viernes, 3 de abril de 2015

viernes, abril 03, 2015

March 29, 2015 6:13 pm
 
Lex in-depth: Universal Banks
 
One-stop banks always have an excuse for lacklustre performance, but it is time for them to make bold changes
 
 
 
 
 
The Goldman analysts were right to raise the question. Although it dislikes the term, JPMorgan is a prime example of a universal bank. Others — Citigroup, Bank of America Merrill Lynch, Barclays, Deutsche Bank — also combine retail and investment banking but JPMorgan is the most prominent. 


And universal banks have been, to put it politely, a disappointment. JPMorgan produced a return on equity of 9.4 per cent last year. That is barely adequate but it is the best of a bad bunch. None of the others made it past 5 per cent. And last year was not out of the ordinary



Those five universal banks together have managed an average return on equity of 5 per cent over the past five years. There is always an excuse — fines, new rules, restructuring charges, tough conditions in one market or another — but these are all part and parcel of universal banking.

Compare that with the specialists. Look at Wells Fargo, which is predominantly in the retail sector, with a 12 per cent five-year average ROE. Or even Goldman, a pure investment bank, with 11 per cent.
 
The universal banking model is broken, a fact some banks have realised. UBS and RBS have moved. Others — Deutsche and Barclays, for example — have been less radical so far and need to go further.
 
The US universal banks are the most wedded to the model, promising better returns in the future. But shares in almost all of them trade at a discount to specialists. The message from investors is clear.

Not what we signed up for

There ought to be benefits to scale, especially when it comes to funding and to covering the growing costs of compliance and IT.

Marianne Lake, JPMorgan’s chief financial officer, was in fine form at the bank’s investor day in February as she laid out the case for its structure — $15bn in cross-selling benefits and $3bn in cost synergies adds up to $6bn-$7bn of net income, or 30 per cent of the group total. That is a big chunk of profit to put at risk in the vague hope that the resulting companies would merit a higher stock price.

Academics are less convinced. Berenberg points out that two years ago the Bank for International Settlements looked at whether size brought benefits in banking. Of 37 academic studies reviewed, only 15 said it did. Hardly a resounding show of support.

Most of the universal banks are failing to prove that economies of scale exist. Cost-to-income ratios — a measure of an institution’s efficiency— are high at the universal banks: JPMorgan’s is 63 per cent, Citi’s 72 per cent and Bank of America’s 88 per cent. Again, the specialists tend to do better. Wells Fargo and Santander manage 58 per cent and 47 per cent respectively. Goldman, manages 64 per cent.
 
Diverse companies ought to be safer. As one side of the business falters, the other thrives and the ship sails on. Some of the biggest failures of the crisis — Lehman Brothers, Bear Stearns, Washington Mutual, HBOS — were specialists, rather than universal banks.
 
So in theory, diversification should reduce funding costs. And that is before we even get into the debate about whether big banks benefit from an implicit government guarantee or whether cheap retail deposits can be used to finance (supposedly higher returning) investment banking activities — a practice that post-crisis regulators are stamping out.

But these benefits are also absent. Post-crisis rules force the biggest global banks to hold more shareholder capital, a relatively expensive form of funding. JPMorgan will eventually have to have a common equity tier one capital ratio of 11.5 per cent. Citi will probably need about 11 per cent (the rules are still being firmed up). Smaller, less systemic banks can get away with holding less.

On the debt side universal banks, with all their diversity, do not tend to enjoy lower credit ratings.

JPMorgan, Deutsche, Citigroup, Goldman and Wells Fargo all have single A ratings from S&P. Prices of the credit default swaps — the cost of insuring against a default — are not much lower either. Insuring against a default from JPMorgan or BofA is cheaper than for the likes of Goldman and Santander, but more expensive than Lloyds and Wells Fargo, according to Markit.

That may be because of the added risks of complexity and opacity. As banks grow, it becomes more difficult for management to have full control. HSBC was taken by surprise by its Swiss private banking operation. The problems are a decade old but Stuart Gulliver, the chief executive, says he cannot know what all 257,000 of the bank’s staff are doing. In 2012 JPMorgan lost $6bn in the so-called London whale incident, when it lost control of risk-taking in its chief investment office. Such complexity was a big problem in the crisis, when banks struggled to understand what was on their own balance sheets let alone everybody else’s.
 
The universal banks have to change. They have three options.

The axe

The most obvious is to get out the axe and sever one of the limbs. The Royal Bank of Scotland is attempting something like this, dispensing with most of its investment banking activities. It plans to cut risk-weighted assets in the investment bank from £147bn in 2013 to as little as £35bn by 2019.

Investment banking is a popular target for cuts. Revenues in the industry have been falling 6 per cent a year since 2009, according to data from Morgan Stanley and Oliver Wyman. The fixed income, currencies and commodities sectors — the most capital intensive part of the business — have been falling 9 per cent a year.
 
But the axe does not have to fall on the investment bank. For Deutsche, its retail arm appears to be the bigger obstacle to profitability, employing €14.4bn of equity for a 6 per cent return in 2014. Germans tend to borrow little and there is a lot of competition for those who do. Deutsche should spin off its retail business and become a specialist investment bank, pushing companies to borrow in the capital markets rather than via bank balance sheets.
 
This would not be an easy process. In particular, the departure of the bank’s €210bn of retail deposits would pose a challenge for the liquidity coverage ratio (a new rule stipulating that all long-term assets have to be matched by long-term liabilities). So in response it would have to cut assets in the investment bank to balance things out — Jefferies thinks a cut of €100bn is necessary. But that would not be a disaster.

The scissors

For those who lack the stomach for such radical solutions, there are the scissors. Here the example is UBS, which in 2012 decided to scale back its investment bank to focus on wealth management. Equity employed in the investment bank has shrunk from SFr10.9bn in 2012 to SFr7.6bn at the end of last year. Its share price has felt the benefit. Before the 2012 changes, the shares traded at 0.8 times book value. They now trade at 1.4 times.
 
Two banks would benefit from this sort of approach. The first is Barclays. It has committed to cutting its investment bank but the unit, which uses £15bn of equity — almost as much as the better performing retail business — produced an ROE of 2.7 per cent last year. The cuts have not gone far enough. Incoming chairman John McFarlane may have an appetite for hefty reforms. An investment bank serving UK-based corporate clients and perhaps also working with Barclays’ African interests would make sense. If that means that the 2008 acquisition of Lehman’s US operations looks like a mistake in hindsight, then so be it.

The other is UBS’s local rival Credit Suisse. Incoming chief executive Tidjane Thiam is unlikely to have been brought in with a mandate to expand the investment bank. Like UBS, it should shape its investment operation to serve the wealth management business. Analysts at Deutsche estimate that an exit from most of the FICC businesses, for example, would release SFr10bn of capital and that the drop in earnings could be offset by the higher share price. (Credit Suisse trades at a 30 per cent discount to UBS.)
 
The nail file
 
This is the easiest approach. Tweak some parts of the business as rules and market conditions evolve, but stick with the idea that universal banking will eventually pay off. JPMorgan, with its insistence on the cross-selling benefits and cost synergies, fits into this category. It is making some changes — cutting costs in the investment bank by $2.8bn (or 13 per cent) by 2017, for example. But the shape of the bank is not changing.

In JPMorgan’s defence, it is making universal banking work much better than its peers, and performs better than many specialists. It promises to deliver a return on tangible equity (which tends to produce higher numbers than straight ROE) of 15 per cent over the next three years, against last year’s 13 per cent. Higher interest

But JPMorgan’s share price, at one times book value, suggests a degree of scepticism about the model — Wells Fargo and Goldman both attract higher ratings. The scepticism is not limited to JPMorgan. A small shareholder has forced a break-up proposal on to the agenda for the Bank of America annual meeting, and plans to push similar proposals at Citigroup and JPMorgan.

The banks are not unfamiliar with break-ups. In recent years JPMorgan has advised Liberty Media, CBS, Time Warner and News Corp on their demergers or spin-offs, according to Dealogic. The objection is that the costs of a split would be huge. And so they would. But that is no reason to stick with a failing business model which, over the long term, will destroy more value than the one-off shock of a break-up.
 
And this is just the momento when the model should not be failing. The US economy grew 2.2 per cent last year and is forecast to grow 3 per cent this year. Such conditions ought to be good for US banks, despite the drag from low interest rates. The sun is shining; the universal banks ought to be making hay. But they are not. Even the best of them only just covers its cost of capital.

For the universal banks, then, 2015 is a critical year. If they cannot make the model work, they should admit that the nail file has failed — and get out the axe.

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