Friday, December 12, 2014

How Was 2014? Not Bad?

Not glowing, but not bad
This was the year that stayed the course, proceeding along a smooth track with occasional bumps in the road until the bottom nearly fell in early autumn. In the beginning, financial consultants and those who dare to project a year or two down the road reminded us that stock markets couldn't repeat the astounding double-digit returns of 2013. But the markets, they said, could still manage satisfactory returns. 

Now there's that bit about our rocky autumn, when markets tumbled and rumbled, and we had begun to wonder whether another crisis or period of turmoil was on the horizon. So in finance, how has the year turned out?


The year has been eventful, but it won't deserve a long chapter in financial history. For much of the period, we prepared for "tapering," the Federal Reserve's plan to pull back on "QE"(Quantitative Easing, or its efforts to ignite the economy by buying bonds, thus injecting more money into the overall supply and keeping interest rates low.) We braced ourselves (as we have done for a few years now) for the Fed's pull-back and for a sudden rise in interest rates. 

Financial advisers warned about loading up portfolios with fixed-income securities (especially those with longer terms) lest interest-rate increases would cause rampart losses. But soaring interest rates haven't happened yet (at least not in 2014), and bond portfolios haven't plunged as much as many have predicted. 

In corporate bonds, the looming 2014 story is investors' desperation for higher returns in a low-interest environment. In the hunt for a decent return, they have "chased returns" by accepting more risk. Hence, investors that heretofore wouldn't touch a non-investment-grade (or "junk"?) bond are now getting comfortable with purchases with credit grades below BBB+. They reason it's worth the risk of probability of default to get a return much higher than the paltry 1-2% returns on high-rated bonds. 

Risk-management skeptics are watching this trend closely. While the demand for more yield pushes upward the demand to invest in more corporate bonds near "junk" thresholds, it also increases prices higher than they should be on a risk-reward scale. 

This leads to investment portfolios becoming saturated with risky bonds, which, at least right now, don't appear risky, but could become a terrifying albatross in a market downturn. The skeptics say chasing yields too much by taking more risk leads to being insufficiently compensated for the risks accepted. 

Fixed-income departments, meanwhile, at major financial institutions (known in the industry as "FICC" ("CC" refers to currencies and commodities)) continue to languish. Banks have observed declining volume, so much so that they can hardly rationalize supporting FICC departments. 

They suffer, too, from the industry's migration toward electronic trading. (Equity markets and trading have experienced the same migration, too, toward computer trading.) Banks and dealers, especially those that rely on trading volume to generate profits, can no longer justify hiring and paying high compensation for rows of trading desks populated by high-bonused humans. 

Some banks have elected to withdraw from FICC; others, like Goldman Sachs, have decided they have the edge and capital to profit from sheer heft and the  massive volume partly achieved from other banks' paring down FICC units to bare bones.

MERGERS AND ACQUISITIONS: The Trends for the Moment 

Statistics show this has been a banner year in mergers and acquisitions. Big banks and boutiques have thrived. From the flurry of deals, two trends have surfaced: 

a) Activist shareholders have become forces to be dealt with. They have evolved into industry-shapers who confront board members and shareholders and exert financial will-power to get their way regarding strategies to increase a company's share price. No company is off limits, whether it's Apple or Herbalife, as we've seen in the last two years. 

When they "get their way" or successfully convince board members or big shareholders their financial strategy will work, that results in a barnyard of M&A activity--a sale of assets, a sale of divisions, a separate spin-off to existing shareholders, a proposal to acquire another company, or a proposal to sell the entire company. 

b) We appear to be in a financial era where selling off unwanted, lagging, money-losing or unrelated operations (subsidiaries, fixed-assets, product lines, e.g.) seems a viable financial strategy to boost a company's market value (or share value). This would be the antithesis of the momentous era of conglomerates (in the 1960's and certain periods thereafter). (Credit Suisse has identified over 25 global companies that are now considering or have announced spin-offs, asset sales of significant size, or divestitures.) 

Hark back, for a moment, to those periods in financial history when diversity in product lines, businesses, and investments ruled corporate strategy. Corporate finance theory supported diversifying assets to reduce risks. Management practice stipulated that a struggling, declining business unit could be offset by another less-correlated, growing business unit. 

Now corporate strategists (and M&A advisers) have promoted a different tactic: Get lean, streamline operations, and focus on what you do best--which means, too, become less diverse. The strategy has spurred some M&A activity in the last year, most notably H&P's announcement to split into two smaller companies (a consumer-products company and a cloud-computing, software company for a corporate clientele). The sale of PayPal by eBay was another well-known divestiture during the year. 

Be watchful, however. M&A trends toss and turn. They depend on investment opportunities and cash reserves held by large companies. They also depend on prevailing fads and financial maneuverings, banks' willingness to finance mergers, and regulators who worry from the sidelines that the careless financing of deals might be getting out of hand. 

HEDGE FUNDS: Who's Shutting Down Now? 

Hedge funds and their industry are hurting. Funds big and fall have disappointed investors; funds here and abroad have shut down in stunning numbers. 

Let's give an example. The S&P equity index, through October, was up 11% in 2014. The HFRI index, an example of hedge-fund performance among multiple strategies, is up only 2%. Investors must wonder why they would share significant profits with hedge-fund managers who have under-performed a basic market (minimal-cost) index. 

Hedge-fund managers argue they offer less volatility on returns (and many statistics prove that), but the argument hasn't been persuasive enough to keep some funds from closing or some of their investors from demanding redemption. 

The better known funds with decades of a track record or those that have (share we dare say) diversified into many opportunities and operations will survive. Citadel, the fund and the firm, and Bridgewater, the fabled fund in Connecticut, come to mind. 


Banks have become stifled by financial regulation, often frustrated, sometimes claiming that regulatory compliance distracts them from trying to find ways to achieve reasonable profits and returns with fewer business lines and surging capital requirements. JPMorgan, for example, announced during the year the thousands it has hired in regulatory compliance and billions it has invested in compliance technology. 

For banks, it was the year to respond to "MRA's," or "Matters requiring attention" from regulators. Stroll the corridors of bank headquarters and listen to executives discussing liquidity ratios and liquidity requirements, stress tests, leverage requirements, and definitions and requirements of "SIFI's," strategically important financial institutions now saddled with even more strenuous regulations. For big banks (Citi, JPMorgan, Goldman Sachs, Wells Fargo, et. al.), it's the new normal. 

Now more than ever, a big bank's board is faced with a nearly impossible challenge: How does the bank achieve returns on capital of 10-12% with reduced leverage, reduced risks, and increased capital requirements and much of that capital invested in compliance activity? Stay tuned. 

BITCOINS: What happened? 

A year ago, a fuss, a fury and an infatuation with Bitcoins swamped business headlines. Some said it would be the investment opportunity of the decade; others swore that Bitcoins, its payments system, and its increasing values would supplant foreign-currency activity or perhaps credit-card payments and some factions of the banking payments system. Proponents argued that investors, traders, large corporations and even consumers would be foolish to ignore the trend. 

Much of the glow of Bitcoins has dimmed, especially after a few Bitcoin-related companies imploded and became mired in legal turmoil. The volatility of the value of Bitcoin, at unacceptable levels, also proved too much for many investors or payments-users. Many were discouraged by the secrecy that surrounds the system and by the complexity in explaining how value and Bitcoins are derived or created. What was valued at over $1,000 a year ago has now dwindled to just over $300. 

Bitcoins haven't disappeared. The desperate urge to get into this profit-surging game before it's too late seems to have dwindled. Meanwhile, the puncturing of an apparent fad gives regulators a chance to catch up, understand the system and consider how to regulate it appropriately--an advantage regulators didn't have when other complex financial instruments were bombarding the markets in the 1990's and 2000's. We assume, of course, regulators haven't shelved the phenomenon for the time being, too. 

ALIBABA: Touchdown on U.S. Soil 

Who knew much about Alibaba before the company decided to plant itself (at least in the way of doing an IPO) on American soil? The company's IPO at the New York Stock Exchange, one of the biggest ever and involving a roomful of stalwart underwriters, might be called the industry's deal of the year. 

The company propelled itself onto U.S. capital-markets terrain with its $25 billion offering and a market valuation around and about $200 billion, threatening to go head-to-head with Amazon, eBay, Google and any digital enterprise on these shores. By becoming a household name in homes from Nevada to New Hampshire, it achieved its biggest milestones (becoming known and talked about). In the board rooms and senior suites at Amazon and Google, they now much take a peek at what's hovering over their shoulders from China. 


Business schools are like the marathon runner who doesn't give up. They adjust and push ahead and change gears. They continue to try to stay relevant. MBA curricula everywhere are tweaked and massaged. Occasionally at some schools, the course outline is overhauled and many have instituted online courses to supplement the case approach, lectures, group work and problem sets. 

Business schools, even the best ones, tag along following trends in business and capital markets, riding the coattails of free enterprise's every move. They are more willing to scrap what doesn't work more than, say, their counterparts in law or medicine schools. And they embrace new topics that hardly existed as a discipline just a few years ago. 

Business schools now sponsor courses in digital advertising, data analytics, venture financing, financial regulation and electronic trading. Just about every year, they redesign core courses, subtracting something, adding a few, rethinking what the consummate MBA graduate should master before landing on the doorsteps of Morgan Stanley, Microsoft, McKinsey or Pepsico. Many top schools require MBA candidates to spend time overseas in projects, internships and courses of study. 

Yet they never feel they've caught up. They worry, too, that tuition costs will deter top students. So they spend perhaps too much in resources to accommodate students with state-of-the-art facilities (to help students justify tuition payments and opportunity costs in not working). In some places, those facilities architectural gems. Schools such as Yale, Wharton, Michigan and Stanford (some of them Consortium schools) have built sparkling campuses to attract students and faculty. Those that haven't (Columbia, e.g.) are hustling to do so. 

The year expires with markets trying to interpret the impact of the late-2014 plunge in oil prices. Markets gyrate now and then, even in December, trying to evaluate whether such a decline prices is good for consumers and companies or bad for large energy companies and whether what's bad for energy companies has greater impact than what's good in other sectors.

Some will say, let the markets gyrate a little, when we never expected fuel prices to have dwindled so low. Not a bad thing. 

And not so bad a year. 

Tracy Williams

See also:

Friday, December 5, 2014

Preparing for a Diverse Work World

Phil Miller, Consortium board member,
Assistant Dean, Univ. Wisconsin
Phil Miller is assistant dean for research programs at the Wisconsin School of Business, a Consortium school. He is also a 15-year board member of the Consortium and has been one of its most ardent, consistent supporters. Few have pushed harder for diversity initiatives at Wisconsin and for increasing the awareness of the business school than Miller. Wisconsin is like many large, well-known business schools.  The efforts to promote and maintain diversity among students and faculty are ongoing. They don't stop. Arguably, few have thought longer and deeper than Miller about how to improve diversity at schools like Wisconsin. 

Miller shared perspectives in a Nov. 14 edition of the Capital Times, the news journal based in Wisconsin.  He explained yet another reason why business schools must take a greater, more emphatic and visible lead in diversity: If business schools are not diverse, more than ever before, large, reputable companies will be reluctant to recruit there.   

The article mentions cases where companies like Procter & Gamble, General Motors and Alcoa halted their recruiting programs because the student population at schools like Wisconsin wasn't as diverse as it could be.  The companies stopped not only because schools didn't have meaningful diversity in its ranks (among students and faculty at undergraduate and graduate levels), but because they felt the students there would not be sufficiently prepared for a diverse workplace (or, just as much, a diverse customer base).

Think about it.  Companies, especially large, global institutions with international markets and customers, want evidence, too, that students are prepared to work for, work with or lead others that have different backgrounds and perhaps different perspectives and points of view.  

As companies expand, it's not just about America. ("This is not America's century," Consortium CEO Peter Aranda states in the same article. "U.S. companies used to be able to go someone, plant the flag and be better then everyone else. That is no longer reality.) It's about international talent, multiple markets and unique cultures. It's about an expansive, broad customer base that may be as unfamiliar to Madison, Wisconsin, as Wisconsin may be to them. Business schools, Miller says, must prepare students to do business anywhere and with colleagues and clients from around the world. 

Hence, when they roam non-diverse campuses, attend their corporate receptions and give presentations to students, companies have become concerned the students aren't ready for or accustomed to diversity.  

Wisconsin felt the pressure, needed to do something about it, and Miller has taken a lead there for many years. "Diverse perspectives enrich the education of majority students," he told the Capital Times.  

"Businesses drove us to change, not just to provide a diverse pool for their hiring needs, but also because so many majority students were not prepared to face a diverse work world," Miller said.  He has had many administrative positions at the business school the past 15 years. 

There has been noticeable progress at Wisconsin. In the undergraduate business school, the percentage of blacks, Latinos, Native Americans and Asians has risen from 2.7% to 7.3% in the last seven years, according to the article. 

The statistics are better at its full-time MBA program.  Its affiliation with the Consortium is a factor in better numbers, because the Consortium helps ensure a steady pipeline. In the current second-year class, 14% of the class is classified as minority; 14%, international.  In the current first-year class, the numbers are even better:  17% minority and 25% international. 

The school is also unique in offering special concentrations in such fields as risk managment, insurance, arts administration, investment analysis, and supply-chain management.  

The school, like others around the country, was swift-kicked to improve diversity on campus. But it quickly understood the premise.  Recruiters weren't going to show up on campus, and students who attended the school would be disadvantaged.  

And recruiters these days (at least those from global companies with global markets) want to be assured business-school graduates will thrive in a business environment with other professionals who were born elsewhere, who had starkly different upbringings, who were nurtured in different cultures, who likely speak different languages, and all of whom have invaluable perspectives and points of view.

Tracy Williams

See also:

Sunday, November 16, 2014

This Fall's Big-Bank Thorn: FX

Banks must now settle FX-market-related charges
Senior management at big, global banks these days operates as if they are shell-shocked.   Or operates as if another debilitating dooms day is on the horizon. Every page they turn and everywhere they look, an apparent crisis looms. Or the apparent crisis becomes the real ordeal, particularly one where the end result is a billion-dollar hit to earnings because of reserves they must take for previous transgressions, legal settlements or massive reorganization.

On top of crisis management, senior bankers must manage (what they perceive) overwhelming regulatory requirements and other priorities of the moment.  Bankers in this decade spend much of their time responding to the lingo of the moment:  "MRA's" or "matters requiring action" (jargon used by regulators to help banks prioritize what they need to do to get on the regulators' good side).

Think about the long list of issues banks must address--minute by minute, everyday, all the time: mortgage-related settlements, derivatives-trading processes, increasing capital requirements, stress tests, equity trading and "dark pools," threats from shadow-banking segments, compensation restrictions, and a Libor scandal (and the related settlements).

In the current year, the challenges continue to mount: cybersecurity, balance-sheet leverage restrictions, and contemplation of what a "SIFI" (systemically important financial institutions) designation implies.

Now comes another crushing headache:  Allegations of cheating, collusion and misrepresentation in one of the biggest markets big banks have controlled over the past four decades--the trillion-dollar market for foreign-exchange sales and trading.

FX sales and trading have been a stable, profitable machine for large global banks for decades. They have controlled markets, trading, processing and clearing, products, and pricing. They are the dealers in the middle of the fray around which all other players, participants and users must operate. Hedge funds, speculators, small dealers, and the treasury teams at major corporations that use FX for hedging and payments purposes must--for the most part--go through the circle of big banks.

Banks control access to and insight regarding FX markets, partly because they have history and experience in FX and partly because they control the deposit accounts and funds-transfer systems that allow the market to operate.

They make markets in currencies of all kinds, estasblish prices and facilitate actual settlement (receipt and delivery of currency into bank accounts).  Banks also have expertise in specialty products: FX options, long-dated FX trading (trading for settlements at dates in the future), and currency swaps. FX market participants who need, use or even want to speculate in currencies can't avoid banks, unless they choose to do this entirely in futures markets, and even then, they will likely use banks for clearance, brokerage and settlement.

Think of the FX market as a commodity market with foreign currencies traded as if they were products, subject to supply and demand and influenced by the machinations of interest rates and macro-economic factors. Companies that do business internationally (exports and imports, e.g.) will require currencies for payments or receive currencies in sales. They may also engage in FX transactions to hedge balance sheets and earnings statements from the impact of FX volatility.

Because prices fluctuate in predictable and unpredictable ways, speculators are attracted to the market. Price movement will imply opportunities to profit from the increase or the decline in the values of currencies.

Think of banks as operating a the top echelon of this vast market, one that features a shelf of sometimes oddly behaving and sometimes predictably reacting commodities (Euro, sterling pound, Japanese yen, etc.).

Now banks are in trouble in this marketplace in the way they were in the fixed-income arena in the Libor and mortgage-related scandals the past decade.  A bevy of regulators in the U.S. and in Europe has investigated and begun to levy billions in fines and penalties or arrange for legal settlements (over $4 billion in total so far, and over $300 million at many banks).

This fall has become another migraine for big banks (including HSBC, Barclays, JPMorgan, RBS, Citi and UBS). Another quarter with a special loss provision to account for the transgressions regulators claimed banks committed. (Front-running trading--in front of their own clients for their own accounts--is one allegation. Price collusion in setting daily prices is another.)

With banks forced to clean up strings of lingering issues, is this one reason why we haven't seen new products, banking innovation, and new financing ideas in the way we saw financing creativity in the 1990's through mid-2000's?  Has financing creativity been discouraged, because it has been linked often to the financial failures of the crisis?

Or have banks resigned themselves to the notion that innovation and efforts at fancy transactions and novel banking products will eventually lead to market implosion, reputation risks and billion-dollar legal settlements a decade later? Or just as important, will the process of introducing a new product or a new financing method take much longer, as banks decide whether the financial and reputation risks are worth it? Are the risks now perceived to be too overwhelming for the short-term rewards?

A decade or so ago, who would ever have thought that plain-vanila FX sales and trading (not to mention, pegging Libor interest rates) would result in alleged scandal and billion-dollar blows to earnings?

Tracy Williams

See also:
CFN:  Libor in Crisis, 2012
CFN:  Making Sense of Derivatives, 2013
CFN:  High-frequency Trading, 2012
CFN:  Can You Stand Market Volatility, 2011
CFN:  JPMorgan's Regulatory Strategy, 2014

Friday, October 31, 2014

Market Volatility: Delivering the Message

The participants, players and pros in finance (the traders, bankers, analysts, and deal-makers) love euphemisms.  They play with words and phrases to get deals done, raise capital, make investments, advise companies, and keep investors comfortable. Sometimes they are guilty of rolling out old products with brand-new, updated nomenclature.

Remember "junk bonds."  When the industry introduced them as an important, popular financing channel for young companies in the 1980's--thanks mostly to the trading prowess of then-powerhouse bank Drexel Burnham, nobody minded calling them "junk." When the junk market imploded for a period in the late 1980's-early 1990's and after Drexel was railroaded into non-existence partly because of fraud, market-makers and bankers avoided the term.

When the market revived and such bonds found a permanent place on the fixed-income shelf, the industry preferred to call them "high-yield" instruments.  They are still referred to as high-yield bonds. "Junk bonds," the term, receded into finance history.

Finance historians will likely be able to identify other times when the industry recycled instruments and financial strategies, but unveiled them later under the banner of new terms, new phrasing.  A play on words.

This fall, financial markets have rocked and rolled like a roller-coaster with plunges that remind us of episodes during the financial crisis.  But investment analysts, the media, financial consultants and bankers have been careful in their choice of words, if only to keep investors comfortable and calm, if only to avert the possibility of panic and rampant selling. Markets have fallen steeply some days; other days they have crept upward. 

But industry participants prefer not to convey to investors (clients, shareholders, et. al.) that markets are in trouble.  They prefer more palatable terms.  You hear often these days that markets are going through a "correction"--which implies that the surges in the past year overstepped their targets and are settling back to where they should be.  You hear markets are "recalibrating," suggesting that equity-market values are settling into their proper valuations.

You also hear such terms as "volatility" and "divergence."

Are advisers, bankers, and the media being deceitful? Or are they doing their part to discourage investors and traders from irrational, panic-stricken behavior? Are the terms a fair interpretation of what is actually going on?  If headlines hint at "market recalibration" instead of exclaiming "market plunge," will that keep traders and investors focused on fundamentals and long-term strategies and trends?

It's likely a little of both.  A little bit of deceit, and a lot of encouraging investors and market-players to act rationally.  And it's also a little bit of acknowledging how equity markets have moved in the past.  If traders and investment managers say the market is "recalibrating" while the Dow is falling by hundreds of points, they suggest, too, that (a) markets might have over-shot their true values in the past year and (b) decades of technical analysis suggest equity markets (at least those in the U.S.) do tend to bounce back. To ensure investors and traders (from the Baby Boomers with nest eggs to the black boxes in the back rooms of hedge funds) use common sense and not stir trouble, they avoid declaring markets are in a free for all.

The industry works that way.  Use terminology that won't unsettle stomachs.  Bankers won't necessarily say a company lacks cash, but will suggest it is "illiquid."  A company with exorbitant amounts of debt, struggling to find ways to meet interest and principal payments, is not necessarily over-burdened with too many loans, but is "highly leveraged." The company with dwindling net worth is "under-capitalized."

Creative terminology is not new in finance.  There is, nonetheless, the ongoing tendency to come up with even more clever terms to describe market activity.  When stock markets crashed in 1929, few headlines denoted a "market correction."  When they crashed in 1989, we didn't hear much about "market recalibrations." Each market event spawns more terms to attempt to describe what's going on...

...and to keep investors sane and in the game.

Tracy Williams

See also:
CFN:  Market Volatility:  Can You Stand It? 2011
CFN: Dark Days at Knight Capital, 2012
CFN:  Alibaba's IPO, 2014
CFN:  High Frequency Trading:  What's Next? 2012
CFN:  No Time for Doldrums, 2013

Sunday, October 19, 2014

Will HP's Split-up Help Stock Values?

Does separating the company into two equal parts create more value than a consolidated whole?
As the third quarter, 2014, ended and before companies had a chance to announce earnings, HP slipped through to report it plans to split the company --literally (based on revenues) into two equal parts:  One half, to be called HP Enterprise, will focus on a corporate client base (cloud computing, business software, business services and data storage).  The other will focus on consumers who purchase personal computers and printers.  Right down the middle.

HP is a $100 billion-dollar company, enormous by most measures. The split-up (accomplished by spinning off the personal-computer business to current shareholders) will result in two $50 billion businesses, each still large enough to appear on Fortune 500-type lists. (HP will present a stock -like dividend to shareholders and allow the market to re-value what remains. They, along with their expensive banking advisers, hope the sum of the parts will be greater than the historical whole.)

Does the split (or spin-off) make sense? Was this a surprise?  Was this a maneuver it pondered for years, but CEO Meg Whitman now dares to do it?  Or did shareholder activists push for a financial-engineering move to help boost stock values? Corporate-finance experts:  What achieves maximum shareholder value--spinning off the perceived valuable parts of a global giant or accumulating diverse, well-run businesses to achieve the advantages of diversity?

The 1960's marked a finance period when investment gurus claimed equity values surge by building conglomerates (via mergers and acquisitions). (Think ITT, as the business-school's classic example.)

In current times, investing activists argue equity values rise because of focused management: Companies, they reason, increase equity values (and boost stock prices) by getting leaner, more nimble, and more targeted toward few product lines.  Company management is less distracted, corporate strategy is simple, costs are better controlled, and resources (human and funding) are less constrained.

If it isn't a subject already, HP's mishaps in management strategy and management misdirection and its misguided efforts to go head-to-head with any formidable competitor could be seminal business-school cases in corporate strategy. Whitman, after her renowned tenure at eBay and foiled attempts in politics, swooped in to try to salvage the company or at least restore some of its prominence.

With competition getting more fierce and with a fickle customer base always drifting to the latest new thing, Whitman may have been boxed into making this latest move.

In the eyes of equity investors, HP has slipped, recovered, stumbled, and been revived intermittently for years, but question marks still shroud its long-term outlook.

Its financial performance, nonetheless, has been laudable and overlooked by the fuss over strategy and competition.  Yes, total revenues have reached a plateau (with occasional slippage), and it absorbed giant losses as it restructured itself in the last few years.  As big as it is and as much as some project that competition and technology evolution will puncture it into non-existence, its track record for generating sound returns on equity and managing costs consistently is satisfactory.  (ROE in 2013 = 19%, and the company is on pace to generate  ROE = 16% in 2014.). The company didn't have to break up to return to profitability, because earnings exist and cost margins have been stable.

Its balance sheet is fragile, because about a third of it (over $50 billion) includes intangibles and it needs the debt that's piled on. (That intangible overload, which includes "goodwill" arising from a chain of flimsy acquisitions, leads to reported negative tangible equity; hence, liabilities exceed assets that can be touched, felt and presumably sold. Debt burden, which might be normal, in most financial situations is exacerbated with the existence of such negative tangible equity.)

Fortunately debt doesn't swallow the balance sheet too much, and stable (if not growing) cash flow from business activity keep debt investors comfortable.  (Ratings agencies haven't been harsh--BBB+/A---although they too have criticized management strategy in years past.)

But equity investors want the promise of growth.  They want to see sales increasing in leaps and bounds for indefinite periods. And they want to see returns on equity creeping toward 20%. The combination of impressive, boundless growth in sales, earnings, and ROE leads to big gains in stock price.

The split-up, they argue, is the best way to reach those big gains. Conglomerates contend big combinations of business result in cost synergies and economies of scale.  HP advisers and its board will try to show that dividing the company into two parts will give the company a chance to rationalize and reduce costs and clarify strategy.  The market, they claim, will know what HP Enterprise wants to be and do. The market will understand, they hope, that HP (the consumer side) will need to (and will successfully) figure out what it wants to be.

Another view? Institutional investors and activists prefer investments in two companies--one with stagnating prospects and one with growth possibilities--than an investment in one company with an uncertain, unstable outlook or the possibility of arm dragging down the other.

What poses a challenge in achieving those gains after the division?

1.  As the two entities polish their strategies and introduce products and services that can compete capably, how will costs be divided? Will they be divided fairly or divided in a way to give one a value boost more quickly than the other?

2.  CEO Whitman will have senior presiding roles in both entities.  Will management attention be even more stretched and pulled apart than it is already?

3.  That fragile, awkward balance sheet:  Which entity will accept the burden? Will deal-structurers decide to present HP, the consumer side, the gift of a sturdy, sound balance sheet with positive tangible capital and manageable debt burden?  Will HP Enterprise bear the burden of a capital structure with far more debt than its sister (or cousin?) company?

Dividing the company into two fairly equal parts sounds straightforward. But creating sturdy balance sheets for both and manageable cost structures (as one is extracted from the other) will be formidable tasks--enough to possibly postpone the scheduled late 2015 spin-off.

And enough to give investing activists enough time to develop or discover the next value-creating equity trend.

Tracy Williams

See also:

CFN:  Merger Mania, Boom Times Ahead?  2013
CFN:  What Will 2014 Bring?  
CFN:  Why is Dell Going Private?  2013

Monday, October 13, 2014

The Finance Resume' and Recruiters

A bank Vice President is tapped to be involved in recruiting new bankers for the upcoming year. The group plans to expand its business with new deal flow, new clients, new accounts, and perhaps a new office presence in London or Tokyo. The group must, therefore, expand the number of associates who analyze and rationalize deals, prepare presentations to clients, research markets and market trends, and explain the pros and cons of financial instruments.

She and others on her recruiting team are asked to review a handful of resumes' to determine who should be offered chances to interview in first rounds or who should be rewarded with "call backs" for further rounds.

For each resume', the team reviews, sizes up, summarizes and concludes in just a few minutes. What did they notice? What stood out? How can they decide who's worthy of more attention (and eventually an offer) from mere glimpses of resume' material that candidates took years to accumulate? What do they see? What do they look for? And what do they target on a page filled with words, recruiting jargon, and an array of experiences?

Or how does the candidate in finance (before the interview, before the laborious second and third rounds) make a resume' impression in just a few minutes?

Career advisers and MBA counselors like to refer to the "elevator speech,"  the 30 seconds a candidate might sell himself when he encounters a senior department head at a reception, after a meeting or, in fact, in the elevator.  On a resume', the candidate must sell himself to the recruiting team in a frightening flash.

If the role is in finance (corporate finance, banking, trading, investing, asset management, equity research, corporate banking, e.g.), in the midst of a list of highlights of candidates who, say, captained their debate teams, recruiting teams look quickly for clues that the candidate can do the work. First things first, does the candidate have first-rate technical skills? Can the candidate excel in the day-to-day requirements of the job of a job in finance?

In finance, for MBA's, that often means proving competence in accounting, corporate finance, financial analysis, and capital markets.  At some firms, it will mean proving competence in much more:  financial modeling, corporate firm valuation, and financial products.

Recruiting teams can't give a test to ascertain competence. (That can wait for second-round interviews.)  But they can look for familiar clues.  An MBA in finance, a CFA certification (even Level I passing), a CPA certification, and experience in banking and finance will be superb clues that the candidate can thrive in a world of numbers, spreadsheets, projections, forecasts, ratios, sensitivity analyses, and financial theory.

Sometimes listing specific courses (in an MBA course) will help, too.  Courses in intermediate corporate finance, intermediate accounting, options theory, mergers & acquisitions, derivatives markets and equity valuation will confirm competence.  If an MBA candidate has thrived in a course expounding on Black Scholes options theory or if the candidate has studied how FX currency markets are tied to interest-rate expectations, then recruiting teams will check with a plus.

There is no one way to promote technical skills and competence on a resume'.  They should be highlighted clearly and, if possible, headlined (not buried).  Recruiting teams must get over this hurdle before they begin to look for other qualities. The MBA student or graduate from Dartmouth-Tuck with a specialty in corporate finance, who studied corporate valuation, who worked previously at Lazard Freres, who has an engineering undergraduate degree, and who won prizes for stock-market valuation, will vault to the front lines in the eyes of prospective employers.

Unfortunately large numbers of candidates will meet these initial tests.  So finance professionals looking to hire will look for other qualities.  They then cast their eyes on clues that demonstrate productivity, professionalism, engagement, impact, creativity, and teamwork.  They ask:  What is there on the resume' that will show us that the candidate will get work done, can produce an enormous amount within tight deadlines, will show special insight and make useful recommendations, and represent the company in a professional way.

This exercise is more difficult for recruiting teams. Sometimes it requires a dissection of intangibles and qualities. If the candidate uses numbers to show priority or impact, employers must understand the context.  Still, on the resume', the candidate must maximize impression with specific experiences, good examples, and clarity.

Yes, clarity counts for much in reading resumes'.  Some of the best candidates hurt themselves because when they describe experiences, they retreat to fancy jargon or awkward (or erroneous) terminology.

Even the most qualified technical MBA's should showcase intangibles and special qualities on the resume'.  There is no formula, but they can ask themselves what examples and experiences will show impact, creativity, and productivity.

What hurts on the resume'?  Remember, the recruiting team is dissecting a lifetime of activities in a few minutes.  Tedium, detail, and illogical presentation of material slow down the reader.  Or they  distract the reader.  Unexplained, confusing descriptions of past experiences hamper the reader, too.  In an effort to upgrade experiences or embellish them, sometimes candidates end up describing gobbledygook. Simplicity and clarity work best.  If busy finance professionals can understand the experience immediately, there is another check plus.

Hyperbole hurts, too. Too often candidates slip and exaggerate past achievement, not realizing how the description sounds.  If the MBA student says he started a $100 million hedge fund at age 21, a fund that exceeded all benchmarks during years when many funds stumbled and closed, is that believable? Will recruiting teams apply a question mark, instead a check plus?

Recruiting professionals and career counselors will say resume' preparation also involves promoting a brand, becoming marketable, and showing ambition.  But first things first, the experienced recruiting teams at big banks and notable firms take a first-things-first approach:  Prove technical competence (from classes, courses, and previous work).  Prove impact, productivity, creativity and professionalism with crisp, simple descriptions of past experiences and past accomplishments. And then survive the second and third rounds.

Tracy Williams

See also:

CFN: MBA's Eye the Summer, 2014

CFN:  MBA Recruiting:  Working the Game Plan, 2013
CFN:  MBA Job Hunting:  No Need to Panic Yet, 2012
CFN:  First-year MBA's:  Internships and Recruiting, 2011

Tuesday, September 16, 2014

Wall Street's Favorite Business Schools

This is not an assessment of the ranking of business schools, although such rankings tend to be unveiled this time of the year when fall classes start.  This is about the MBA programs that tend to send large numbers of graduates into coveted positions in investment banking, corporate banking, sales & trading, capital markets, and equity research.

This is less about the schools' efforts to channel and push MBA students into certain directions.  For the most part, they don't.  Business schools don't shove students into banking and finance, although there are implied messages (based, for example, on the resources the school might devote to finance, finance instruction, and career-advisory services in finance).  Business schools certainly don't ignore benefactors, including sponsors that will include large banks and private-equity firms or alumni holding senior positions in finance. And schools do their best to cultivate close relationships with top institutions.

Business schools, for their part, facilitate a pathway into banking and finance, if large numbers of students prefer to go in that direction.

This is more about the major financial institutions and where they go to fill up the first-year slots in banking and finance.  What are the favorite schools (including those with ties to the Consortium) and why?

The careers website eFinancial Careers updated its list this month. It tries to list schools based on a calculated index, which of course will inevitably be biased or flawed. It acknowledges that.  But the exercise presents a valid picture.  It can tell MBA students and graduates from where major financial institutions (from Morgan Stanley to BNP Paribas) hire business-school graduates in financial centers in the U.S. and Europe. In other words, what are the top "target" schools, not necessarily the best schools, but the top schools where they have had success in steering graduates toward major positions in finance?

Some of that success is due to aggressive efforts by the financial institutions, including their recruiting programs and the relationships they establish and nurture at certain schools.  A lot of that success is influenced by the alumni employed at the bank or firm.  If a large number of senior and influential bankers at a certain bank went to Michigan-Ross, then it is likely the bank will continue to maintain a meaningful relationship that results in a high-frequency recruiting pipeline.  Another factor is the institution inferring that if past graduates of the school have performed well, then the bank should go back and get more of them.

This latest list includes the typical business schools known for corporate finance and investment management and for sending dozens of graduates to Wall Street every year. That includes Penn-Wharton, Columbia, and Chicago-Booth.  The list of 35 includes at least seven Consortium schools:  Yale, Cornell-Johnson, Dartmouth-Tuck, UCLA-Anderson, Michigan-Ross, NYU-Stern and Carnegie Mellon-Tepper.

But the list includes some surprises and perhaps some notable omissions.

Yale SOM, a Consortium school, with its history and tradition in general management and public administration, is third on the list.  The list suggests it is a more popular target among major banks than Harvard, Chicago or MIT--at least based on percentages and the school's success in its graduating landing the best banking positions.

Stanford is no. 8 on this list, even if the more popular notion is that its graduates tend to prefer entrepreneurship and technology. We don't observe many of its graduates heading to the East Coast to work for Citi or Deutsche Bank, but the school has an advantage in residing next door to some of the country's top venture-capital firms. The venture firms, if they choose to, can manage an open-door relationship with the business school just across the road.

Rice-Jones in Houston appears high on the list (14th), higher than even Michigan-Ross, Duke and Dartmouth, despite the well-documented record that Tuck sends large numbers into prominent slots at the top banks and finance firms.  And most would have thought that Texas, another Consortium school in Rice's region, which doesn't appear on the list, would be a more attractive finance target than Rice. 

Virginia-Darden and Indiana-Kelley, Consortium schools with prominent programs and graduates in finance, are not on the list.  Regional preferences among its graduates may explain that.  eFinancial doesn't claim to offer a perfect or a fair list. It reminds list-users that it attempts to capture what appears to be favorite target schools among favorite target banks.

Critics might dismiss one impactful bias about the list.  It opts to divide financial institutions into three tiers and gives more credit to schools with graduates who go to work at the top-tier banks (Goldman Sachs, Citi, JPMorgan, e.g.).  It, therefore, penalizes, schools with large numbers of alumni who work at such institutions as Credit Suisse, Barclays, RBS, Regions Financial, US Bancorp, Sun Trust, HSBC (not regarded as top-tier by these list-preparers) or work at the prominent boutique firms that, in some tallies, have seized some market share from the bulge-brackets.

Remember, this is a list, one that will be out-dated by next summer and one, like all others, should be examined with caution.  While it may be true that Bank of America and JPMorgan enjoy recruiting large numbers from NYU for corporate-finance roles, it doesn't mean a graduate from UNC-Kenan Flagler or Emory-Goizueta won't have a chance to gain an offer.

Tracy Williams

See also:
CFN: Who Are the Most Satisfied Business School Alumni? 2011
CFN:Yet Another Ranking of Business Schools?  2010
CFN:  Be Cautious with Business-School Rankings, 2009
CFN: UCLA--Going Out on Its Own? 2011
CFN:  Yale SOM Gets a New Look, 2014
CFN:  Georgetown Becomes the Consortium's Newest School, 2013 


Monday, September 8, 2014

Work-Life Balance: The Discussions Continue

These are times when banks and other financial institutions worry about their junior resources, the analysts and associates who toil in cubicles, working legions of hours each week cranking out spreadsheets, pitch books, industry analyses and client presentations. It's exhausting, tiring, grinding work.

Picture a first-year associate who makes plans with college buddies on a Friday evening at about 8:30 pm after a long, tough week. Just as she taps the elevator button, she is summoned back to her desk, because a vice president in M&A just received an e-mail from a managing director, who just received a phone call from a client CFO who on a whim decided to increase the offer price that the client company wants to make on a target firm. The CFO, responding to the CEO, wants to know if the numbers make sense for the new offering price and wants to know the answer by Saturday afternoon.

The associate returns to her desk and cancels her Friday plans and all hopes of spending a weekend winding down from a week of hard labor. Back into the dozens of variations of Excel spreadsheets depicting merger-acquisition scenarios she plunges. Nothing is new. She and her analyst and associate colleagues encounter this scene several times a month.

The tale is told frequently, year after year.  In post-crisis times and in times when recent college and MBA graduates can be lured into other more humane (and perhaps similarly compensated) career choices, some financial institutions worry they must do something about a potential talent drain. This tale, however, has been told over generations. Financial analysis, financial modeling, and the early years of banking and financial research have been marked by stories of hours working until 2 a.m. and weekends erased by a sudden tap on the shoulder.

Banks, too, have endured intermittent panics about about potential talent drain since the mid-1990's. The current times aren't the only times they've hustled among themselves to do something about it. Remember the dot-com craze of the late 1990's and early 2000's? An analyst from this period wrote a memorable treatise, a state-of-banking message about what banks must do to appease the junior crowd and keep them from escaping to more interesting dot-com jobs on the West Coast. His plea and his presentation of soft demands appeared on the front page the New York Times.

Around that time, banks, one by one, began to ease the starched-shirt, Brooks Brothers suit dress code and permit what is now know as "business casual" fashion in the office. Many of his "demands" from that time, however, have disappeared into history, and banks quickly resumed their culture of expectations that analysts and associates must work marathon hours to justify their handsome compensation packages and must, as industry old-timers contend, "pay their dues just as those who trekked before them."

Voluminous websites, chat-rooms, magazine stories, and books have been written about the lifestyles and work burdens of those in their early career years working at banks, private-equity firms or hedge funds. In recent years, especially in 2014, big banks have reviewed work-life balance in the trenches and tried to come up with satisfactory solutions, including offering juniors the occasional weekend off and presenting ways to relieve the work pressures and daily burdens.

Some banks are considering increasing the number of hires in the coming year under the premise that (a) business conditions are better, (b) there is more work to be done for clients and (c) it would be better to spread this work among a larger number of analysts and associates. In the last few weeks, a few banks (notably, Goldman Sachs stepping out in the middle of summer with its announcement that it will pay analysts and associates base salaries that are about 20 percent higher) have decided to increase compensation in ways they did routinely before the crisis.

History suggests the pathways to better work experiences are slippery. They improve. Business (deals, client activity, trading, and expansion) takes off. Competition grows stiffer. Work burdens pile up. Work environment inevitably sinks back to days of dreary, exhausting work weeks. Banks resolved and committed to improve the work-life balance of young professionals. But the real world got in the way.

When deals must get done before they are lost to competitors and when client presentations must be prepared overnight, or when market conditions change suddenly as stocks rumble or interest rates surge, vice presidents and managing directors hardly think about work-life experiences. Bank senior managers slip back into old habits and forget about the newly implemented programs to improve the lives of juniors.

(In banking, the competition to win a client or a new deal has been and continues to be fierce.  Bankers know that clients sometimes resort to whimsical, illogical criteria in choosing a winning bank.  Pricing, fees and execution may be a primary reason why a Fortune 500 company chooses Citi to lead a financing deal (or why Alibaba opted for Goldman to lead its upcoming IPO).

But in some cases, bankers know the client might choose a bank based on exuberant vibes in a client meeting, a polished presentation before the client's board of directors, or a personal relationship that goes back to good times in a freshman-year dorm. Bankers, therefore, don't want to take chances; hence, they summon analysts and associates to be accessible 24/7 to help find more ways to increase the probability that their bank will be selected.)

After the financial crisis of the late 2000's, banks once again felt they reached an emergency state, where they feared the best and brightest will ignore Wall Street. Most inside and outside the industry (whether they were just about to embark on a career or had survived decades) contemplated deeply about long-term careers in financial services: How will roles change? When will client activity rebound? What impact will regulation have on roles? As banks re-engineered the organization, how would they re-design work roles?  Will bank jettison entire units (trading desks, departments, etc.) over time or in one leap?

An industry in turmoil also had to confront criticism from every direction--regulators, politicians, the public, other market participants, and clients. How could financial institutions, therefore, convince a recent Brown graduate or a new Michigan MBA that he should migrate to Wall Street and be assured that his business unit will be in operation a year or two later? And how could they convince him to ignore a sweet offer to work at Google or at a West Coast start-up, where the grass is green, the sun shines, lunch is free, and time spent away from the office is applauded?

The environment continues to be tweaked. Banks (and hedge funds and private-equity firms) continually address work conditions, even as traders and deal-doers slip back into old habits. Even if the long work hours are still characteristic of the banking life, the discussion continues.

Tracy Williams

Se also:

CFN:  Delicate Balance:  Long Hours and Personal Lives, 2010
CFN:  Goldman Sachs and Work-life Balance, 2013
CFN:  MBA's and Investment Banking, 2013

Tuesday, August 19, 2014

Financial Modeling: Yet More Tools

A clearinghouse of financial models
Visualize how analysts, bankers and researchers performed financial analysis decades ago, especially if they set out to analyze a company, assess whether a company can pay down debt obligations or determine the equity value of a company.

Analysis involves financial statements, financial ratios, projections of income statements, cash flows and balance sheets, and a presentation of various business scenarios. It also involves an assessment of the financial condition of the company and often a careful determination of its value.  Decades ago analysts and bankers used pencil, erasers and paper spreadsheets to do these exercises, aided by slow calculators and rock-hard patience to complete these tasks over 1-2 days.

Today, analysts, whether they know it or now, are gifted with technology tools to perform the same tasks in just a few hours. In days of yore, financial analysts endured tedium to ensure that numbers were transferred from detailed financial reports to paper spreadsheets accurately. Balancing balance sheets was a monumental task. Because these tasks were physical and time-consuming, there were limits in what analysis could do--limits in the way company performance could be projected, limits in how many scenarios could be presented and evaluated, or limits in what growth rates or interest rates to use in assessing a company's value or creditworthiness.

Today, these exercises are conducted using elaborate, precise, sometimes complex financial models, all performed swiftly with computing assistance. Researchers and analysts no longer "do spreadsheets," as much as they tweak them, adjust them, or churn them through countless scenarios. What an irony. With vast amounts of computer power and with innumerable financial models available to perform almost any kind of financial evaluation of a company, financial analysts and associates at banks, hedge funds and private-equity firms continue to labor inhumane hours each week (and weekend) doing the work that those in a long-ago generation performed via labor and hand muscle.

Many will say in current times, the stakes are higher; banking deals are done at much larger amounts (some in the billions). Competition is fiercer, tougher.  And business demands to get the deal done right, with precision and no tolerance for failure, become primary factors that keep junior associates toiling in bank cubicles until the wee hours. Clients want answers and updates right now.  Trading and investment decisions must be made on the spot. 

Yet with all the computing power and available financial models, today's analysts are blessed with boundless resources.  Financial information is available everywhere online--sometimes free and accessible, other times purchased from special-services companies.  Analysts, traders and researchers don't need to pore through dated paper 10-K reports or hard-copy financial statements.  The tools that exist to streamline the analytical process are bountiful.

And now along come financial-services companies like Thinknum, which permit analysts to share their financial models online, accessible to anyone among the public looking for assistance, guidance or insight when it's time to analyze the financial condition of a company or assess its value. Thinknum was formed last year by banking and hedge-fund analysts, recent Princeton graduates, who thought the industry and broader marketplace could benefit from a financial-modeling clearinghouse that lets analysts pull from a virtual shelf any model or equity or debt analysis  for whatever need that suits them.

Founders Justin Zhen and Gregory Ugwi told the CFA Institute that the new company's services are "radically open." They pattern the company after GitHub, a computer-software company that allows programmers to share their coding with the public, a collaboration that helps improve software and makes it available to anyone who needs it.  Same idea for those who need and use financial models.

Thinknum acknowledges most equity research analysts present their work publicly, including the thousands of assessments of just about all publicly traded companies.  However, they present their conclusions. They don't necessarily share their detailed models. Thinknum wants to display the analysis behind the conclusions and wants to help others build their own models based on the work of others.

Take Apple, Inc., the computer giant. If an analyst seeks to determine its intrinsic corporate value, based on a projection of earnings and cash flows, she can start from scratch and develop her own financial model and incorporate projections, scenarios, and assumptions. Or she could decide to examine the work and models of others, study them, and tweak and revise them for her purpose. She may disagree with others' assumptions of growth or may decide that a rise in interest rates may have little impact on the company's fortunes.  Thinknum would permit the analyst to dial up and review others models (and projections and calculations of value) before immersing herself into the exercise.

Yes, she could copy their models and present them without adjustment or change, but those who share their work are aware their analyses might be used for any purpose. Or she could study them to gain insight--to find something new or to unearth a factor or variable she may have previously neglected. On Thinknum's site, with Apple, she can see the company valuation performed by a handful of analysts around the country, including one from a prominent business-school professor. She can explore the assumptions they used, the long-term business conditions they describe, and their attempts to project earnings and cash flow out several years.

Thinknum's founders say the forum, the sharing of models and model ideas, should reduce the labor of analysis, help analysts focus more deeply on valuation concepts, debt structures, business scenarios and management--less time on figuring out why balance-sheet items don't reconcile.

In certain industries, financial analysts already have access to private services that provide financial information, financial ratios, and ready-made spreads. But they come at a cost and typically an expensive contractual subscription. Other services, including, for example Google-finance, provide financial information and ratios, but stop far short of doing analysis or making an evaluation. Thinknum's services, meanwhile, are available as easily as it is to type " Apple" into a search box.

Will such services take off? Will they contribute to vast improvements in the work-life balance among young bankers? Not so fast, the big banks and hedge funds will say. They will argue they have privileged access to and use significant amounts of confidential information from client companies. That information, used as inputs in models and used to enhance them and make them more detailed, could never be offered to an at-large public forum. They will also argue that many models they use are proprietary and are specially designed in a way to give them an analytical edge above competitors. When Bank of America advises a client that a target company is worth X, the bank and the client will not want to convey to public markets how it derived the value X--at least not until it's necessary.

But give Thinknum the credit it's due, especially in its efforts to expose the details of how banks might determine whether a company can pay down millions in debt or how banks determine at what price a client should sell new stock or why a hedge fund might have discovered intrinsic value in an unpopular stock. There are much art, magic, intuition and mystique to deal-doing or trading, but much of it starts with a methodical, more scientific process, the process of assembling the financial numbers and getting them to tell us something about the future (future worth or value, or future ability to generate cash to meet obligations).

In some sense, banking will still be banking. The hours will still be long. Decades ago, because they were strapped with pencil and paper, bankers and analysts were satisfied with one or two business scenarios (based on growth rates, interest rates, or leverage ratios). In these times, because there is technology, two scenarios won't suffice, when a dozen or more can be performed and presented with the click of a button.

Tracy Williams

See also:

CFN:  Mastering Technical Skills, 2010
CFN:  Apple, With All That Cash, 2013
CFN:  Verizon, Big Numbers, Big Debt, 2013
CFN:  Who's Betting on Blackberry, 2013
CFN:  New Financial Technology, 2014
CFN:  The Most Popular MBA Professors, 2011

Monday, July 14, 2014

Wells Fargo: Sticking to What It Does Best

Wells Fargo:  A well-deserved Double-A rating
Give some deserving credit to the bank Wells Fargo.  It's one of the largest, most important financial institutions in the world and certainly one of the most recognizable banks anywhere in the U.S., thanks to a widespread branch network that puts a Wells Fargo office on just about every other corner in most regions of this country. 

Among regulators, the bank is deemed, like other big institutions wielding similar financial impact, a "systemically important financial institution," (or "SIFI," as they are called).  (Accompanying that tag are extra attention, potentially more capital requirements, and a requirement to pass occasional stress tests administered by regulators.) Its "SIFI" designation came about because of its size and geographic scope and because of its large customer base of both retail and institutional clients.  Wells Fargo, like its peers Citigroup, Bank of America and JPMorgan Chase, is a "trillion-dollar bank" with assets now above $1.5 trillion dollars.  A trillion dollars in deposits support a loan portfolio of hundreds of billions.

Without much fanfare and limelight, Wells Fargo has maintained profitability and market strength, while its peers continue to wrestle with financial-crisis issues and scramble for ways to generate profits investors like. The bank just reported second-quarter, 2014, earnings:  Another period of excellent performance ($5.7 billion in net income for the first quarter, $11.5 billion for the first six months). Yet some market doubters have begun to worry about revenue growth and about how the bank will be able to sustain such performance. 

In the past several years, while big banks have confronted every imaginable detrimental financial risk, from strangling new regulation to huge losses tied to imploded mortgage portfolios, Wells Fargo hangs in there from quarter to quarter with handsome returns on equity (12% in 2013, 13% in the second quarter, 2014, e.g.), a relatively clean balance sheet, and fairly basic business lines. 

Headlines about  financial institutions often scream about management shortcomings or major challenges at banks like Goldman Sachs, Morgan Stanley, JPMorgan, and Citi.  Wells Fargo, perhaps to its liking, gets crowded off the front pages.  Even those who follow the industry closely won't know its CEO by name (John Stumpf) as well as everybody knows the names Jamie Dimon at JPMorgan Chase or Lloyd Blankfein at Goldman Sachs.

What is Wells Fargo doing right? And how does it get it done?

1.  A bread-and-butter business.  The bank sticks to its niche, for the most part, and that seems to be basic commercial banking: deposit-taking and loan-making. Profits come from a shrewd management of interest spreads, maintaining loan quality and managing costs carefully.

Its peers long ago ventured into far-ranging activities such as investment banking, institutional sales and trading, derivatives and financial engineering of all kinds (and did so successfully until the crisis and until regulators decided to put straps on all that activity).

The bank has now reached a trillion dollars in deposits, which accrue low or no interest expenses.  Over 75% of the these low-rate deposits (no rates, in some cases) support a vast loan portfolio, now exceeding $800 billion (but not growing as fast lately as some investors and market-watchers would like).  (Because of the deposits, net-interest spreads exceed 500 basis points.)

2.  A clean balance sheet.  Like all big banks, Wells had to scrub its balance sheet to manage through or get rid of bad corporate loans, defaulting mortgages and trading assets, while raising capital and reducing risks. (Over $175 billion in equity capital anchors that balance sheet.)  The clean-up exercise, however, didn't lead to billions and billions in settlements and reserves, as other banks incurred. Some banks are still suffering from the recession, still paying settlements to investors and regulators (Bank of America in recent months), and still trying to shake off the crushing blows of the crisis.

Despite the many ways mortgage abuses and incompetence in managing mortgage risks led to billions in losses, Wells Fargo emerged as a leader in mortgage banking, devoting even more capital to this business line than ever, but likely prudent in what it does and how it does it.  Mortgages today comprise a large portion of its $800-billion loan portfolio; mortgage-servicing contributes about 11% of total net revenues.

Marketable securities and trading assets comprise about 20% of all assets, suggesting the bank is still vulnerable to market volatility and still maintains a big trading operation.  Yet in 2014, it hasn't had to grapple with big trading losses, nor is it entrenched in the trading activities (fixed-income, derivatives, e.g.) that are pummeling other big banks.

3.  Few thorns from the Wachovia merger. Wells Fargo had to digest Wachovia in recent years.  Wachovia had not been healthy financially in the late 2000's, and Wells Fargo was even nudged to make the acquisition.  Years after acquiring it, Wells Fargo doesn't appear to have had regrets in the way Bank of America and JPMorgan Chase are second-guessing themselves on acquisitions of Countrywide, Merrill Lynch, Bear Stearns and Washington Mutual.

Either Wachovia was in far better shape than the quartet Bank of America and JPMorgan purchased, or Wachovia and Wells Fargo complemented each other more perfectly than expected.

4.  Less temptation to get too fancy.  With regulators pounding their doors, many banks have retreated, too, to more basic banking activities to comply with tough new rules and to find ways to be profitable.  Wells Fargo, it could be argued, has had an easier time, because it didn't have an aggressive global investment-banking and trading operation and it never seemed tempted to expand beyond what it is comfortable doing.  Think Wells Fargo, and you think of mortgages booked in North Carolina and not exotic derivatives traded in Singapore.

5.  Ability to prepare for regulation.  The bank is well prepared for the Basel III and Dodd-Frank.  It has already begun to meet capital requirements for 2014-19, and Volcker Rules prohibiting proprietary trading won't have the impact it has had on, say, Morgan Stanley and Goldman Sachs.  Equity capital has grown steadily with earnings (about 11% the past 15 months). 

6.  Strong ratings from ratings agencies. The ratings agencies like Wells Fargo, too.  It has one of the best ratings among large financial institutions (Aa3 by Moody's).  Compare to Baa2 at Bank of America, Morgan Stanley and Citigroup, several notches below, or A1 at JPMorgan and Baa1 at Goldman Sachs.  It's not just the clean balance sheet it likes, but stable, consistent earnings in easily understood business segments help, too.

Are there worries?

Investors (and the equity markets) will push for more.  They want assurance the bank can generate 12-13% returns on equity from quarter to quarter and evidence that every quarter going forward will result in more than $5 billion in net profits.  They'll want to see earnings growth from steady increases in the loan volume. But loan volume is a function of other factors, as well, including limits on customer demand, economic cycles, and a long list of competing banks that won't give in. Wells Fargo will strive to push volume without sacrificing loan quality and taking desperate steps. 

For now, slap its back and applaud the San Francisco-based institution for showing how plain-vanilla activities can achieve good returns, strong ratings from credit agencies, and a nod of approval from regulators.

Tracy Williams

See also:

CFN:  JPMorgan: Is $13 Billion a Lot of Money? 2013
CFN: Morgan Stanley: Can It Please Analysts? 2012
CFN:  Why Was Citi's CEO Asked to Resign? 2012
CFN:  Basel III: Becoming Real, 2013
CFN:  UBS Throws in the IB Flag, 2012
CFN:  What About Corporate Banking? 2010
CFN:  Today's "Bulge Brackets," 2013