Investment banking

Bonfire of the bankers

Profits down, jobs cut, strategy needed

Feb 4th 2012


IT SUCKED,” says the head of investment banking at one of Europe’s biggest banks, reviewing the fourth quarter of 2011. That succinct assessment will take few by surprise. The sale and trading of bonds and shares slowed to a trickle last year. Analysts at Credit Suisse reckon that investment-banking revenues among the big American banks slumped by a quarter in 2011. Trading bonds, currencies and commodities (activities known as FICC) is the industry’s bread and butter: FICC revenues fell by about 15% in America. Things are even worse in Europe. Credit Suisse reckons that European investment banks will post a 43% drop in revenue for 2011. On February 2nd Deutsche Bank announced a fourth-quarter loss for its investment bank.

The first few weeks of this year also look dire. Markets have recovered relative to December, but there has not been the usual January leap. Analysts at Citigroup gloomily predict a further 10% fall in FICC revenues in Europe this year.

The question dogging the industry is whether these falls are temporary or permanent. Trading goes up, trading goes down,” Jamie Dimon, the boss of JPMorgan Chase, told journalists in January. “When things come back these numbers will boom again and we’ll be geniuses, and it won’t be because we did anything, it will be because we stayed in the game.”


If surviving the downturn is the goal, the logical response is to cut variable costs (see chart 1). The banks have been slashing headcounts with vigour. CEBR, an economics consultancy, forecast in October that 27,000 jobs would be lost in London’s financial district in 2011, taking the number of financial employees in the City down to a level last seen in 1998. Not only the City is suffering. Financial News, a specialist newspaper, reckons that 16 of the biggest investment banks have cut 26,600 jobs globally over the past six months. That represents 8% of their total headcount.

From diets to gastric bands

Times are also grim for those bankers who have kept their jobs. In the past investment banks fired some people but still paid big bonuses to those that remained.

Now costs are being cut more deeply and banks are less concerned about being outbid in pay. Compensation is going to get crushed,” says the head of one large investment bank. “Investors are concerned about returns.

[Their] bigger concern is about the split between shareholders and employees.” CEBR reckons that the bonus pool in London’s financial district will slump by some 38% this year, leaving it at about a third of the level it was before the financial crisis. On Wall Street banks including Citigroup, Morgan Stanley and Goldman Sachs are said to be cutting pay by anything from 30% to 70%.

Slimming cures are not enough for many banks, however. Some are changing their business models. Under pressure from regulators, banks everywhere are crowding into client-focused businesses which do not eat up as much capital.

Britain and Switzerland in particular are pressing their banks to hold lots more capital; past disasters have also persuaded management to cut their losses. UBS, Switzerland’s biggest bank, is cutting risk-weighted assets at its investment bank by almost half over the next five years and is pulling out of several business lines. Royal Bank of Scotland (RBS), which once had ambitions to be a leading global investment bank, is now shedding assets: on February 1st RBS announced that it was selling its Hoare Govett corporate-broking unit to Jefferies, an American investment bank.

All this will lead to consolidation in two ways. The first is that as some banks pull back, they create an opportunity for rivals to gain market share.

The second is that as banks crowd into capital-lightflow businesses”—trading bonds, currencies or shares—they are likely to drive down margins. That will please banks’ customers but will also lead to a concentration of market share among the biggest firms.

This process is not new. Two decades ago an investment bank could buy a telephone and earn decent margins by quoting bond or currency prices to ignorant customers. These days corporate customers trade electronically and have terminals providing a stream of prices. Although “flow businessesdo not require much regulatory capital, they do need massive investments in computer systems.

Firms with the best systems tend to attract the most liquidity and in turn are able to offer the most competitive rates. That suggests that only a fewflow monsters” can achieve sufficient volumes of trade to cover the costs of their infrastructure. In areas such as currencies, which are almost entirely traded electronically, this consolidation has already largely taken place: JPMorgan, Goldman Sachs and Deutsche Bank already have big market shares. The next frontier will be the move of bonds onto similar platforms: the same handful of banks is likely to benefit again.

Niche work if you can get it.


With money tight and capital a scarce resource, investment banks must also choose whether to specialise in areas where they are strongest. The very top tier of global investment banks will still hope to generate synergies across diverse businesseslending a firm money, say, and then helping it to sell shares and to hedge currency movements on the capital it is raising. This elite bunch will probably include Barclays Capital, Deutsche Bank, Citigroup, JPMorgan and Goldman Sachs (see chart 2).

Most banks, however, will slim down. “We’re seeing an additional specialisation in investment banking,” says the head of a bank. “Firms are fundamentally either debt or equity [specialists]. They have debt or equity in their DNA.”

A second area of specialisation will be geographic. All but a handful of the very biggest banks will probably be forced to give up their ambitions of being global and concentrate instead on the regions where they are strongest. The retreat is partly driven by capital and cost pressures at home, partly by the realisation that there is less room than expected for outsiders in many of the fastest-growing emerging markets.

A home bias in investment banking is not new, nor is it confined to emerging markets. Of the top five corporate feepayers in the industry last year, four gave most of their investment-banking work to firms from their country or region, according to Thomson Reuters. But the trend is likely to be reinforced as foreign banks become less willing to make cheap loans to prise open new markets and win investment-banking mandates.

As dire as the outlook is, it would be foolish to underestimate the resourcefulness of the industry. The investment banks are staffed by clever, entrepreneurial people with a knack for inventing new financial products and selling them to the world. Instead of going through a grinding decade of job cuts and restructuring, investment bankers could come up with another big, money-spinning innovation.

But even if markets simply bounce back as Mr Dimon expects, the investment-banking industry will look quite different in a few years’ time. There will be fewer big firms straddling the globe; the rest will try to dominate their own niches. And if revenues do stay flat, shareholders may still benefit as employees make do with less of the pot. For bankers that really will suck.

February 2, 2012 3:06 am

Carmaking: in the slow lane

.By John Reed
A sector long seen as an engine of European industry looks increasingly shaky

Last summer, as Europe’s sovereign debt crisis gathered pace, Philippe Varin was sitting in his Paris office, studying disturbing figures from the field. The suave, steely 59-year-old boss of PSA Peugeot Citroën, the continent’s biggest carmaker after Volkswagen, was seeing sales slide for some models – notably the subcompact 207.

Demand for the car had surged in 2009 and 2010, when France and other European countries introduced cash-for-clunkerssubsidies to bolster the sector after the banking crisis devastated car sales. Scrappage schemes had prompted buyers to trade in old models for small and cheap cars, keeping producers busy making models such as VW’s Polo, Ford Motor’s Fiesta and Fiat’s 500.

But with these incentives long discontinued, the 207 was now one of the oldest in a brutally competitive segment. Peugeot’s customers, and some dealers, were pressing for unsustainably deep discounts to match those of other carmakers. Meanwhile, consumer confidence was evaporating in four of Peugeot’s biggest markets: France, the UK, Spain and Italy.

Mr Varin reacted fast. He cut production days at the four plants that make the 207 in France, Slovakia, and Spain. In October the company said it would cut 6,000 jobs and make €800m of cost savings, and that it was heading for a significant second-half loss. The share price dropped.

Peugeot Citroën was the first big victim of the eurozone crisis in the region’s carmaking industry. However, the profit warning presaged what is certain to be a dismal year for the continent’s mass-market industry. Ford Motor reported a fourth-quarter $190m loss in Europe last week; Fiat on Wednesday reported higher 2011 and fourth-quarter earnings, lifted mainly by its US Chrysler unit and sales in Brazil, but acknowledged its mass-market business in Europe had lost €500m last year. France’s Renault and General Motors’ European Opel/Vauxhall arm are expected to report sagging fourth-quarter earnings in coming days.

Europe’s flagging car market – sales fell 6 per cent year-on-year for the month of December and are forecast to fall again this year – has brought the industry’s problems to a head. But the root causes lie deeper, in oversupply issues plaguing a cornerstone industry always under scrutiny from politicians and the public.

Analysts are describing Europe as the sector’ssick man”, a status held until recently by Detroit’s three carmakers, which restructured deeply during the crisis. All the European carmakers are running against the treadmill, in some cases with increasing speed,” says Stefano Aversa of AlixPartners, the turnround consultancy whose clients include GM.

Executives warn of coming distress in the sector, which directly employs more than 2m Europeans and comprises some of the region’s biggest employers and exporters. With eurozone unemployment at a record high, at stake are much-needed jobs in a sector that in good times reliably provides them, but in times of crisis can become a liability.

Sergio Marchionne, Fiat chief executive – also vulnerable to the euro crisis because of its exposure both to the troubled Italian economy and to small carsrecently likened the scene to orphans jostling for food. “If you don’t see growth, whoever’s left at the table is going to be left fighting for scraps of food,” he told the Financial Times in Detroit last month.

Europe’s car industry did not heal itself during the financial crisis. Detroit’s producers closed dozens of plants between 2006 and 2009 and now have lean operations supplying a resurgent market.

Asian peers have plenty of demand to keep them busy. But Europe is still saddled with capacity to make millions more cars than the market wants. Because of political and union pressure, too many high-cost plants have been kept open at home when growth and profits have largely moved overseas.

Worse, the billions of euros of aid extended to European carmakers in 2009-10 – including scrappage and the €6bn French bail-out of Peugeot Citroën and Renault – may have merely postponed much-needed restructuring.

When the US Treasury ushered GM and Chrysler through bankruptcy, it required them to produce crisis-proof business plans and downsize operations. Paris, by contrast, told Peugeot Citroën and Renault to keep plants open as the price of emergency loans.

While GM, Ford and Chrysler closed dozens of plants, in Europe just two factories have shut since 2008: Opel’s in Antwerp and Fiat’s in Sicily. Plants in the countries at the heart of the eurozone crisis – notably France, Italy and Spain – are looking especially extraneous, as bosses search out cost savings. However, in a business that disregards borders, operations in countries from the UK to Slovakia and Romania are vulnerable too.

. . .

Three years on, scrappage programmes also look like an un­sustainable quick fix. They cushioned producers from falling demand and trained European consumers to expect big discounts, especially for small cars.
According to Jato Dynamics, an industry research group, dealers and manufacturers between them offer incentives on mass-market cars that average one-third of their suggested retail price.

Arthur Maher of the LMC Automotive consultancy estimates that the European industry now has the capacity to build 10m more cars annually than the market wants – equivalent to 20-25 car plants. Given the forecast severity of the continent’s economic downturn this year, he expects more redundancies. Some carmakers, he says, are postponing investment.

Arndt Ellinghorst of Credit Suisse says: “Weak European mass-makers will get weaker, and balance sheets and liquidity will become a huge issue. Banks are more selective about who they give money to.”

To be sure, Europe’s carmakers will find some relief in emerging markets. But stripped of overseas income, most – except possibly VW, bolstered by its large scale and luxury brandsmake only slender profits or lose money.

In any other industry, such losses would have led to rationalisation, entailing some business failures and a return to profits for the survivors. But Europe’s car sector, to its short-term benefit and long-term detriment, is treated by politicians and family or state shareholders as a special case – an employment-generating scheme.

Peugeot’s Mr Varin earned his reputation in steel, an industry like carmaking saddled until recently with overcapacity. At Corus, the Frenchman presided over a deep restructuring and its sale to India’s Tata Steel. 

Under Mr Varin, Peugeot Citroën, has diversified away from low-margin small cars and western Europe, launching higher-priced products such as Peugeot’s stylish RCZ roadster or Citroën’s upscale new DS line, which it plans to build in China. Peugeot last year sold 42 per cent of its cars outside Europe, up from 39 per cent in 2010.

But since announcing plans to cut jobs, Mr Varin has had to tread gingerly. Although Peugeot Citroën long ago repaid its bail-out loan, plans for its French plants are under close scrutiny in an election year. When a French newspaper published a company document suggesting Peugeot might close the plant in Aulnay on the outskirts of Paris that makes Citroën’s C3 supermini, it faced accusations from some pundits and politicians of “delocalisation”.

Speaking to a committee in the French national assembly in December, Mr Varin took pains to explain that, for a global carmaker, investing overseas was not a zero-sum game. “I find it normal to have 1,500 people in São Paulo who work on models with specific features that must be adapted for this country,” he said. He pointed out that Peugeot Citroën made twice as many cars in France as it sold there.

Because closing French plants is politically taboo, Peugeot has sought to keep them busy by producing higher-margin models such as the DS. It has also streamlined operations at underused factories in a process it calls compactage.

Similarly, Renault – while investing in plants in low-cost regions such as Morocco – has concentrated production of higher-margin products such as electric cars in France.

. . .

Analysts have long argued that France does not need two carmakers. But the industry’s symbolic status as a repository of national self-worthcombined with the prevalence of powerful family and state shareholders – have hampered mergers.

Thierry Peugeot, Peugeot Citroën’s chairman, in 2009 signalled his openness to alliances but set conditions – notably that the family remain the dominant shareholder. After talks with Fiat, the company failed to reach a deal because of disputes over control and other issues. Mr Varin discussed a cross-shareholding alliance with Japan’s Mitsubishi in 2010 but scrapped talks, claiming they might hurt his company’s credit rating.

In this context he has one of the least enviable jobs in European industry today. “If you were an adviser to Philippe Varin, it would be difficult to tell him what to do differently,” says Stuart Pearson of Morgan Stanley.
“There are constraints politically, from the family, and financially.”

Mr Marchionne of Fiat says he is still hunting for a partner to make small and very small cars, and recently forecast that the eurozone crisis would finally force rationalisation of operations. Last month he met Mr Varin at a dinner at Detroit’s car show, renewing speculation about a merger with Peugeot Citroën. The latter said afterwards that it was “absolutely open” to alliances with a rival, but that conditions were not yet right.

The French company last week tempered the gloom of its downsizing when it launched production of the new 208, a successor to the 207, at its plant in Poissy on the outskirts of Paris. It said it was investing €600m in France, and that the car confirmed its “deep commitment to its home country”. The 208 will feature super-efficient new engines.

But Europe’s oversupplied car market has no lack of good small cars. Analysts say that whatever Mr Varin’s assurances, the group will have to downsize on the continent and invest more overseas. “Eventually, Peugeot will shrink its industrial footprint in France, just as Renault has, and rely on lower-cost locations,” says Stephen Reitman, analyst with Société Générale. “That is inevitable.”

PREMIUM MODELS: Luxury brands speed past industry woes to record sales

While the plants of Europe’s French- and US-owned volume car brands have been cutting production days, most of their German competitors are working at full capacity.

BMW, Mercedes-Benz, Audi and Porsche all saw their brand power and growing presence in emerging markets drive record 2011 sales.
Unlike Peugeot, Renault, General Motors or Ford Motor, who tailor their cars for drivers in Asia and Latin America, opting to build them there to save costs, most German premium cars are made in Europe. Luxury cars are easier to make in one place and then export because they are global products, with minimal regional tweaks. The margins they deliver are fat enough to cover shipping costs and tariffs.

The big four premium brands also like to build close to home because they are spending billions on new and commercially sensitive technology, such as lightweight carbon fibre.

Demand for luxury, extremely profitable cars is high. BMW’s 7 Series and Mercedes’ S-Class are selling at record levels in China, now the segment’s biggest market. Top-end sport utility vehicles, including Audi’s Q5 and Porsche’s Cayenne, sell well everywhere.

Because German products are in such strong demand – and are so globally homogenous would-be Chinese drivers are in a global buying race that strengthens the brands’ pricing power.

Effectively, a Chinese consumer is competing with a European consumer and with a US consumer for a 7 Series,” says Stuart Pearson of Morgan Stanley. BMW can sell to the highest-bidding customer because of their capacity constraints.” Premium carmakers also profit from the strength of the German market – the only big country in Europe where sales are still rising.

But in a business as cyclical as carmaking, even premium brands cannot afford to be complacent. BMW, Mercedes and Audi suffered early in the financial crisis, when the credit crunch wreaked havoc on their large leasing businesses in the US. Mercedes was too slow to cut its production to match falling sales.

Analysts warn that the Germans could be hurt by their growing reliance on China, especially if demand there cools. Serious turmoil in the eurozone would hurt demand for their products in Germany, and a squeeze on credit could dry up their sources of funds.

Peugeot Citroën: Exposed

Where it is: carmaker most exposed to Europe’s structurally declining market is widely seen as likeliest candidate for
consolidation with a rival

Philippe Varin, chief executive, says “we will be in significant loss in the second half of the year, with a negative cash flow

Renault: Under pressure
Where it is: Renault is cushioned by partnerships with Nissan and Daimler but, 15 per cent state-owned, it faces pressure to preserve jobs in France

Carlos Ghosn, chief executive, says “we know that the first quarter of the year is not going to be good ... the order bank has been going down
Fiat: Hurting at home
Where it is: Fiat’s core European small-car business is lossmaking. Chrysler and Brazil, where it is market leader, are keeping the Italian carmaker afloat

Sergio Marchionne, chief executive, says “best prognostication” for Europe until 2014 is “flatlinegrowth, and he is seeking to form an alliance

GM: Boxed in
Where it is: restructuring at Opel, GM’s European unit, has led to job cuts (with hints of more to come) and a plant closure. Low emerging market presence

Dan Akerson, chief executive, says third-quarter losses of $292m in Europe are “not sustainable”. Rumours of an Opel sale persist.

Ford: Discount pressure

Where it is: recording bumper global profits but losing money in Europe, where it faces pressure to discount. Looking at shedding temporary staff

Alan Mulally, chief executive, says “a deteriorating external environment impacted most of our automotive operations outside of North America

VW: Solid earner

Where it is: VW’s huge global volumes, trucks, and sales at Audi and Skoda make it Europe’s least at-risk mass producer. But not immune to slowdown

Martin Winterkorn, chief executive, says “2012 will be substantially harder, above all in Europe, and especially in highly indebted countries like Italy

Copyright The Financial Times Limited 2012.


The war on finance

Attacking your creditors is an intriguing strategy

Feb 4th 2012

THE man who the polls suggest will be the next French president, François Hollande, claims that finance is his “real adversary” in the coming election. Britain has just stripped the former chief executive of the Royal Bank of Scotland of his knighthood. Even Newt Gingrich is attacking the “vulture capitalists” in the private-equity industry. Perhaps the West is set for a “war on finance” along the lines of the “war on terror”, with similar uncertainty about how to define victory.

Politicians seem to have three main beefs with the financial sector. The first is that bankers earn too much. The second is that banks take reckless risks and then need rescuing by governments. And the third complaint is that investors in financial markets have undue influence over an economy through their ability to affect bond yields and equity prices.
The first two problems are really related. People do not worry too much about footballers’ high pay.

The problem with bankers is the extent to which they are subsidised by explicit and implicit taxpayer support. (Of course, you might worry about income inequality in general but that is not specific to banks and can be tackled by redistributive taxation.) It is hard to disagree with Paul Tucker of the Bank of England, who has written that: “Those who most espouse the disciplines of capitalismbankers and financiers—should live by them.”

The problem of banks being “too big to fail” is being addressed, albeit slowly, by the higher capital ratios being imposed by regulators. Higher capital ratios should mean lower returns on equity; over time, this should lead to less rapid pay growth for bankers. Andrew Haldane, a colleague of Mr Tucker’s, has found that the pay of bank bosses correlated well with returns on equity, but not with returns on assets—in other words, managers prospered by gearing up bank balance-sheets. That is now harder to pull off.

The finance sector has also, in some people’s eyes, had a pernicious effect on politics. Like any other interest group, the industry lobbied on its own behalf and achieved some notable regulatory gains in the 1980s and 1990s, such as the abolition in America of the old Glass-Steagall divide between investment and commercial banking. Its doyens have gained powerful positions in government, although this may be down to the modern assumption that if people are rich they must be smart.

But this influence did not stop Congress passing the Dodd-Frank act, has yet to stop Britain’s planned divide between commercial and investment banking, and has not held up a host of new EU regulations. This suggests that democracy can overcome vested financial interest. Indeed, there are plenty of votes in bashing bankers, as Mr Hollande is only too aware.

The third political beef is a very longstanding complaint: recall, for example, Harold Wilson, a former British prime minister, and his rants about the “gnomes of Zurich” who were speculating against the pound. The German chancellor, Angela Merkel, called for “the primacy of politics over the markets” in 2010.

This seems an odd battle to fight. All euro-zone governments need to borrow money from the markets. The political message seems to be: “We hate private-sector creditors. We will penalise you by defaulting on your debts but not on debts to official creditors. We will endeavour to stop you protecting yourselves against our actions by making it difficult to collect on insurance in the credit-default-swaps market. Now, can we please borrow some money at a very cheap rate?”

The underlying complaint is that speculators drive up bond yields, making it harder for governments to finance themselves. As a result governments are forced into austerity programmes, against the wishes of their electors.

Yet the same markets are more than willing to lend money to governments in America, Britain and Germany at negative real (ie, after inflation) rates. This may be down to the influence of other buyerscentral banks, commercial banks, pension funds—who are not that interested in maximising their return.

That suggests the problem might not be with the markets after all. What happens to countries like Greece which lose access to private-sector finance? They become dependent on the largesse of official creditors—the International Monetary Fund, the European Central Bank, other EU nations—which can be even more stringent in demanding austerity programmes. After a few bouts with the ECB, the 57-year-old Mr Hollande may end up wishing that his planned retirement age of 60 also applied to presidents.