Credit Suisse, Lloyds's HBoS fallout and Bank Leumi USA
Patrick Jenkins and guests discuss the campaign by a Swiss activist hedge fund to break up Credit Suisse, the fallout from HBoS for Lloyds banking group, and Bank Leumi's growth plans in the US. With special guests David Herro of Harris Associates, Davide Serra of Algebris and Bank Leumi USA's Avner Mendelson
Presented by Patrick Jenkins and produced by Fiona Symon and Aimee Keane
Welcome to Banking Weekly from the Financial Times with me, Patrick Jenkins. Joining me in the studio today are Emma Dunkley, our retail banking correspondent, Jonathan Ford, our city editor, and Attracta Mooney, our investment correspondent. Down the line from Hong Kong, we have Laura Newnan, our investment banking correspondent. And we're also talking to David Herro, who is from Harris Associates, Credit Suisse's biggest investor. And our guest here in London is Davide Serra, from hedge fund Algebrist. Down the line from New York, we have Ben McClanahan, our US banking editor, who's been in conversation with Avner Mendelson of Leumi Bank.
This week, we'll be discussing the activist investor campaign against Credit Suisse, the latest fallout from HBOS for Lloyds Banking Group, and that interview in the US with Avner Mendelson of Leumi Bank by Ben.
So let's go to our first item on Credit Suisse. As the Financial Times reported on Monday evening, the bank has been targeted by a Swiss activist hedge fund. This is the campaign that this small hedge fund that not many people will have heard of have gone after. The other two haven't been in the banking sector.
Well, Laura joins us now from Hong Kong to talk about this. Laura, it might be worth spelling out exactly what's happened here and how the proposal from this activist investor compares with Credit Suisse's current situation.
We're two years on from when Credit Suisse's then-new CEO, Tidjane Thiam, announced a restructuring plan for the bank. And his plan was basically to concentrate the bank more around Asia-Pacific, to concentrate it around wealth management, to take some resources away from the investment bank-- which at the time was tying up a lot of Credit Suisse's capital and was quite expensive-- and then to use that to grow other parts of the bank. At the time, he also wanted to separate out Credit Suisse's Swiss bank, and he was going to IPO that separately.
Since then, they have changed their mind about the Swiss IPO, but the rest of it remains pretty much on track. And the idea is that Credit Suisse will be a wealth manager which will then leverage the wealth management to grow revenue for the investment bank. And they also have a retail bank. And that's pretty much the bones of it.
And the Credit Suisse management argument is that the group works best like that when there are lots of synergies from having their various activities all under the one group.
In the last couple of days, it has emerged that there is a hedge fund which has built a stake, a pretty small stake. At this stage, they we're talking about less than half of a percent of Credit Suisse's equity capital. But they've built this stake, and what they want Credit Suisse to do is effectively split the business into three. So in the US, you would have an investment bank, which will go under the old First Boston brand, which Credit Suisse bought a number of years ago. And then you have a wealth manager come retail bank, and that will be a separate entity. And then a third entity, which will be Credit Suisse's asset management arm. And they think that they could make it a much more profitable entity by doing this.
Now, we've been there done that when we think about the investment banks. We've had several campaigns, one in UBS run by [INAUDIBLE] Bank, where they were trying to separate UBS. It hasn't worked before. But when they look at this now, they say that there are some unique advantages to doing it for Credit Suisse at this juncture.
OK. Well, thanks for setting the scene. I think the bottom line is that these guys have had a successful track record, though limited. But what's different here is it is a far bigger organisation that they're going after. They've got a far smaller stake. So I suppose it would be useful to hear from Attracta. Attracta, you write about the asset management industry, and you've seen this entity, RBR, go after a big asset manager in Switzerland, GAM, and be pretty successful. What can you tell us about their modus operandi and particularly the individual who heads this RBR business called Rudi Bohli?
Rudi is a controversial figure. He is friendly in person but not afraid to criticise individuals as well as companies. And with the GAM story this year, they were pretty aggressive and professional, and I think that's probably one of the key points. They brought in consultants. They developed a huge plan for how they would revamp GAM, which included overhauling its board, cutting jobs, getting rid of the CEO, various different measures. And the proposals actually won support from the big proxy advisors that advise and thus decide the vote, which is a pretty big feat because it can be hard to get their support. And that was because they said that the proposals were fairly professional. And although they didn't agree with everything, they saw he was making a decent case.
So with the GAM story, they did not get somebody on the board, but what they did manage to do was have a revolt over pay. And over the time where they were invested, which was a little under a year period, the share price rose significantly. And the same with Gategroup, which was a company they targeted a year previously. They were pretty successful with that campaign, too, and saw it being sold off in the end with a 20% premium.
So they are small campaigns but growing bigger by each year. And he has been noisy is probably the best description. He is good at making noise and drawing attention to these companies.
Well, he's going to be making some more noise in the coming days. Our understanding is that he's due to present his strategic case at a conference in New York later this week, the so-called Robin Hood conference organised by JP Morgan. And he's also, we gather, signed nondisclosure agreements with 100 other investors. This would suggest that he's trying to get new investors on board as part of a mission to get a momentum of feeling against Credit Suisse's current strategy and in favour of his own alternative breakup model.
Let's go now to Harris Associates and David Herro who is the biggest investor in Credit Suisse. David, thank you very much for joining us. I just wondered, for many people, this approach by this small, relatively unheard of Swiss hedge fund would have come out of the blue. You're the biggest shareholder in Credit Suisse. Do you think it has any merit?
Well, I don't really think there's a lot of merit because, though theoretically it seems to make sense and it sounds good, when you get into the details and when you look at the complexity of the business, the businesses underneath the Credit Suisse umbrella-- multiple jurisdictions, multiple regulators-- and the interdependence of some of the various divisions with one another, from a practical perspective it would be very difficult.
And I think, secondly, the new First Boston Corp, which would be the new name of the investment bank, the assumption is that it would have the same valuation as like a Goldman Sachs or a Morgan Stanley, and I just don't believe that to be the case. I think the businesses are different, and Morgan Stanley and Goldman Sachs have been a long-established independent houses. It would be quite a stretch to think that the spinoff could be adequately capitalised and strong enough to compete head to head.
Yes, there are niches, but I think there's no way that the spinoff, First Boston, would be able to be ranked in the equivalency of a Morgan Stanley or Goldman Sachs.
Yeah. There are clearly quite a lot of leaps of faith in terms of the valuation. What about the idea of a split up per se? Because, there's obviously talk in this hedge fund proposal of kind of conglomerate dissynergies. Does that ring true to you?
Not really because, at this stage, there is interdependency amongst the various groups within Credit Suisse, especially in the Asian business where often an investment banking client becomes a private bank client and vice versa. A lot of these wealthy family groups in Asia, who may start for instance as a private bank client, then want to float some of their businesses or do something on the corporate side. So there clearly is some synergy.
And secondly, at this stage, we would just prefer to see the management focus on executing the plan that they developed two years ago. And we're literally 7/8, 90% of the way through with it. And so I think to disrupt the execution of that plan, which includes moving capital to earn a higher return, which includes focusing on businesses in the investment bank where they're most strong and have the greatest unique selling proposition, which includes becoming more efficient and cutting costs but at the same time, growing revenue streams-- these are all characteristics of the current business plan that we would like to see finished.
And do you think Chief Executive Tidjane Thiam has won over the sceptics. It sounds like he's won you over, certainly as the biggest shareholder. But do you think he's got the majority of opinion on his side?
Well, people need to see results. And I think the good news is, over the last couple of quarters anyway, we're finally starting to see results. And especially as the SRU, the unit where all the bad debts and the bad assets are held, continues to be wound down-- and this should be wound down in the next few years-- then we will really see the true earnings power of the firm. And as they continue to gather more assets in Asia, and if they continue to stabilise the investment bank both in Europe and in the US, I think we're starting to see signs that the strategy that Mr. Thiam put in place is leading to success.
And so this isn't just hope. I think we're already starting to see this over the last two or three quarters.
And the share price performance, I guess, of late has reflected that.
Yeah. Year to date, it's been better, but I still think there's significant upside. I think the market is failing to differentiate their earnings by subtracting out the special resolution units losses. And when those losses are gone, and as we continue to grow wealth management and apply kind of a multiple to that business, the market will work these things out. I don't think this company needs to be broken up to achieve a higher valuation.
Now, Mr. Rudi Bohli, who's the gentleman behind this RBR hedge fund, has been doing quite a lot of lobbying behind closed doors, not least within Credit Suisse, but also among the investment community. I gather he signed 100 non-disclosure agreements with certain investors. Has he been in touch with you?
Yes, but we don't like the idea of signing a non-disclosure agreement and being made insiders because then that freezes. So he asked if we could talk. He did not tell me the subject matter. And I said no thank you.
We know him because we were both co-invested in a small company called Gategroup, and we've been relatively successful working with him to achieve a better situation there. But I think in this case, there's too many assumptions that are not realistic that go into his conclusions.
So a final conclusion, will it go anywhere? Will it achieve anything? Even if he doesn't succeed in his efforts, will it actually galvanise some rethink about the value of Credit Suisse, do you think?
Well, I do think the company remains substantially undervalued. So this has brought light to that belief. Secondly, there are some things he brought up which require further examination. For instance, redomiciling the investment bank to a more friendly region where the capital requirements aren't so stringent, the regulatory requirements aren't so stringent, some of these things the management should be taking a look at. I think the general thesis of splitting this thing up, in my view, is incorrect, but he does have some points that require a second thought.
So I guess you'll be urging Tidjane Thiam and others to at least look at some of those good ideas that might be hidden inside the bigger plan?
Very good. David Herro, thank you so much for joining us. Let's hear now from another investor, Algebrist, which is a big financial investor-- although not particularly in the Credit Suisse situation, but maybe for a slightly more dispassionate point of view. Davide Serra, their founder and chief executive joins us on the line now.
Davide, hi. The question I wanted to ask you was, why do you not agree with the RBR breakup plan?
The reason why I do not agree with the breakup plan is because shareholders will be worse off. Clients will be worse off. Creditors will be worst off. So it's a lose-lose.
Why it's a lose-lose, because Credit Suisse is a group that has been formed over the last 100, 150 years. And today, you do have a balance sheet. With the current balance sheet, if you are trying to separate the investment bank, the retail operation, and asset management, you will actually have to put more capital not less, and you'll have massive attrition of clients because clients who will have an unstable institution all of a sudden. And at the same time, the synergies that can actually be achieved-- whether in digital, in product, in running an integrated firm-- will be lost.
Hence, I think here the activist that has invested in a firm that has three business pillars. And assuming that you create value by breaking it up, it just makes no sense. If what he wants is pure asset management or retail, then he should invest in terms that only do that, like [INAUDIBLE] or a pure asset manager. The company Credit Suisse, it's an integrated firm. And breaking it up would actually, in my view, destroy value rather than creating it.
He makes the argument that there are big dissynergies in this conglomerate structure and that, I think, the valuation that he's suggested might be released from break-up would be in aggregate a doubling of the valuation, particularly on the wealth management side, which he argues is discounted heavily by being in the same group structure as an investment bank. You don't buy that, though?
Well, the issue is the investment bank is the loss-making in my view, de facto. And so the assumption he runs is that you can value of the equity in the investment bank at cash, and hence the wealth management is much more valuable and hence you should double the value of the overall group.
But those are two wrong assumptions. The investment bank will never be able to attract cash value. It will acquire more equity. God knows who's going to ever fund it. And as a result, you have a big liability in it. So the only way you reduce their liability is actually managing, cutting costs, integrating, serving clients, which is what the Tidjane is trying to do, similar to what John Cryan is trying to do in charge Deutsche Bank.
And the attractiveness of Credit Suisse is that it has this fantastic wealth management franchise and private banking franchise globally, which is the core jewel of the firm, but you can just value the good bits and ignore the bad bits. It doesn't work that way because you have both bits, and you can't just chop one off.
And what those within the bank would argue, I suppose, is that you need the investment bank to service the clients within the private bank. A final thought from you then, Davide. I don't know if you know Rudolf Bohli from RBR. But whether you do or you don't, do you think he's going to have success in rounding up support for his view? However flawed that view might be, will other investors buy into it?
So on average, I support activists because there's always a reason why someone is happy to speak up and step up. I think in this case what they are proposing, it's wrong. It's against the shareholder interest. It's against company interest. And I don't think he will have shareholder support because shareholders ultimately vote in their own interest. And in my view, this is against their own interest.
What he highlights is that there is value in the firm, which I do agree. There is long-term value, but we need two, three years to execute the plan. I give an example. Tidjane first thought of floating the retail unit. I thought that was a bad idea, and then he changed course and he decided to raise capital rather than floating the retail business.
Why the retail business is better off inside? Because if you create suddenly conflict of interest between asset management, investment banking, wealth management, what happens is, rather than looking their own client interest, you're just having people fighting against each other. And that's against both the client and the overall stakeholders. As a result, I think their plan will not float, will not work. And most importantly, if you were to ask the regulator, the regulator would probably tell you no way. This is a regulated business, so the ultimate say, it's in the regulator's hands. And I can tell you, being Credit Suisse is a G-SIFI, there is no way they will ever allow a break-up of it.
Yeah. As you say, as a G-SIFI, or a so-called systemically important bank, you get much closer regulatory scrutiny than any other bank in the world. Davide, thank you so much for joining us and giving us your thoughts.
Well, let's move on now to our second story, which is a look at an upcoming trial involving HBOS. This is the former Halifax Bank of Scotland bank which was acquired by Lloyds in the heat of the financial crisis. And Emma, we have this trial starting things on Wednesday, which is brought by disaffected investors. What exactly is the trial all about?
Yes. So thousands of shareholders in Lloyds Bank are suing the lender and five former directors in court for 600 million pounds. They allege that the bank did not properly conduct due diligence over Halifax Bank of Scotland when it took over the beleaguered lender in 2008. And these shareholders also believe that the bank and the former directors did not disclose a lot of relevant information for investors within the prospectus. So this includes, for example, a 25 billion pounds loan from the Bank of England that was deemed emergency funding at the time.
And just to put this into context, obviously, this takeover was during the financial crisis when HBOS was particularly weak and Chancellor Alistair Darling was keen to ensure that the banking system did not face broader systemic risks.
OK. It does feel as if this is coming out at quite a bad time for Lloyds. Jonathan, you're joining us as a guest this week. Thanks for being with us. And you've done a lot of investigative work about another element of the HBOS takeover which has come back to haunt Lloyds, which is this fraudulent Reading-based non-performing loans unit. Maybe you can just summarise a little bit about that, and then maybe talk about how you think this links in with the broader HBOS legacy coming back to haunt Lloyds.
Yeah. I think there must be in the back of most people's minds at Lloyds a wish that Victor Blank had never turned up to that cocktail party where he met Gordon Brown and essentially the deal was originally done.
And Victor Blank, of course, was the former chairman of Lloyds who got from then-Prime Minister Gordon Brown, as you say, the nod and a wink that this deal would not be blocked by the authorities.
Yeah. I mean, essentially, Lloyds inherited in HBOS a bank that was falling to bits quite literally during the crisis. And one of the reasons why was that it had embarked on an extraordinary imprudent burst of corporate lending with a view to effectively substituting for the sort of synergies that were promised at the original merger of Halifax and the Bank of Scotland in 2001.
And one of the consequences of that lack of control, or one of the symptoms of it, was what went on in the Reading branch of HBOS, where essentially a group of managers were given an enormous amount of latitude for reasons that have still not been fully explained to extend loans to smaller companies and indeed medium-sized companies. And effectively, they ended up doing a lot of corrupt deals with a turnaround consultant and running off with quite a lot of the proceeds, not all of which had been recovered.
Now, in terms of the problems for Lloyds with this story, clearly this is all a long time ago. But the victims in this Reading fraud were never compensated, and they were effectively left dangling for a decade. So you still have a lot of very angry people who feel correctly that they were cheated, who are angrily denouncing the management at Lloyds and asking to be compensated. And that process hasn't completed.
So how this feeds into this situation with the trial is, obviously, a lot of the victims are looking for information to come out of this trial which will provide further evidence that not only was, as we know, HBOS extraordinarily badly-run bank, but also that once it was acquired by Lloyds, Lloyds essentially had reasons not to look too deeply under the stone of what it had just acquired. Because, it was worried that if it did declare after the acquisition that it was a disaster its own shareholders would turn on the management, which is why, essentially, it all comes back again to the question of who knew what when with the HBOS takeover.
Absolutely. Just to bring Emma back in for a final thought on this. Clearly, annoying your customer base and annoying your shareholders is not a great way to run an institution. Has this come back to bite Lloyds in terms of-- I don't know-- the share price performance of the bank or anything more tangible?
Well, just to put it into context, it's nothing compared to the 18 billion pounds that Lloyds had to set aside to cover the ongoing debacle it is its misselling of payment protection insurance. So this 600 million pounds that the shareholders are claiming pales by comparison. However, the ongoing reputational damage that is dredged up by this case is not great for Chief Executive Antonio Horta Osorio, who is desperately trying to draw a line under the legacy scandals that have played Lloyds for a decade.
And the bank came out of state ownership earlier this year, at which point the share price rebounded. However, it's now languishing at about 66p, which is some way below the price the government paid to bail out Lloyds when it took a 43% stake in 2008 and 2009 at 72p a share. So I think Mr. Horta Osorio will be looking forward to when this trial ends.
In the meantime, I suspect, as Jonathan says, there's likely to be very interesting evidence emerging, which may make for painful hearing for everyone concerned. Thank you both for that.
Finally, let's go to our third item, and Ben McClanahan in New York has been talking to Avner Mendelson, who is the US head of Israel's Leumi Bank. And he's been talking to him about the outlook for the bank's business in the US.
Avner, welcome. Let's talk about consolidation. You're a sort of low- to mid-tier banker. Your roughly $7 billion assets?
Yes, just under.
And the next threshold, of course, for more severe regulation kicks in at $10. What's your feeling these days about growth and organic versus inorganic growth?
We think about growth and organic growth as the main driver for growth for us. We are growing at a double-digit rate over the last couple of years, both in terms of our asset size, deposits, loans, and revenues. And we see, still, a lot of runway for us to grow organically. That's our focus today. But as an almost $7 billion bank seeing the sort of the $10 billion threshold there in the horizon--
What happens at $10 very briefly?
As of today, there is sort of a defined change in terms of regulatory supervision coming from both the FDIC and the state that we're being regulated on, which brings a little bit of a different framework of regulatory supervision requirements that are being raised a little bit from a bar as well as the consumer bureau oversight that comes into effect.
So you're looking really to crash through that threshold rather than just sort of tiptoe through, and then accumulate lots of extra costs?
We are thinking about that we still have a couple of years on the horizon before we get there, but I am talking to CEOs of banks who have gone through the threshold, who made the jump whether organically or inorganically, and trying to understand the implications that they've seen not just from a cost structure purely, but also just from operationally. What needs to change, what needs to be in place from a platform to support a prudent crossing of the $10 billion mark?
So do you have a list of potential targets drawn up [INAUDIBLE] across America.
Oh no. Not yet. Too early. And what about the regulation environment? Because under the old regime, under the vice chair of the Fed, Dan Tarullo, I think the understanding was, as I say, if banks wanted to combine, they get bigger, they get riskier, and it's a menace to the system. Is that changing under the new regime?
I would say that I believe-- and we're not regulated by the OCC-- but our experience and from talking to colleagues, CEOs of banks in our sort of space, we haven't seen such fears from the regulators when it comes to consolidation. I don't think that $20 or $30 billion banks are becoming a systematic threat for the system and neither do the regulators. And they understand the incentive and the rationale for making such combinations.
I think any prudent regulator will look to make sure that, in such a merger, there's the right platforms for managing risks and making sure that the interests of the clients and customers are taken care of. But we haven't seen any regulatory move against such mergers.
So in the absence of a deal, what's going to drive the growth? What has been driving the growth at Leumi?
People. Having the right talent, having the right teams, and building the right culture, making sure you have the right products, and focusing on the sectors and issues.
What sectors, what asset classes are you looking at?
So again, we're a traditional, middle-market, relation-driven bank, so we're serving mostly commercial companies with revenues anywhere between $20 and $300 million. And the value proposition at the end of the day is the people, the service, the ability to tailor the solutions. And obviously, we need to make sure that we have at least a stable stake product offering and technology offering to compete with the rest of the market and with the big banks.
And which sections in particular? Commercial real estate is important, isn't it, for you?
So commercial real estate. For any bank almost in the US-- and definitely any bank in New York area-- commercial real estate is a big part of it. For us, relatively, it's a little bit lower. It's about 40% of our portfolio. But a fantastic growth engine that has been for us. We also have quite a significant presence in the health, mostly the skilled nursing home sector across the country.
Is that cycle-proof?
That's cycle-proof in the sense that it's less driven by the economic cycle, and that's why we like this. It's mostly driven by demographic and demand. It is not regulatory-proof. And as we all experienced today, there's definitely elements that could affect the profitability of this sector and the dynamics going forward, which we are obviously aware of.
And with commercial real estate, it seems every six months the OCC-- you're not directly regulated by-- but it is coming up with warnings regularly about overexposure.
All regulators. All regulators will here it.
What's your feeling? Is this justified this concern?
My view is yes, and the reason is any overconcentration, every rapid growth that you see possesses risks. Even if you can really define it, put your finger on defining them, we're talking about banks, organisations managing other people money, and increased growth, increased concentration, the hike in prices that we've seen are all potential threats. It doesn't mean we should stop doing business in this sector, but I think heightened awareness and having the right limits in place are critical.
Are there any regional markets in particular that you're steering clear of now?
We traditionally have been focused in the markets where we have a presence, which are sort of the greater New York area, south Florida, Illinois, and south California. We're not staying away of any of those markets. I think there is asset classes which traditionally we've not been very much focused on which will continue not to be, such as the luxury high-end residential market and retail as a whole are two sectors where we're traditionally have been staying away. And especially in these days and seeing some of the trends in those markets, we're a little bit more cautious as well.
We have a lot of clients in the wholesale business-- apparel industries-- who are all suppliers for big-box retailers, and we've been seeing the sluggish performance there over the past three, four, five years even if you really want to look back and see that. And that's obviously creating constraints not just for the retailers but also somewhat for the suppliers. And again, you don't need to be a banker or an expert to see where the trend is going, where shoppers are going, where are they buying.
And just going back to that consolidation thing quickly, one of the reasons why that regulators have looked askance at some of these combinations is cyber. The protections in some cases aren't as good as they should be. And, of course, Equifax recently has demonstrated the peril of turning a blind eye to potential patches that could have helped. How much of a concern is it for you on a day-to-day basis?
Huge. Not just because it's a top priority for our regulators, whether it's the FDIC and the New York State. And the New York State Department of Financial Services actually came up last year with more--
So you're personally signing attestations are you, that your controls are up to scratch?
Apparently I am, yeah.
How does that make you feel?
Nervous. But I have to say, I'm nervous not because I'm signing. I'm nervous because of the risks that are there are involved there. We're not a big retail bank. We serve tens of thousands of clients not millions. But it doesn't change still the risk for both the bank's safety and our clients' safety. The way we think about that is also obviously making sure we have the right layers of protection. A lot of them are human-driven, not just the right software and systems to protect or put the firewalls, but also to make sure people have the awareness and take the right steps that will not create the vulnerabilities or not create the data leakage opportunities for threats.
But also, a big part-- and our regulators are putting a big emphasis on it-- is the reaction plans. What do you do when something happens? How do you quickly react? How do you make sure you notify the right parties, whether it's your clients and your regulators? And what are the mitigant actions that you take as an organisation to ensure business as usual can continue but also protect the safety of your clients and obviously the privacy of their information?
These extra costs, are they yet another reason to consider doing deals-- for banks in general?
I think generally the costs of running a bank are growing, both from regulatory compliance costs-- whether it's the AML/BSA requirement, the customer experience that you want to provide or your clients are expecting in terms of technology advancements, data management, cyber, talent acquisition-- all of those are rationales for creating a larger scale in the industry.
Yes, cyber is one of them. And we're fortunate to have a shareholder, which is a Bank Leumi in Israel, which is really a leader in the cybersecurity space. It's a hub for cyber generally in Israel, and the bank in Israel is definitely a center. And we're trying to benefit from that and leverage the capabilities and skills and know-how that the bank has built.
Great. Avner Mendelson, thank you very much for joining me.
Well, that's it for this week. All that's left for me to do is to thank all of our guests. That's Emma, Jonathan, and Attracta here in London, Laura down the line from Hong Kong, Davide Serra from Algebrist. My thanks, too, David Herro from Harris Associates, and Ben in New York with his guest, Avner Mendelson from Leumi Bank.
Thank you also for listening. Remember, you can keep up to date with all of the latest banking stories at FT.com/banking. Banking Weekly was produced by Fiona Symon and Aimee Keane. Until next week, goodbye.