Thursday, 20 September 2018

Steady course

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Despite the inclement financial climate, the UK banking sector reckons it can still make hay. With focused strategies, the country's major banks all remain committed to their business mix, and are convinced they will see out the crisis and emerge with relatively stronger market positions. David Cox reports.

When IFR conducted a survey of British investment banking a year ago, all of the major players were in an upbeat mood. At the time storm clouds were beginning to gather over the financial markets, with the fallout from the US sub prime crisis starting to spread overseas, combined with a stalling in leveraged finance activity. Despite these worries, few expected the crisis to be as long standing or as deep as it has proved to be.

"This has been the most challenging market I have seen in my career, where any improvements have been both slight and temporary," said Mark Grant, head of debt capital markets at Lloyds TSB. "The crisis caused a massive shift in how banks interact with each other and continued stresses on capital levels means funding is still a challenge for many banks."

Gloom has spread from the banking sector into the wider economy and the outcome for the coming year looks uncertain at best. As a country exposed more than most the to financial sector, the UK banking industry has told more than its fair share of horror stories, of which the now nationalised Northern Rock is the grisliest. Even if the country's major banks have avoided the excesses that led to the demise of the Newcastle-based mortgage bank, share prices have been hit savagely across the board with none escaping sizable write downs.

RBS has probably had the most dramatic year. It outbid it domestic rival, Barclays, in acquiring ABN AMRO with a €71bn cash break-up bid. RBS was then forced into a £12bn rights issue - the largest in British history - and reported its first ever lost with a pre-tax half year deficit of £691m. This loss was a reversal of a £3.6bn profit recorded across the same period in 2007 and came after write-downs totalling £5.9bn.

In the firm's global banking and markets division – where the capital markets and investment banking activities sit – income fell by 10% before one-off items and write-downs, to £5.3bn. But losses and write-downs took the division into a loss of £3.2bn.

"The market is clearly pretty difficult in certain areas an we have seen significantly reduced volumes in real estate, securitisation and our leveraged finance businesses. However, notwithstanding reported writedowns our underlying business has held up well,"" said Leith Robertson, deputy CEO, Global Banking & Markets. "In the large corporate market we have been active on all of the year's major transactions in Europe, and in the the US we are now #5 in the corporate market. Our businesses in areas such as rates, currencies and commodities have all done very well and have taken market share"

If RBS's woes are dramatic, they are by no means unique. After raising a £4.5bn chunk in fresh capital, Barclays reported a 33% drop in pre-tax profit for the first half of the year at £2.75bn, after taking a writedown of £2bn on the value of risky assets. At the investment bank, profits fell 68% to £524m after a £1.98bn writedown on credit market exposures net of a £852m gain on holding its own debt.

Lloyds TSB also reported sharply reduced profits at the first half of the year with a 70% reduction compared with the same period last year at £585m. Given the bank's more conservative stance, it took write downs of £387m in the first quarter, on top of a £280m writedown in 2007.

Despite this depressing news, British banks remain focused on their strategies and convinced that the crisis will offer opportunities to expand existing business lines.

"Overall market conditions are challenging, specifically in the areas that have been severely impacted by the credit crunch such as leveraged finance and securitisation," said Jerry del Missier, president of Barclays Capital. "However, in other market sectors, investors are still active and we've been well placed to take advantage in areas such as interest rates, forex and commodities."

"We've been helped by the diversity of our business and though there has been a slowdown in several areas, we have been able to outperform in others," he added.

Both Barclays and RBS remain committed to the universal banking model – the ability to offer integrated product solutions with a "product agnostic" approach. RBS's acquisition of ABN AMRO has both pushed that bank up the debt league tables and provided it with a ready made equity franchise

"The integration of ABN AMRO means we are now a global player with a broad financing , risk management and advisory product capability," said Robertson, "We are active in over 50 countries and this local presence combined with our global product capbility and the ability to execute cross border transactions means we are a true global player.”

"The benefits of bringing the two organisations together are already becoming apparent in our ability to win new mandates."

Leith points to RBS's advisory role in helping INA Schaeffler in its bid to take control of tyre maker Continental as the type of bulge bracket deal that the combined ABN AMRO and RBS is able to win. Indeed, the bank stresses that the move into advisory and equity capital markets is a natural extension of its previous debt focused business. It believes its franchise should now be benchmarked by the world's global banks.

Opportunities for Barlcays

Despite Barclays' failure to acquire ABN AMRO, the bank still sees opportunities to expand, specifically in its US high yield business, the equity franchise in the US and Asia, and it emerging markets business. It all points to its overriding ambition to turn itself into a top tier US investment bank.

Indeed Barclays has continued the expansion of its US franchise apace this year, most notably through the hiring of a Houston based energy investment banking team. The build-out of the energy team was another step in the broadening of the firm's sector expertise following on from increased coverage in the healthcare, paper and packaging and retail sectors. The selective hiring process meant that - perhaps uniquely among top tier investment banks -Barclays added staff in the year to June, adding around 100 people while managing to reduce costs by 30%.

"We have reduced our staffing capacity in areas where volumes have fallen, and are building in other areas where we see opportunity,” said Del Missier. “We are fully committed to our graduate programme and are still looking to take advantage of conditions to build out areas where we have identified opportunities to deepen our client relationships."

Lloyds stays focused

While both Barclays and RBS seek to build global investment banks, Lloyds has taken a different track. The bank remains predominantly focused on the UK middle market, and has sought to expand the suite of products it can offer clients. Traditionally seen as a domestic lender, the bank has sought to leverage its UK relationships to extract higher margin business. With its strong balance sheet and its Aaa/AA credit rating, the bank has been able to benefit from the crisis as borrowers turn to banks with the strength to support them through the crisis.

"Our measured approach to this business has positioned us well at a time when there is an awful lot of stress in the financial sector." said Grant. "We offer stability as a trusted adviser and we are not a bank that over promises and under delivers."

The bank has been building up its investment banking operation over the past 18-months and has made targeted hires, most notably in the debt capital markets. The strategy appears to be paying dividend and the bank has made notable gains in leveraged finance – where it is now a top 10 player in Europe – as well as significant moves into bond bookrunning – bringing some £3bn of new supply to market this year. Lloyds has also made move to step into equity underwriting. Although general competition for UK mid-market business is strong, these clients are underserved in the equity space and Lloyds has identified this as a potential area for expansion.

"We have long term relationships with our clients and our priority is to support them over the cycle and we can now do this with a wider product set," added Grant. "Lloyds TSB Corporate Markets is also looking at opportunities to start relationships with new clients, though these are only likely to be pursued in this market if we can step up as a core bank from the start."

As a bank firmly rooted in the British commercial banking tradition, Lloyds is able to make a virtue of its conservatism and present itself as a corporate bank that has the ability and balance sheet to stick with clients through the bad times as well as the good. This is reflected in both the bank's increased and diversified business flow, and in the calibre of new hires.

The UK banks faith and focus on their strategy means they remain quietly confident as the credit crisis enters its second phase. However, most expect significant shifts in the banking topography with change coming through via regulation and consolidation.

"The investment banking environment remains challenging, this will certainly be a catalyst for consolidation," said Barclays’ Del Missier. "In addition there is clearly going to be a reform of banking supervision, and this will certainly take various forms. Banks have to realise their industry faces change, but we are confident that change will only come after meaningful consultation with all stakeholders."

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