Ken Lewis is Confused - BoA's Investment Banking to Remain Second Rate, even with Merrill Acquisition

“Merrill was paying typical Wall Street pay... We intend to pay market instead.” - Ken Lewis

Ken Lewis, CEO of Bank of America, has gone on the record making the statement above. And while this statement may seem to make sense to some, it really betrays Ken's confusion and fundamental lack of understanding about Wall Street and the investment banking business.

Mr Lewis seems to imply that there is a difference between "typical Wall Street pay" and "market pay." But While Merrill Lynch gives generous pay packets to its bankers and other staff, this WAS market pay - for the investment banking business. That's why it was typical. Typical Wall Street Market Pay!

But you see, Ken Lewis really didn't mean to say he intended to "pay market," because "paying market" means paying "typical Wall Street pay." What Ken Lewis really meant was this - We intend to pay "commercial bank pay". After all, that's what BoA has been, is, and will continue to be, predominantly - a huge lumbering commercial bank, and a second rate investment bank. Acquiring Merrill isn't going to change that, and here's why:

Paying investment bankers commercial banking pay, is simply going to see the investment bankers either:

1. leave for other bulge bracket banks which are going to continue paying wall street market pay, or


2. see them leaving to start their own corporate finance advisory houses and/or join other boutique investment banking shops, or


3. leave to start their hedge funds and/or private equity shops

Indeed, that's why we see what's going on today: top Merrill talent is already being snapped up by its competitors. Banks like Barclays, Goldman Sachs and Morgan Stanley are swooping in like vultures to scoop up the talent that has been wounded by Ken Lewis' foolish rhetoric. I mean, what would you expect the investment bankers to do when their egos are hurt by Ken Lewis' statements saying that he hates Wall Street's inflated pay?

That's why Lewis' cost cutting strategies with Countrywide and FleetBoston are going to fail miserably when he applies the same to Merrill. Merrill is NOT a commercial bank where the bargaining power lies with the bank and cost-cutting is the way to go. Merrill is primarily a relationship business where its most important assets are its people. And as Lewis will learn in time to come, your business goes out the door when your most important assets go out the door. And your assets go out the door when your bankers and brokers go out the door.

Commercial banking is fundamentally different to investment banking, and Ken Lewis doesn't get that. That's why BoA is going to continue to have a second rate investment banking franchise. And that's why, in the years to come, we're going to see write-downs on Lewis' ill considered and ill executed acquisition.

Good luck all you BoA shareholders. You're going to need it =)

Lee Kuan Yew vs. Warren Buffett - Round 2

Some time last week, Lee Kuan Yew made a few comments about GIC's investments in the big banks, and also about Warren Buffett. He said in a Bloomberg interview:

Singapore's GIC May Seek More Bank Assets, Lee Says
By Haslinda Amin and Linus Chua

April 30 (Bloomberg) -- Government of Singapore Investment Corp. may add more bank assets to its $18 billion of investments in UBS AG and Citigroup Inc. as it chases stable returns over periods as long as 30 years, Minister Mentor Lee Kuan Yew said.

The Singapore sovereign wealth fund, which manages more than $100 billion, bought stakes in the two banks as they sought to repair balance sheets after writedowns linked to U.S. subprime mortgages. GIC, as the fund is known, may hold the stakes for two to three decades, said Lee, who's GIC's chairman.

``If there are other banks of the quality of the two that we bought into, with the promise and the capabilities and inherent capabilities to recover, we have got the liquidity to meet it, to make such an investment,'' Lee, 84, said in a Bloomberg Television interview late yesterday. ``We will not rule it out.''

This week, Warren Buffett, the wealthiest man in the world, gets his chance to give his take on the credit crunch and the banking sector:

Buffett says U.S. in recession; banks to face pain
Sun May 4, 2008 7:51pm EDT

OMAHA, Nebraska (Reuters) - Warren Buffett on Sunday said he does not expect financial markets to panic as write-downs and losses for bad debts mount in the financial services industry, but said those losses were not over "by a long shot."

The world's richest person, who runs Berkshire Hathaway Inc, said at a press conference the Federal Reserve brought markets back from a precipice in March in helping broker JPMorgan Chase & Co's purchase of Bear Stearns Cos, which was on the brink of bankruptcy.

"There's going to be more pain, sure," Buffett said. "The action of the Fed, in terms of Bear Stearns, prevented in my opinion the contagion where you're essentially going to have bank runs on the investment banks ... The idea of a financial panic ... has been pretty well taken care of. That was a watershed event."

He added, though: "That doesn't mean the losses are over by a long shot ... We've looked at some of the investment banks, and it's clear some more losses are going to be incurred."

Is Lee Kuan Yew listening?

He showed he clearly didn't listen to Jim Rogers by making comments about GIC possibly buying into more banks. And he most probably isn't listening to Warren Buffett either. Hell, Lee doesn't even really understand Warren Buffett's investment philosophy.

Buffett was speaking at his annual shareholder meeting, and had more to add:

In a question-and-answer session at the shareholder meeting, Buffett said that from a risk perspective, some banks got ``too big to manage.''

Sound familiar? What's the biggest bank in the world? I think it's one of the banks that Lee Kuan Yew's GIC invested in: Citigroup! which according to LKY, has

"an enormous spread worldwide as a retail bank".

Well, now we really know what an "enormous spread" is - it's a liability.

To finish off, be sure that it's not just about words, but it's also about making prudent investment decisions. Warren Buffett, like LKY & GIC, had the chance to pick up a stake in the banks. But Mr Buffett chose differently:

And Mr Buffett said banks need better risk management. He said he recently considered the prospects of a large investment bank, which he did not identify, by reading its 270-page annual report. He said he highlighted 25 pages where he did not understand what he had read.

'I decided not to pick that one,' Mr Buffett added.

Lee Kuan Yew and GIC, however, decided to plonk billions into Citigroup and UBS, now two of the greatest loss making banks since the credit crunch began.

Who do you think made the correct decision? Mr. Buffett or Mr. Lee?

I seriously think there's no debate!

----------------
[Update - A reader has kindly informed:
"LKY is a senior advisor to Citigroup which means that he get millions off from Citigroup from deal, salary and payment every month, every year.
http://www.citigroup.com/citigroup/press/2006/060905c.htm
Please add this important disclosure as it might shred light why LKY is so eager to invest in frailing banks."]

------
Related Posts:
Lee Kuan Yew Ain't No Warren Buffett
GIC, UBS & Jim Rogers

GIC, UBS & Jim Rogers

Back on 10th December 2007, the following was reported on Channel News Asia regarding GIC's investment in UBS.

The Government of Singapore Investment Corp (GIC) is injecting 11 million Swiss francs, or nearly US$10 billion, into the troubled Swiss banking giant UBS.

This will give GIC an almost 9 percent stake in UBS.

The deal comes as UBS announced that it was making further multi-billion dollar writedowns for its US sub-prime exposure.

A few months later, on March 5th, 2008, the following was reported on many news sources, including reuters, about Jim Rogers' comments that Singapore was going to lose money on its investments in investment banks. (For those who don't know, Jim Rogers is one of the most successful investors of all time, and partnered George Soros when the two ran their Quantum Fund)

"It grieves me to see what Singapore is doing. They are going to lose money," he added, referring to investments by Government of Singapore Investment Corp and Temasek in Citigroup, Switzerland's UBS and Merrill Lynch.

Just today (April 1st, 2008) UBS has announced massive losses and is again trying to raise capital, just a few months after its massive capital raising exercise that involved GIC. Reuters reports:

UBS AG doubled its writedowns from the subprime crisis, parted company with its chairman and asked shareholders for more emergency capital on Tuesday in a second dramatic attempt to reverse its fortunes.

The Swiss bank wrote down an additional $19 billion on U.S. real estate and related assets, causing a net loss of 12 billion Swiss francs ($12.03 billion) in the first quarter, and said it would seek 15 billion francs through a rights issue of shares.

But what is interesting about GIC's 'investment' is that UBS has been characterised as requesting more 'emergency capital' to 'reverse its fortunes'. I'm not sure I'd really put money in such a company and call it an investment.

Well, of course, GIC and Temasek would say that their investments are 'for the long term' and that the performance of these investments cannot be evaluated simply on the basis of their performance in a few short months.

After all, a 40% drop in stock price in 4 months can't be that bad... right?

Well, in any case, it looks like Jim Rogers is far out in the lead in this race as to who will eventually turn out to be right (click for full images):

Uni-Asia Finance Corp

Introduction

Uni-Asia Finance Corp is a recently-listed finance and investment company with operations in China, Hong Kong and Japan. It was founded by three Japanese bankers experienced in the field of structured finance. The main lines of business of the company are thus all related to structured finance and are as follows:

The structured finance income is derived from transactions that the bankers assist in advisory and origination and is akin to investment banking revenue. The ship investment income is income from the company’s investment in ships. This portion of income, which is a significant portion (56.6% in FY 06) of the company’s income, has very similar economic characteristics to shipping trusts. The distressed assets investment income is somewhat in common with the structured finance investments of the Babcock & Brown structured finance fund. All in all, Uni-Asia operates primarily as an alternative assets investment manager with structured finance investment banking income.

Financial & Profitability Analysis

The table below lists the FY results of Uni-Asia from 2004 thru 2006.

The numbers for Uni-Asia are not too far from a comparable, Westcomb financial. The P/E of the company seems reasonable and P/B is conservative.

At the current moment it is difficult to do a comparative analysis between the latest results of Westcomb and Uni-Asia as the latter has not released HY07 results. So I shall keep an eye on this company and do deeper analysis later in the year when results are released and the post-IPO numbers give a better springboard for analysis.

SGX's Competitive Strategy

Today in the Business Times was an interview of SGX's head of listings, Laurence Wong:

'The smart way in dealing with competition is not only to make ourselves better but to really differentiate ourselves so that we deliver things that are difficult for other people to,' Mr Wong told BT.

In view of the competitive market environment, is this the correct strategy for SGX?

China is currently pushing for Shanghai to be its main financial centre, many of the top-tier Chinese companies have listed their shares on the Shanghai bourse. With this natural competitive advantage of the hinterland, Shanghai's stock market is well positioned for growth by concentrating on fund raising of the major companies in China. The combination of geographical proximity and political will gives Shanghai a natural advantage that is very difficult for a player like SGX to assail, so SGX naturally should not aim to bring the large Chinese companies to list on its trading board.

The Hong Kong Exchange also shares the advantage of close proximity to the mainland, as well as the advantage of being a very well developed capital market. As such, the major Chinese companies have also dual-listed on the HK Ex as part of the capital raising. In combination with the entrepreneurial culture of Hong Kongers which have created many local businesses, HK also has a natural advantage compared to Singapore when it comes to securing big business.

Where does that leave SGX? Well, it sounds like SGX is left with the scraps. But that doesn't have to be the case. With Mainland and HK investment bankers going for the big guns, Singapore's investment banking and brokerage community can focus on its comparative advantage by pursuing a differentiation strategy which involves focusing on specific niches. And from the looks of it, SGX has done this. By expanding its REIT market and pursuing second-tier companies in the smaller cities around China, SGX makes itself an attractive destination for companies which may not be able to attract the attention of investors and bankers in Shanghai and Hong Kong. So, as far as this area is concerned, I think SGX has got it right.

An interesting idea would be for SGX to pursue an acquisition of a bourse in China that has a similar competitive position to it, if and when regulations allow and the opportunity presents itself. The Shenzhen stock exchange seems like an interesting option. Of course, if the acquisition opportunity does not materialise, joint venture and cooperative agreements can be seeked. The Shenzhen stock exchange is a second-tier exchange that has lagged its bigger brothers in Shanghai and Hongkong, and has a similar market positioning to SGX in the sense that it seeks smaller companies to list. With this convergence of strategic interests, the Shenzhen bourse would make a very interesting partner for SGX to work with.