Posts Tagged ‘Investment banks’

Still too big to fail

June 23, 2011

Tom Hoenig, president of the Federal Reserve Bank of Kansas City and a skeptic on loose monetary policy and the state of the world’s biggest banks, is convinced the United States still hasn’t heeded the lessons of the last financial crisis.

During an otherwise happy gathering in our hometown, the “CFO of the Year” awards event organized by the Kansas City Business Journal, Hoenig climbed on his soapbox to warn of the prospect of another crisis in the future. The trouble is, he said, the same too-big-to-fail banks that starred in the 2008 meltdown and the recent HBO dramatization of Andrew Ross Sorkin’s book Too Big to Fail are still, well, too big to fail – even moreso.

The financial reform law enacted in 2010 to guard against the next crisis doesn’t solve the issue of systemic risk, Hoenig said. And the world’s central banks continue to be “held hostage” by issues raised in 2008, he said. Exhibit A is the way everyone is worrying that debt problems of one smallish country could reverberate through big banks worldwide – roiling capital markets and threatening a new crisis.

“Dodd-Frank does three things, and it leaves one thing undone – and that is the most significant thing,” Hoenig said. What the financial reform law does:

  • Enhances supervision. “We’ve enhanced supervision after every crisis,” and it hasn’t prevented the next cycle of financial collapses, Hoenig noted.
  • Raises capital standards. But commercial banks used to hold capital around 15% of assets, and now some bankers feel 8% is too onerous a requirement, he said.
  • Mandates a new resolution process. But the next time a giant bank teeters on the brink, the bailout impulse will be as strong as ever, Hoenig said.

What Dodd-Frank leaves undone is addressing “too big to fail,” Hoenig said. The U.S. banking system is more concentrated than ever, and that fact haunts the financial markets, he said.

Hoenig offered a “TBTF” history lesson: In 1913, when the Federal Reserve was created, the five largest U.S. financial institutions managed assets totaling 2½% of the country’s GDP. In the Great Depression, the government created a safety net for banks – FDIC insurance and the like – and barred bank holding companies from speculative activities through the Glass-Steagall Act of 1933.

And it worked, Hoenig said. Banks lent money and cushioned their balance sheets against downturns. Investment banks, kept separate from the safety net, took on leverage and invested in riskier assets for greater returns. The economy grew. Markets did well. While the banks expanded, by 1980 the five biggest still held assets equal to only 14% of GDP. One failure wouldn’t have crashed the system.

That changed after the 1999 repeal of Glass-Steagall freed banks to enter other financial services, growing bigger and bigger – and taking on more and more risk. Despite the turmoil of 2007 to 2010, Hoenig said, the banks kept getting bigger.

“Even today, after the crisis, the five largest financial institutions control 20% more assets than before the crisis,” Hoenig said. With the mergers caused by the financial crisis, concentration in U.S. banking has grown to around 60% of GDP.

As one who has lived through weekend “too big to fail” negotiating sessions, Hoenig said, when another giant teeters on the brink the story will be the same. Given the threat that a huge bank failure could lead to collapse in the real economy, he said, “on Sunday evening, before the Asian markets open, you will in fact bail it out.”

Before that next crisis arrives, Hoenig suggested, big U.S. banks should be broken into more manageable pieces – especially, separating commercial banking with its publicly provided safety net from those riskier investment activities in the capital markets. Hoenig laid out more specifics in a speech last month in Philadelphia.

I agree. Let’s dismantle too-big-to-fail before it fails us, again.

© 2011 Johnson Strategic Communications Inc.

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I-bankers & God’s work

March 18, 2010

A little commentary tucked into today’s Wall Street Journal (p.C4) riffs on Lloyd Blankfein’s statement last fall about investment bankers “doing God’s work” – and may hold a lesson, too, for investor relations professionals and our companies.

John Terrill, who heads the Center for Integrity in Business at Seattle Pacific University, shares his thoughts on i-bankers doing good through their work:

Investment banking, if it meets its objective of capital matchmaking, can move, ought to move, capital around in ways that allow communities to flourish.

Terrill says benefiting society in business is about aligning what you do with broader purposes, realizing, “Hey, my work has a purpose beyond the paycheck.”

Asked how to measure whether investment bankers are contributing to the common good, Terrill focuses on integrity – a oneness between purpose and action. This test also applies to corporations and their messaging for investors.

Terrill says integrity consists of three layers:

The first two layers are associated with damage control – compliance with the law and acting appropriately when there is no law. But, as others have pointed out … there is a third layer that is focused on mission control. Mission control is pursuing the good, aligning the mission of the organization and the good of society.

Disclosure focusing on corporate social responsibility is a growing concern for investor relations staffs – amid regulatory pressures (such as the recent SEC guidance on  climate change disclosure) and interest from institutional investors.

Terrill’s three “layers” suggest a useful framework for reporting on corporate interactions with society:

  1. Compliance with the law,
  2. Standards of conduct that go beyond the law, and
  3. The company’s broad mission in serving customers and providing products or services to society.

Disclosure to investors would tie any specific issues in with business performance – near and longer term – which would include regulatory threats, costs of compliance and effects on customer relationships.

The Terrill essay referenced by the WSJ article, “The Moral Imperative of Investment Banking,” offers additional comments.

© 2010 Johnson Strategic Communications Inc.

Anthropology of Wall Street

September 24, 2009

If you’ve worked on stock offerings or M&A transactions, you have probably noticed that the smartest guy in the room is always the investment banker. At least in the investment banker’s opinion. (And I say this without any envy or doubts.)

So I perked up when I saw a piece in my college alumni magazine about a new book. In Liquidated: An Ethnography of Wall Street, Karen Ho explores the culture of investment banks. She says the i-bank tribe’s most revered value is “smartness.”

Ms. Ho started researching the culture of Wall Street as a Princeton grad student in Anthropology. Usually, talk of Anthropology conjures images of going to a rain forest to study strange customs. But Ms. Ho, now an Anthropology prof, finds her cultural oddities in the jungle of downtown Manhattan.

At one point she decided field interviews were not enough – she needed to get inside Wall Street by working there. She recalls a Goldman Sachs recruiting session:

“So why should you work here?” asked the recent white male alumnus from Harvard. “Because if you hang out with dumb people, you’ll learn dumb things. In investment banking, the people are very smart; that’s why they got the job. It’s very fast, very challenging, and they’ll teach as quickly as you can learn.”

Sound a little elitist? Repeatedly, Ms. Ho says, Wall Streeters told Ivy League prospects in recruiting sessions for i-banks things like, “We hire only superstars” and “You are the cream of the crop” and “You are all so smart!” (A few years ago, recall, Wall Streeters had jobs – and even needed to hire more.)

Once inside, of course, the oh-so-smart bankers reinforce the self-image. Ms. Ho says that feeling of smartness is what the Wall Street culture is all about.

Now fast forward to the financial meltdown of 2007-09. The article notes Ms. Ho’s conclusion that Wall Street’s latest downfall resulted not so much from greed or stupidity as from the smartest-guy-in-the-room syndrome:

The crash is the natural result of a Wall Street culture in which the self-proclaimed smartest people in the world came to believe that high share prices trumped all other corporate values and, in doing so, imposed their ethos of live-for-today risk-taking on the economy at large.

Not everyone on Wall Street, of course, embraces an elitist culture. I have worked with i-bankers who are humble, down-to-earth and friendly. And some investor relations and corporate execs play know-it-all. On the other hand, as a stereotype for i-bankers, there is some truth to the image of “smartest guy in the room.”

[Disclosure: I have not read Ms. Ho’s book. The magazine version was fine, but I don’t think I’m up for an Anthropology tome published by a university press. Her bottom-line conclusion is interesting. Let me know if you read the ethnography.]

What’s a good price?

August 5, 2009

Clunkers_in_JunkyardClunkers are in the news as part of the government’s weird but popular “Cash for Clunkers” stimulus program. Regardless of its policy merits, I’m pleased not to be in the market for a car right now, buying or selling. For me, anyway, the process is unpleasant – especially getting to the right price, including trade-ins and so forth. Plus clunkers, for now. The price always seems debatable.

Mergers and acquisitions seem a bit like that. As an investor relations person, I’m not part of the negotiating process for corporate deals. Folks who do negotiate the deals earn the big bucks – but that’s OK. My job is to communicate a deal once it’s done. I’ve enjoyed strategizing and helping communicate dozens of deals over the years, so I thought I might share a few ideas on M&A communication.

First, one more thought about clunkers: Buyers and sellers have different points of view in negotiating (and then communicating) a transaction. The pattern is so much a part of human nature that deal making spawned an ancient proverb: “‘It’s no good, it’s no good!’ says the buyer; then off he goes and boasts about his purchase.” The seller, also, has one story in negotiations – “You’re looking at an absolute gem!” – and later brags what a great price he got for the old heap.

Please don’t think me cynical. It’s just that, in communicating an M&A transaction, talking about price is one of the biggest challenges. Is it high, is it low? A windfall for the sellers, a bargain for the buyers? What comparisons can add perspective?

That single number – “How much per share?” – is the most important fact of the whole deal to shareholders of a company that is selling. It’s important, too, for shareholders of the buyer. Other questions about the deal, at least among financial audiences, often seek to shed light on whether it’s is a good price.

So how do we describe the price being offered or paid in an M&A transaction?

  • Realize that communicating a deal is a collaborative effort. Rules often are dictated by the delicate relationship between buyer and seller – and by their lawyers. Both sides have to be able to explain why this is a good deal for them. The lawyers provide cautious language and disclaimers to keep everyone on the right side of securities regulations. How about putting all the parties around a table to hash out key messages for communication? Or connecting the two communication staffs to cooperate on an announcement?
  • When a deal is almost ready to announce, the investment banker is a key resource for communicators who are crafting messages. Regardless of how you feel about i-bankers the rest of the time, they know how to sell a deal – and its price. A financial adviser’s fairness opinion typically is at the heart of formal communications to shareholders. Look for key messages and words in the presentations used to sell the deal to your board, and go from there.
  • Comparisons offer perspective – though picking the right ones can be tricky. The first place everyone looks is the “premium” – what percentage is the offer above the last price at which the target company’s stock traded? But that’s not the only comparison. A stock’s 52-week high is the most common benchmark used in negotiating public-company deals, according to a Harvard B-school study of 7,500 deals cited in the July-August 2009 CFO. If the offer is above the 52-week high, fine; if not, boards are afraid shareholders will balk. Providing the 52-week range is easy and factual.
  • Be prepared to discuss valuation measures. Whether or not you use them in a press release or formal presentation, metrics like multiples of EBITDA or book value (picking the right metrics is industry-specific) help tell the story to well-informed investors who already have a sense of what multiples are fair.
  • On the buying company’s side, consider how the price interacts with hoped-for the synergies, cost savings and strategic quantum-leaps that your CEO will want to discuss. And at least ask the question, “What kind of return do we expect to earn on this investment?” Shareholders like to hear that an acquisition is earnings-neutral, or accretive this year or next. But the bigger question is what’s the ROI or ROE we’re getting for shareholders’ money?
  • Talk about timing. Any deal being negotiated now has a lot to do with the stage of the business cycle – prices are depressed, sellers may be more willing because cash (or credit) is running out, and an expected recovery may figure into the buyer’s rationale for expecting an economic return. This context is relevant for shareholders on both sides.

All of which brings me to the TV game show “The Price Is Right.” You know, the 1950s-style program where contestants try to guess the true value of some consumer item. It’s been around so long Bob Barker had to retire, but the show goes on. Its durability, I think, comes from the fact that people enjoy debating prices and values of things. And that’s certainly true in the market for stocks of public companies – watch the argument triggered by just about any M&A deal.

In preparing to announce a sale or acquisition, therefore, investor relations people need to take price into consideration as a message. It’s a key question in any transaction. And I believe we should try to answer investors’ questions, even before they’re asked, as proactively and completely as possible.

Those are my ideas. I welcome your M&A insights – just click “Leave a comment.”