LONDON May 5 It has taken banks years to rein
in their optimism and start setting targets they have some
chance of meeting, finally chastened by conspicuous failure in
meeting the unrealistic expectations they touted.
After the collapse of investment bank Lehman Brothers in
2008, industry survivors reacted to the crisis of confidence in
the sector by reassuring shaken investors with a raft of
promises to show they were ahead of a perilous game.
But new research by Cambridge-based consultancy Tricumen
shows the capital markets units of eight of the world's biggest
investment banks have, so far at least, met less than a third of
the close to 80 targets they have cited in investor
presentations since late 2008.
In 2009/10, they promised revenue growth, job cuts, lower
cost-income ratios and better profit margins.
"I would characterise a lot of those targets as
aspirational," said the CFO of one major bank of its 2009 aims.
A source at another said their financial targets were "swept
away by the crisis", while a third said, "Of course we didn't
make our pretax profit targets. Nobody did."
Banks met most of their 'firm' cost/headcount reductions and
funding targets but "largely missed their revenue/profitability
targets", Tricumen said.
The section on Deutsche Bank shows that in late
2009 Germany's biggest bank unveiled eye-catching 2011 earnings
targets for its investment bank, including pretax income of 6.4
billion euros for its corporate banking and securities unit,
when analysts had pencilled in 4.5 billion euros.
Ultimately, it managed just 2.9 billion euros.
French bank Societe Generale (SocGen) wowed
investors with medium-term targets' for return on equity (ROE)
in May 2009, which Tricumen said it missed.
Deutsche Bank and SocGen declined to say why, but for most
of the sector it's no mystery.
"Growth recovered in 2009, and management teams were far too
bullish - headcount increased in 2010 as investment banks
targeted revenue growth, a clear mistake, with hindsight," said
Deutsche Bank analyst Matt Spick, speaking about banks in
general, not his own institution.
COST OF REGULATION
The quickening pace of regulation also played a part.
Though new Basel III rules on capital requirements don't
fully come into play until 2019, many banks are already being
measured against them and so have modified their businesses.
"There was a sense of denial about the impact of Basel III
and how quickly it would come," the CFO said.
Beyond the unpredictable revenue line, which many bankers
privately admit they were foolish to target so publicly,
progress on absolute costs has also been slow.
Tricumen doesn't include much detail on banks that missed
cost-cutting targets, but equally finds few that clearly met
them. This is partly because absolute cost targets were embraced
by banks relatively recently, so many stretch beyond 2013.
In the broader universe of European banks, the 39 that
Deutsche covers are expected to have 292 billion euros of
operating costs this year, almost identical to 2010.
Spick said banks faced a major costs challenge as they
migrate from traditional to electronic trading.
"Going electronic sounds more headcount efficient, but banks
initially have to run dual systems," he said.
"Take cash equities; the majority by volume is electronic
execution, yet as an industry we still have 70 percent of the
workforce from the old 'high touch' business, which has meant
that net headcount reductions in cash equities have been far too
small to maintain profits."
"Despite running very fast, banks are standing still," said
Matthieu Lemerle, a London-based partner at McKinsey, which
advises banks on cost cutting.
Ajay Rawal, a managing director with Alvarez & Marsal's
financial industry practice, said IT savings often took longer
than expected, while staff cuts were "a bit more predictable".
In a March 2009 presentation Credit Suisse promised it would
cut investment banking headcount from 21,300 at end-September
2008 to 17,500 by the end of 2009, which Tricumen says it missed
based on detail in Credit Suisse's 2009 accounts.
Credit Suisse says some targets Tricumen shows as
missed were achieved but offset by new hires as it invested in
IT infrastructure, grew its fixed income sales force and upped
numbers in prime services and cash equities. Cost cuts were also
obscured by investment, Credit Suisse added.
More recent industry targets are noticeably different.
Several banks, including Switzerland's UBS, have
moved the message away from revenue and net income towards
absolute cost reduction, which are more within banks' control
but could take years to show as redundancy and other one-off
costs bite. New costs such as regulation and litigation have
also blunted the net effect of even successful cuts programmes.
Another favourite goal is cutting risk-weighted assets
(RWAs), against which a bank's capital adequacy is measured, by
selling assets or changing the business model.
"Banks can decide how much asset risk they want to take into
the balance sheet quite easily. It's hard to control how much
revenue they make," said Spick.
In Barclays February 2013 strategic review
management targeted "single digit growth" for its investment
bank from 2012 to 2015, said RWA would fall between 27 and 47
billion pounds and the ratio of compensation to income would
drop from 39 percent to the "mid 30s". The 2015 ROE target is 14
to 15 percent, against 13.7 percent in 2012.
Others, like SocGen, are moving from hard figures to more
general aims. Its latest presentations on corporate and
investment banking goals "targeted strategic development" where
it will "selectively expand to better serve our clients" and
invest "to increase profitability and capture market share".
"We will communicate on financial targets once we have the
definitive rules of the game. I think it is premature today,"
SocGen CEO Frederic Oudea said in February.
Part of the reason the targeting is getting better is that
banks are now five years into the cost-cut cycle, and the
low-hanging fruit has long been plucked, peeled and swallowed.
The changes banks are contemplating now are far more
fundamental, as revenue settles at a 'new normal', well below
"It's not about removing flowers in the lobby or restricting
access to certain classes of travel," said McKinsey's Lemerle.
"(For some) the underlying complexity of the platform is too
high for the new revenue-generating capability of the platform."
Some are introducing solutions like LEAN manufacturing
techniques to the trading floor so traders work across a wider
range of assets and have less slow time in a day.
"The widget I'm selling is a derivative trade. I have to
apply industrial discipline to that product," said Lemerle.
Selling widgets might be lightyears from the self-image of
investment banking's erstwhile 'Masters of the Universe', but
after too many broken promises, the pressure is on to deliver.
"We just want to be known as the management team that does
what we've said we'll do," said the CFO.