Monday, 16 July 2018

Time to earn what you're worth

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SwissInvest strategist Anthony Peters says less capital for banks means less earnings for bankers

Anthony Peters, SwissInvest Strategist

I WAS WALKING through Canary Wharf one lunchtime recently when I ran into a chap who started life in the City as my graduate trainee. That was in September 1996, so he reminded me, when a good second-class degree in mathematics from a provincial university was still good enough to land a job in an investment bank’s sales and trading operation.

I remembered the lunch we had that first day. There was a wine bar in Basinghall Street – the name escapes me – which had a small bar at street level with a few tall chairs but no proper sit-down facilities. The place was great and served the best chicken escalope and ham and cheese toasties in the City. I took him there for a bottle of red – maybe it was two – and a plate of those marvellous toasted sandwiches.

I recall looking at him as we chatted about the sort of things a seasoned operator and a first-day graduate trainee do and saying to him: “If you think you’ve come into the City to get rich, think again. If you’ve come because you love the job and you love the business, that’s fine. You may get rich, you may not. But if you’re only after the money, forget it.”

I don’t think he quite grasped what I meant at the time but now, 15 and a bit years later, I know he knows.

Like myself, he has become a solid but unspectacular performer, the like of which form the bedrock of the global capital markets in particular. We make a decent living – a darned decent living, to be honest – but have to face up to the fact that we’re never going to make it to the top.

By chance, I had lunched with one of his more senior colleagues last Friday. After cutting through the PR junk about how well his firm is doing in the challenging environment, we concluded that the first quarter of the year had been spectacular, the second looks to be grim, prospects for the third are awful and that therefore the big prayer goes out that Q4 will be good enough to save the year.

Costs are still too high, highly-qualified people are being let go because, in terms of cost savings, they give you more bang for your buck, although when culling executives it’s actually buck for your bang. The industry is shrinking and there is nothing we can do about it. The mines and the steelworks went first; now it’s the turn of the banks.

AND WHEN THE histories of the industry’s secular decline come to be written, one of the key events will be the failed Greek five-year bond auction of January 2010.

That was the day when a weak sovereign Treasury Ministry decided that it would take on the hedge funds without appreciating how much leverage was behind its own borrowings.

Greece and the other peripheral sovereigns seemed to represent a near risk-free carry trade for the hedgies and one which helped the performance no end. But Greece decided to take the hedge funds out of the funding equation and in doing so, forced all of them to review their holdings in peripheral sovereign borrowers on a simple risk-reward basis. Once the camel’s nose was in the tent, it wasn’t long before the rest of camel was in there too.

The mines and the steelworks went first; now it’s the turn of the banks

I suppose it was at that point that the term “risk-free” bit the dust and, when everything became a risk, the great arbitrage went to the wall.

From the days of Jeux Sans Frontieres” to the modern day game show “Total Wipeout”, the concept of watching grown-ups trying to move around while perched on an unstable platform has been a source of huge entertainment.

However, when faced with trying to take investment decisions without a fixed horizon and where the chances of getting it right are no better than 50% – you need to build in a discount factor for Murphy’s Law – sitting tight becomes a viable strategy. Both Bunds and Treasuries are sporting no more than 110bps between two years and 10 years and, it should not be forgotten, the bid/ask spread on a bond or swap can quickly wipe out several months of coupon income. The resulting simple lack of activity has proved a disaster for the banks.

MEANWHILE, BANKS ARE supposed to raise more capital at a time when authorities are telling them not to pay dividends – ECB President Draghi repeated the view at the press conference following the last council meeting – and to hold more capital against credit risks which are perceived to be rising. As they can’t pay divis, they won’t get capital. The capital they do have can’t support as much lending. The vicious circle which besets banking is at the beginning and can only become worse.

Way back when, I wrote a piece in one of the UK broadsheets which assured readers that excessive compensation would self-right as the business shrank and as investment banking earnings gradually became skinnier. Competition by the many for the decreasing number of jobs would eventually lead to the desired wage deflation and recent disclosures would confirm that opinion.

My young chum knows exactly what I mean – he has had a few career hiccups himself – but my heart goes out to those who arrived in the Square Mile or on Wall Street thinking that they could all make millions without taking any entrepreneurial risk and who have found out that earnings risk is no more than the first derivative of capital risk. Less capital, less earnings – and about time too.

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