in Europe and U.S. budget-deficit fuss. But funds tend to forget the past. Or at least they try to.
Others close up shop and reopen in a different incarnation. They move on and start anew. They know, too, they'll benefit from banks being forced to downsize proprietary trading. There will be opportunities, but the industry, as always, will still be difficult to break into. Hedge-fund managers hire cronies, classmates, former colleagues from other trading experiences, graduates from the schools they attended, and sons and daughters of classmates.
11. Venture capital and private equity (financial sponsors). This is the industry of home-runs and American-dream stories of earning millions inside the proverbial five-year window. Opportunities for firms and funds to make money exist in good times (new markets and mature markets) and in bad times (distressed assets, bargain-basement prices, and restructurings). There are some (KKR, e.g.) who have even discovered ways to make investments in battered Europe. But the doors to get inside this industry are difficult to penetrate. Now, next year, and for years to come.
Some (Blackstone comes to mind) have tried to be open-minded about opening their doors to a wider array of talent and backgrounds, partly because a few have become public institutions or have been contemplating going public.
12. Asia, Europe, South America, China. Of course, Europe is in turmoil, and experts project the likelihood of continued problems. Banks there are besieged with issues and capital challenges. Few European institutions (UBS, RBS, Deutsche Bank, HSBC, e.g.) are heralding opportunities while the continent tries to right itself.
Meanwhile, financial institutions everywhere continue to have expansion eyes on parts of Asia, South America (especially Brazil), and China.
13. Diversity initiatives. When institutions struggled to remain alive after the Lehman collapse, many initiatives and much enthusiasm for diversity slipped. You could hardly get a CEO or sector head to discuss the topic, much less attend a meeting or conference call on the topic.
Some enthusiasm has revived since then, partly because some institutions see the long-term benefits and genuinely believe it's a way to hire top talent.
We've reached the corner and are headed toward the new year. Uncertainty prevails, but the mood isn't one of hopelessness or disenchantment. It's about caution and picking the right spots, the right places, and the most optimistic and resourceful institutions.
Tracy Williams
Thursday, September 1, 2011
Is I-Banking Still Hot?
Does investment banking still have the same attraction? Do MBA students still swarm toward investment-banking roles? Do many have dreams of joining a top firm, hitting the ground running doing deals and anticipating big year-end bonuses?
After the industry turmoil and a series of setbacks and embarrassments, is investment banking still a hot area?
There have been upheaval, backlash and calls for reform since Lehman Brothers and Bear Stearns disappeared from the scene. Yet since 2008, trends suggest (a) i-banking is still attractive to many MBA students in finance at top schools and (b) the industry has evolved, but not yet gone through the major overhaul and transformation many predicted or hoped for.
Despite public pleas for changes in how banks conduct business and pay bankers and despite sluggish economic recovery and stomach-churning markets, deals are getting done. Companies are going public, issuing long-term debt, or acquiring other companies. Not necessarily at levels from 2006-07, but there is activity, enough so for banks to continue recruiting and for MBAs to pursue careers.
In this year's entering class of Consortium MBAs, at least 90 new students (about a third) have indicated an interest in finance--a number that is about the same or slightly higher from previous years. Of the 90, as many as 30 (about 10 percent of all Consortium students) have expressed a specific interest in investment banking, corporate banking or corporate finance. The actual number interested in i-banking could be higher, as many students will indicate a general interest in financial services, but have not yet acknowledged an interest in banking.
(Ten students say they are interested in investment managent, and a handful express specific interests in media finance, private equity, venture capital or real estate.)
Most students understand they will probably revise plans as they proceed through a grinding recruiting process. Banks, as they did before, put prospects through rounds of interviews, including tough technical sessions. Some students don't survive the process. Some change their minds, while others switch to other industries. Some become even more charged with enthusiasm about i-banking.
Interest in i-banking, therefore, has not disappeared. The actual number that will be recruited and hired in 2012 has yet to be determined, especially as banks struggle to make sense of this summer of volatility and uncertainty. Those who are committed and will pursue banking will encounter an evolving industry, but one that reflects familiar traditions and practices.
Over the past three years, the players and leading firms have changed. The sudden departure of Lehman and Bear Stearns and the absoprtion of Merrill Lynch by Bank of America left gaping holes in the "bulge bracket" lists. Goldman Sachs, JPMorgan, and Morgan Stanley continue to jockey for the top spots in equity and bond finance and merger activity. However, foreign banks, especially international banks with large investment-banking operations, have shoved themselves into the big picture: UBS, Deutsche, RBC, and of course Barclays, which bought the U.S. operations of Lehman.
Firms like Jefferies and Lazard Freres, once comfortable in their own mid-tier niches, took advantage of industry shake-out and expanded their reach and business. Jefferies is a more diversified, comprehensive bank than it was a decade ago. Some regionals--mostly the i-banking units of commercial banks--have also stepped up where they could.
Smaller "boutique" firms have picked up pieces and grabbed business that bulge-bracket firms once kept among themselves. Bulge brackets are now "bank holding companies," subject to banking oversight by the Federal Reserve an often weighed down--in their eyes--by onerous capital requirements and ominous regulation.
As with all banks, bulge brackets must address a laundry list of issues since TARP rolled out in 2008. Dodd-Frank regulation will force them re-engineer their businesses. They can no longer rely on surges in trading revenues to offset the cyclicality of i-banking. While big banks tend to internal restructuring and worry about declining returns, boutiques have slipped in and swiped a few lucrative deals away from them.
Boutiques absorbed experienced bankers who were dismissed by bulge brackets let go or were demoralized by the crisis. The new bankers brought clients, deals, relationships and junior staff with them. Boutiques, meanwhile, have remained steadfast in being experts in special areas (M&A, media finance, technology finance, restructuring, capital-raising, or strategic advisory).
They didn't venture to foreign lands or create hard-to-manage bureaucracies and processes. And they seldom need to scratch their heads managing conflicts of interests, "tail" risks, or burdensome capital requirements. They just do deals.
And they've done more than their share over the past year. Centerview and Qatalyst, boutique banks, had primary advisory roles in the recently announced Google-Motorola merger. Sandler O'Neill, adamant about remaining small, is one of the top banks for financial institutions. Moelis, Evercore, Allen & Co., Greenhill, Keefe Bruyette, and Perella Weingberg are all respected, if not envied, players.
Some challenges and issues continue to stifle firms these days, big and small--enough to frustrate senior managers and deal-doers who wish they could focus on clients and deals and enough to discourage some MBAs from pursuing a career.
The turtle-crawl economic recovery has a direct bearing on i-banking activity. Corporations are reluctant to grow their busineses or consider acquisitions. They hesitate to issue new capital (debt or equity) to invest in new business or innovative products. They let cash reserves sit around because they are engulfed in uncertainty. In the end, investment banks can't convince corporate CFOs or CEOs to take their advice or proceed with financings that at least make sense in Excel spreadsheets. Deals ready to go to market are suddenly shelved.
Thus, fees and revenues from mergers, acquisitions, underwritings, lending, and new products fluctuate unpredictably, while senior bankers figure out how to endure uncertainty and MBAs ponder whether they should pursue a dream.
Pending regulation and reform are looming challenges. Banks try to interpret new rules and anticipate what they will be once regulators write them up more formally. Then they huddle in backrooms to reorganize their business to make them operate profitably with the new restrictions. The 25% return on equity some bulge brackets could count on in the glory days of the mid-2000s or late 1990s might become an unreasonable target. Disgruntled shareholders may need to become accustomed to, at best, 15% returns under new models.
Risk management at all banks has gotten much attention. Banks have increased risk staff and force deal-doers to assess, probe, analyze, and measure the worst-case risks in doing a deal or bring in a new client. Risk-vs.-reward exercises are more prominent than ever.
Derivatives once attracted Ph.d. graduates and quant jocks and spawned floods of profits over the past decade or so. Going forward, regulation will force most of them to be traded on exchanges and through designated dealers. Investment banks aren't sure what the new profit dynamics will be or whether it will be worth the effort to encourage quant jocks to create new forms of them. Quant jocks aren't sure they will be welcome or will flee to hedge funds. I-bankers haven't yet figured out what they should say to clients on a consistent basis.
Work-life balance in the industry was supposed to have improved, if only to attract graduates who fear that lower bonus payouts in the future won't make it worth spending 12-14-hour days in the office, six days a week. Anecdotes suggest work-life balance is often discussed and mulled over, but when deals must be done, it's back to back-breaking, suffocating hours in the office.
The current environment with uncertainfy, regulation, and dwindling profitability will add more pressure to bankers to find new clients, win more mandates and get more deals done. Expectations by management and the public have risen the past three years. Competition from other banks is just as fierce, and clients are demanding more from banks. The pressure has not waned.
Yet the attraction to i-banking is still apparent. Despite the nervous environment, Consortium numbers suggest new students still want a shot at doing deals, helping clients borrow money or go public, or advising them on how to expand and grow.
The adrenaline from participating in a headline-grabbing transaction or a billion-dollar bond issue still exists. The satisfaction of deriving and negotiating the fair value of a targeted firm is still there. The thrill in traveling all over the country or globe to meet new clients in new industries continues. Of course, compensation--even if it has become as volatile as markets--is generally still attractive.
One tradition has not changed. I-bank recruiting and the campaign to win a spot on a bank's interview list start the first week MBAs get to campus. Those who have ambitions of securing a spot in 2012 must get going now.
Tracy Williams
After the industry turmoil and a series of setbacks and embarrassments, is investment banking still a hot area?
There have been upheaval, backlash and calls for reform since Lehman Brothers and Bear Stearns disappeared from the scene. Yet since 2008, trends suggest (a) i-banking is still attractive to many MBA students in finance at top schools and (b) the industry has evolved, but not yet gone through the major overhaul and transformation many predicted or hoped for.
Despite public pleas for changes in how banks conduct business and pay bankers and despite sluggish economic recovery and stomach-churning markets, deals are getting done. Companies are going public, issuing long-term debt, or acquiring other companies. Not necessarily at levels from 2006-07, but there is activity, enough so for banks to continue recruiting and for MBAs to pursue careers.
In this year's entering class of Consortium MBAs, at least 90 new students (about a third) have indicated an interest in finance--a number that is about the same or slightly higher from previous years. Of the 90, as many as 30 (about 10 percent of all Consortium students) have expressed a specific interest in investment banking, corporate banking or corporate finance. The actual number interested in i-banking could be higher, as many students will indicate a general interest in financial services, but have not yet acknowledged an interest in banking.
(Ten students say they are interested in investment managent, and a handful express specific interests in media finance, private equity, venture capital or real estate.)
Most students understand they will probably revise plans as they proceed through a grinding recruiting process. Banks, as they did before, put prospects through rounds of interviews, including tough technical sessions. Some students don't survive the process. Some change their minds, while others switch to other industries. Some become even more charged with enthusiasm about i-banking.
Interest in i-banking, therefore, has not disappeared. The actual number that will be recruited and hired in 2012 has yet to be determined, especially as banks struggle to make sense of this summer of volatility and uncertainty. Those who are committed and will pursue banking will encounter an evolving industry, but one that reflects familiar traditions and practices.
Over the past three years, the players and leading firms have changed. The sudden departure of Lehman and Bear Stearns and the absoprtion of Merrill Lynch by Bank of America left gaping holes in the "bulge bracket" lists. Goldman Sachs, JPMorgan, and Morgan Stanley continue to jockey for the top spots in equity and bond finance and merger activity. However, foreign banks, especially international banks with large investment-banking operations, have shoved themselves into the big picture: UBS, Deutsche, RBC, and of course Barclays, which bought the U.S. operations of Lehman.
Firms like Jefferies and Lazard Freres, once comfortable in their own mid-tier niches, took advantage of industry shake-out and expanded their reach and business. Jefferies is a more diversified, comprehensive bank than it was a decade ago. Some regionals--mostly the i-banking units of commercial banks--have also stepped up where they could.
Smaller "boutique" firms have picked up pieces and grabbed business that bulge-bracket firms once kept among themselves. Bulge brackets are now "bank holding companies," subject to banking oversight by the Federal Reserve an often weighed down--in their eyes--by onerous capital requirements and ominous regulation.
As with all banks, bulge brackets must address a laundry list of issues since TARP rolled out in 2008. Dodd-Frank regulation will force them re-engineer their businesses. They can no longer rely on surges in trading revenues to offset the cyclicality of i-banking. While big banks tend to internal restructuring and worry about declining returns, boutiques have slipped in and swiped a few lucrative deals away from them.
Boutiques absorbed experienced bankers who were dismissed by bulge brackets let go or were demoralized by the crisis. The new bankers brought clients, deals, relationships and junior staff with them. Boutiques, meanwhile, have remained steadfast in being experts in special areas (M&A, media finance, technology finance, restructuring, capital-raising, or strategic advisory).
They didn't venture to foreign lands or create hard-to-manage bureaucracies and processes. And they seldom need to scratch their heads managing conflicts of interests, "tail" risks, or burdensome capital requirements. They just do deals.
And they've done more than their share over the past year. Centerview and Qatalyst, boutique banks, had primary advisory roles in the recently announced Google-Motorola merger. Sandler O'Neill, adamant about remaining small, is one of the top banks for financial institutions. Moelis, Evercore, Allen & Co., Greenhill, Keefe Bruyette, and Perella Weingberg are all respected, if not envied, players.
Some challenges and issues continue to stifle firms these days, big and small--enough to frustrate senior managers and deal-doers who wish they could focus on clients and deals and enough to discourage some MBAs from pursuing a career.
The turtle-crawl economic recovery has a direct bearing on i-banking activity. Corporations are reluctant to grow their busineses or consider acquisitions. They hesitate to issue new capital (debt or equity) to invest in new business or innovative products. They let cash reserves sit around because they are engulfed in uncertainty. In the end, investment banks can't convince corporate CFOs or CEOs to take their advice or proceed with financings that at least make sense in Excel spreadsheets. Deals ready to go to market are suddenly shelved.
Thus, fees and revenues from mergers, acquisitions, underwritings, lending, and new products fluctuate unpredictably, while senior bankers figure out how to endure uncertainty and MBAs ponder whether they should pursue a dream.
Pending regulation and reform are looming challenges. Banks try to interpret new rules and anticipate what they will be once regulators write them up more formally. Then they huddle in backrooms to reorganize their business to make them operate profitably with the new restrictions. The 25% return on equity some bulge brackets could count on in the glory days of the mid-2000s or late 1990s might become an unreasonable target. Disgruntled shareholders may need to become accustomed to, at best, 15% returns under new models.
Risk management at all banks has gotten much attention. Banks have increased risk staff and force deal-doers to assess, probe, analyze, and measure the worst-case risks in doing a deal or bring in a new client. Risk-vs.-reward exercises are more prominent than ever.
Derivatives once attracted Ph.d. graduates and quant jocks and spawned floods of profits over the past decade or so. Going forward, regulation will force most of them to be traded on exchanges and through designated dealers. Investment banks aren't sure what the new profit dynamics will be or whether it will be worth the effort to encourage quant jocks to create new forms of them. Quant jocks aren't sure they will be welcome or will flee to hedge funds. I-bankers haven't yet figured out what they should say to clients on a consistent basis.
Work-life balance in the industry was supposed to have improved, if only to attract graduates who fear that lower bonus payouts in the future won't make it worth spending 12-14-hour days in the office, six days a week. Anecdotes suggest work-life balance is often discussed and mulled over, but when deals must be done, it's back to back-breaking, suffocating hours in the office.
The current environment with uncertainfy, regulation, and dwindling profitability will add more pressure to bankers to find new clients, win more mandates and get more deals done. Expectations by management and the public have risen the past three years. Competition from other banks is just as fierce, and clients are demanding more from banks. The pressure has not waned.
Yet the attraction to i-banking is still apparent. Despite the nervous environment, Consortium numbers suggest new students still want a shot at doing deals, helping clients borrow money or go public, or advising them on how to expand and grow.
The adrenaline from participating in a headline-grabbing transaction or a billion-dollar bond issue still exists. The satisfaction of deriving and negotiating the fair value of a targeted firm is still there. The thrill in traveling all over the country or globe to meet new clients in new industries continues. Of course, compensation--even if it has become as volatile as markets--is generally still attractive.
One tradition has not changed. I-bank recruiting and the campaign to win a spot on a bank's interview list start the first week MBAs get to campus. Those who have ambitions of securing a spot in 2012 must get going now.
Tracy Williams
Friday, May 6, 2011
Dimon's "State of the Industry"
Finance types everywhere are familiar with Warren Buffet's annual sermon to shareholders in the form of a letter in the annual report. It's seldom, if ever, a bogged-down analysis of company ratios and trends. More a colloquial finance lecture. Everybody knows the Buffet letter, an honest pontification on business, the economy and the financial system. Derivatives are, he once notably said, "weapons of mass destruction" (although Buffet's Berkshire Hathaway operating vehicle has used them adroitly from time to time).
This year, Buffet has other priorities and distractions. He has an internal crisis to manage. Top deputy David Sokol is under investigation for suspicious trading activity. Sokol reportedly bought an equity stake in a company before Berkshire announced it would purchase it. Buffet has publicly scolded Sokol, and Sokol, as expected, is no longer next in line to run Berkshile.
That thorny current issue undermines the message Buffet delivered from his shareholder-letter pulpit in 2011. Buffet's letter this year is, as always, his usual remarkable finance lecture--a mid-level MBA finance discussion, written in comfortable, flowing style. But you read it wondering about the ethics case that confronts the company right now.
That brings us to JPMorgan Chase CEO Jamie Dimon, who in recent years has stepped up to the plate to provide sharp insight from his Park Avenue pulpit. His letter to shareholders, also colloquial and comfortable, often includes a frank diagnosis of the financial and banking system. It takes a four-prong approach during a period when much has gone wrong in the global financial system: (a) What happened? (b) What went wrong? (c) How can it be fixed? and (d) Who's responsible for fixing it? (And oh, by the way, what do we do with those who were responsible for what went wrong?)
The 2011 letter, just distributed, follows the same course. As in previous years, the letter was eagerly awaited, widely anticipated. Analysts, shareholders, and market watchers wondered, "What would Jamie say this year?"-- in a year, not of turmoil, but one of mild recovery and impressive earnings among large financial institutions. Dimon, as usual, detects what's wrong and proposes a fix-it solution--whether you the reader, the politician or the stock analyst agree or not.
What did Dimon say in 2011?
Up front, he says he caved in and didn't like restoring the bank's high quarterly dividend. He says bluntly and does so on the broad finance stage, "(If) it were up to me personally, I would reinvest all capital into our company and not pay any dividend." But in deference to shareholders, he says, "(This) is not what most shareholders want." Shareholders will understand his sentiment and long-term view, but many wanted some upside after a few years of volatile stock performance.
In general, his message is upbeat, not like the financial death warnings he offered two or three years ago on the same pages.
On risk, he says: "Five years ago, very few people seemed to worry about outsized risk, black swans and fat tails." Five years ago, recall, it was 2006, when markets soared and deals of all kinds (leveraged deals, mergers and acquisitions and thinly documented financings) were getting done. After the crisis, he says, "Today, people see a black swan with a fat tail behind every rock." And he wonders if financial institutions might have been too strickened to take prudent levels of business risks today.
Dimon injects bits of humor. On work ethic, he states, "The American people have a great work ethic, from farmers and factory workers to engineers and businessmen." He adds, "Even bankers and CEOs."
Basell III and Dodd-Frank regulation are big issues at big banks these days. The behemoth banks aren't approaching financial reform with open arms and warm smiles. But they acknowledge the business of banking must be tweaked, and the effort to sustain returns on equity at certain levels will be an immense challenge. Banks will need to divert some attention from normal business activity to implement changes and systems required under new regulation. They also operate with a veil of uncertainty. Many of the details of new regulation are still being written.
Dimon's message this year addresses regulation in depth. He isn't fighting it or arguing for repeal. He is resigned to banks adapting (and whispers that costs might be passed on to customers.) "A likely outcome of the new regulations is that products and their pricing will change," he writes. "Some products will go away, some will be redesigned and some will be repriced."
He devotes passages to the "unintended consequences" of regulation--that Government may have the right intent to propose and enact new legislation, yet the impact could lead to complex consequences--some good for the general public, some very bad for the institutions that must comply. "If a restaurant that sells burgers can't sell french fries (because of a new rule), it risks losing all of its customers."
Dimon relents: "Like it or not, we will adjust...."
And like it or not, the relenting Dimon acceded to shareholders' requests that shareholders be entitled to much higher quarterly dividends.
Tracy Williams
This year, Buffet has other priorities and distractions. He has an internal crisis to manage. Top deputy David Sokol is under investigation for suspicious trading activity. Sokol reportedly bought an equity stake in a company before Berkshire announced it would purchase it. Buffet has publicly scolded Sokol, and Sokol, as expected, is no longer next in line to run Berkshile.
That thorny current issue undermines the message Buffet delivered from his shareholder-letter pulpit in 2011. Buffet's letter this year is, as always, his usual remarkable finance lecture--a mid-level MBA finance discussion, written in comfortable, flowing style. But you read it wondering about the ethics case that confronts the company right now.
 |
| JPMorgan CEO Dimon |
That brings us to JPMorgan Chase CEO Jamie Dimon, who in recent years has stepped up to the plate to provide sharp insight from his Park Avenue pulpit. His letter to shareholders, also colloquial and comfortable, often includes a frank diagnosis of the financial and banking system. It takes a four-prong approach during a period when much has gone wrong in the global financial system: (a) What happened? (b) What went wrong? (c) How can it be fixed? and (d) Who's responsible for fixing it? (And oh, by the way, what do we do with those who were responsible for what went wrong?)
The 2011 letter, just distributed, follows the same course. As in previous years, the letter was eagerly awaited, widely anticipated. Analysts, shareholders, and market watchers wondered, "What would Jamie say this year?"-- in a year, not of turmoil, but one of mild recovery and impressive earnings among large financial institutions. Dimon, as usual, detects what's wrong and proposes a fix-it solution--whether you the reader, the politician or the stock analyst agree or not.
What did Dimon say in 2011?
Up front, he says he caved in and didn't like restoring the bank's high quarterly dividend. He says bluntly and does so on the broad finance stage, "(If) it were up to me personally, I would reinvest all capital into our company and not pay any dividend." But in deference to shareholders, he says, "(This) is not what most shareholders want." Shareholders will understand his sentiment and long-term view, but many wanted some upside after a few years of volatile stock performance.
In general, his message is upbeat, not like the financial death warnings he offered two or three years ago on the same pages.
On risk, he says: "Five years ago, very few people seemed to worry about outsized risk, black swans and fat tails." Five years ago, recall, it was 2006, when markets soared and deals of all kinds (leveraged deals, mergers and acquisitions and thinly documented financings) were getting done. After the crisis, he says, "Today, people see a black swan with a fat tail behind every rock." And he wonders if financial institutions might have been too strickened to take prudent levels of business risks today.
Dimon injects bits of humor. On work ethic, he states, "The American people have a great work ethic, from farmers and factory workers to engineers and businessmen." He adds, "Even bankers and CEOs."
Basell III and Dodd-Frank regulation are big issues at big banks these days. The behemoth banks aren't approaching financial reform with open arms and warm smiles. But they acknowledge the business of banking must be tweaked, and the effort to sustain returns on equity at certain levels will be an immense challenge. Banks will need to divert some attention from normal business activity to implement changes and systems required under new regulation. They also operate with a veil of uncertainty. Many of the details of new regulation are still being written.
Dimon's message this year addresses regulation in depth. He isn't fighting it or arguing for repeal. He is resigned to banks adapting (and whispers that costs might be passed on to customers.) "A likely outcome of the new regulations is that products and their pricing will change," he writes. "Some products will go away, some will be redesigned and some will be repriced."
He devotes passages to the "unintended consequences" of regulation--that Government may have the right intent to propose and enact new legislation, yet the impact could lead to complex consequences--some good for the general public, some very bad for the institutions that must comply. "If a restaurant that sells burgers can't sell french fries (because of a new rule), it risks losing all of its customers."
Dimon relents: "Like it or not, we will adjust...."
And like it or not, the relenting Dimon acceded to shareholders' requests that shareholders be entitled to much higher quarterly dividends.
Tracy Williams
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