Business Times - 04 Apr 2009
Through a banker's looking glass
JP Morgan's chairman and CEO for Asia-Pacific, Gaby Abdelnour, talks about how the crisis is changing the banking landscape. By Vikram Khanna
'WHEN you go out socially these days, if you tell people you're a banker, you get lectured,' jokes Gaby Abdelnour, chairman and CEO of JP Morgan Asia-Pacific. In his more than 30 years in the banking industry, Lebanese born Mr Abdelnour has weathered several crises. However, this is the worst he has been through. 'You have the financial and corporate sectors suffering, consumer spending cut and emerging markets weak. These are pillars of the global economy and they are all weak at the moment. Without at least one of these pillars more secure, we are going to continue to experience financial uncertainty,' he explains.
Surveying the damage wrought by the crisis, especially in the area of investment banking, where he has spent most of his professional life, Mr Abdelnour says the events of the last year have had a transforming impact on the banking industry.
'For example, the stand-alone broker-dealer model has disappeared,' he points out. 'The only remaining independent firms, Morgan Stanley and Goldman Sachs, have become bank holding companies. You could even argue that investment banking itself has disappeared. We're going more and more towards a universal banking model, with certain variations.'
There is a relatively limited number of universal banks - institutions which offer clients a diverse range of financial products and services, rather than working off a narrow base. JP Morgan Chase, the listed entity, which covers corporate, investment, retail and private banking, asset management, treasury and security services as well as card services, is a prime example of the universal banking model. The firm's wholesale and retail platforms have been further expanded since the crisis began by the acquisitions last year of Bear Stearns and Washington Mutual. Analysts will be keenly looking for evidence of the benefits of these purchases when the group announces its first quarter results for 2009 later this month.
But the bank has entered 2009 in a position of strength relative to its peers. At the end of March, JP Morgan Chase had the highest market capitalisation among US banks, at around US$100 billion - almost double that of Bank of America and Citigroup combined. It further strengthened its balance sheet, raising Tier 1 capital by 2.5 per cent to 10.9 per cent by the end of 2008. Also, it earned the top ranking in global investment banking fees in 2008 across mergers and acquisitions, syndicated loans, debt and equity - the only firm ever to finish No 1 in all these categories in a single year.
In Asia, operating as a wholesale bank, JP Morgan continued to grow revenues and profitability. Revenues are up 27 per cent since 2006 to over US$4 billion and Asia's share of global net income is up over four times over the same period. The bank has benefited from the flight to quality across treasury services and asset management businesses.
'We are the poster child for a universal bank,' says Mr Abdelnour. 'We've seen other universal banks run into difficulty. But what makes the difference is who manages the model, and our firm has maintained strict financial discipline, outstanding leadership in all parts of our business and a fortress balance sheet,' he says.
He points out that the one-time giants of investment banking will have to make huge changes. In particular, monolines, such as Morgan Stanley and Goldman Sachs have to dramatically reduce their leverage. 'This raises the question, how do you generate the revenues with much less leverage, without access to cheap funding? So this model has changed for the foreseeable future.' he says. 'I say 'forseeable future',' he adds, 'because let's face it, everytime this industry has faced a challenge, it has found a way to come up with new solutions, new products and go into a new phase. This is likely to happen again.'
But it won't be easy. 'The capital markets are more difficult, and so is trading. Doing illiquid assets and private equity is not what it used to be - the leverage has gone out of the system. So we're going into a period where revenues and returns are going to be under pressure,' Mr Abdelnour adds.
However, even amid the downturn there are opportunities for investment banks, he says. For example, in the area of cross-border mergers and acquisitions, there is a lot of interest. Natural resource investments remain an area of strong activity and JP Morgan has won several important mandates in this sector, as Asian companies, especially China, look to acquire mineral assets in Australia, Latin America and Africa.
Investment grade bond issues are another area in which JP Morgan is very active, according to Mr Abdelnour. 'We're seeing record issuance,' he says. 'Investors view investment grade bonds as a trade that can protect them in a recessionary environment and if the economy recovers, the risk spread tightens so they make money there. So, it's seen as nice hedge, though not a perfect hedge.'
The firm is also seeing record offerings of rights issues, he points out, noting that JP Morgan has led the field in Asian issues. Mr Abdelnour concedes that revenues are already smaller in the current environment, compared to the go-go years. 'We've lost a lot of the securitisation,' he says. 'Proprietary trading has been de-emphasised across all firms and this is the same for complex derivatives and structured products - people lost lots of money in those areas. So there are many products in investment banking today that have been de-emphasised or have gone almost to zero. But there's always another side of the story - other areas that are picking up the slack. That's the nice thing about having a portfolio of businesses, as part of a universal banking model.'
However, the banking industry could see other major changes as a result of new government and regulatory policies. One issue being talked about is the possible nationalisation of banks. This has been especially evident in the UK and the matter is still being widely discussed in other countries. However, a lot of the issues pertaining to nationalisation remain unclear, according to Mr Abdelnour. 'Some people talk about nationalisation in very general terms,' he says. 'It's important to define what nationalisation means and to get granular about that definition. When we talk about nationalisation, are we talking about the delisting of a bank and government putting their own people to run it?' he asks. 'Or are we talking about government becoming a common shareholder, the bank remaining listed and professional management continuing, but with government having a heavy influence in the direction the bank is taking?
'In the event of nationalisation, would the government set the credit policy of the bank, or its international footprint? Would it take a nationalistic view of how the bank should be run? These are very fundamental questions that will have a big impact on what nationalisation actually means.' Mr Abdelbour says.
Moreover, while nationalisation might be workable on paper, in practice there would be uncertainties, he points out. 'How do you execute on a good bank/bad bank strategy? Which assets do you strip out and include in the 'bad bank'? How do you monetise the 'good bank' and liquidate the 'bad bank'?'
Also, nationalising some banks, and not others could potentially create problems for the industry by tilting the playing field, according to Mr Abdelnour. 'If we take the worst case scenario,' he says, 'governments have unlimited capital and allow the bank that they take over to lend and invest wherever they want. Issues such as return on capital, return on risk-weighted assets and loan loss reserves become less important. That puts banks which are not nationalised, such as JP Morgan, at a competitive disadvantage. We have to pay for our capital. We have shareholders who expect a return on equity. We have risk weighted assets we need to be concerned about,' he says.
'So it's natural that banks which are not nationalised view this as unfair competition. So, if nationalisation does happen, it should happen in a way that does not put other banks at a competitive disadvantage.'
There are other areas where there is a lack of policy clarity, according to Mr Abdelnour. 'There is talk about putting banks through stress tests and indeed some are going through this as we speak. We do our own stress tests - every banks does. What will be the criteria that the government will use for its stress tests? And what remedy will they resort to if some banks fail the test and will it be public?' he asks.
'These issues are not clear yet. And in the market today, with all the nervousness that exists and lack of visibility as to where is the bottom, people want clarity more than anything else. They want guidance, they want direction.' Another issue facing the banking industry is executive compensation, about which Mr Abdelnour shares much of the public concern. 'If this crisis has taught financial institutions one thing, it should be that the focus must be on rewarding long-term performance,' he says.
He points out that some banks have imposed 'clawback mechanisms' in compensation plans, which enable bonuses based on unsustained trading gains to be returned. Other banks are moving to base their compensation on the long-term performance of a portfolio of assets. For its part, JP Morgan gives its employees stock grants which vest over three to five years.
'These grants encourage employee loyalty, and at the same time create greater alignment between compensation policies and the long term interests of shareholders,' he says.
However, Mr Abdelnour questions the value of imposing caps on compensation, as has been proposed by some lawmakers in the case of institutions that received bailouts.
'With caps the banking industry runs the risk of losing its best performers,' he says. 'What a policy of caps on compensation would do is to siphon the best talent out of the banking sector and move it elsewhere. And medium to long term, that will damage the banking sector. It is said that you can replace people, but that is not true. Talent can move easily, and you need to nurture and preserve it,' he says. 'In this current environment, we have to be careful not to overreact to this problem by proposing extreme solutions, because extreme solutions can backfire.'
However, Mr Abdelnour is confident that governments will ultimately play a positive role in the resolution of the crisis. 'I always say to people, do not bet against the government because the government will always win. They will print money to solve the problem, if they have to. They may not get it right the first time, but they will eventually get it right. For all of our sakes, the sooner they get it right, and the less money they have to pump into the economy, the better,' he says.
How does Mr Abdelnour view the long-term effects of this crisis for the financial industry? It will play out well for JP Morgan, he says. 'We'll emerge from this crisis with our credibility and reputation greatly enhanced in the minds of global regulators, clients, shareholders and staff. But a lot of people in the industry will be chastened. They will have to start to think more long-term about the ways that they conduct their businesses. The 'lets get rich quickly' policies were clearly a failure. The overall shape of the investment banking landscape will be very different.'
'But this industry has always been fantastic at adapting to challenges, reinventing itself, creating new products, finding ways around constraints, and making money. In the future, the same thing will happen. I only hope that people will learn from the mistakes of the past.'
For now, though, the industry faces uncertainty. 'We are experiencing unique conditions,' says Mr Abdelnour. 'None of what is going on has been written about in business case studies or taught in schools. So, dealing with this environment requires a lot of judgement, common sense and speed. And five years from now, I hope we'll look back at this time and say, 'we have all learned and improved.'
GABY ABDELNOUR
JP Morgan Chairman and CEO
Born in Beirut, Lebanon, 1953
2006 to present: Chairman and CEO for Asia Pacific, JP Morgan Chase
1998-2006: Managing Director (Central and Eastern Europe, Middle East and Africa) JP Morgan Chase
1994-1998: Managing Director Merrill Lynch & Co, Singapore and Hong Kong
1982-1991: Bankers Trust, New York
Education: BSc (Electrical Engineering), MSc (Mechanical Engineering) Lehigh University; MBA, New York University
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