Nomura suffers a Lehman limp

FT.com

On Tuesday September 16 2008, Christian Meissner was much in demand. It was only two days since the Lehman Brothers weekend, when one of the most famous names of Wall Street had collapsed. And the de facto head of the bank's European operations was now confronted with a barrage of questions from more than 2,000 staff desperate to know what would happen to them.

But when Meissner's phone rang that evening, the man on the other end of the line – a veteran Pakistani-born banker called Sadeq Sayeed – suddenly offered him an answer.

Under orders from his bosses at Nomura in Tokyo, Sayeed told Meissner that the Japanese bank was prepared to bail out Lehman's European operations. A similar approach had been made in Asia. Within a week the double-deal was done. Just 10 days after Lehman's collapse, Nomura – a famous name in its domestic market with an afterthought international investment bank tacked on the side – had bet its future on being able to transform itself into a powerhouse to rival Wall Street's finest.

It was the start of a very expensive four years for Nomura. The group's investment banking operations have lost an aggregate ¥34.4 billion ($440 million) since the year to March 2010, the first full year after the Lehman acquisition. And for then chief executive Kenichi Watanabe and chief operating officer Takumi Shibata – the men who gave Sayeed his orders – it has been personally costly. Last week, both CEO and COO were ousted with other senior executives under pressure from colleagues and regulators.

Ironically, the trigger for their departure had little to do with the lossmaking investment banking franchise. It was instead a spiralling insider trading scandal within the bank's Japanese operations that led to their removal. But the consequence was clear – the investment bank would no longer have its champions.

The bank's new chief executive, Koji Nagai, has already said he will remake Nomura into an "appropriately-sized global franchise”, indicating he will scale back unprofitable overseas businesses and reallocate resources to Japan and Asia.

Nagai's vision of the new Nomura could not be further from that of Shibata and Watanabe when they embarked on their bold plan to turn Nomura into a serious force in global markets.

Promising beginnings

Lehman had been the number one equity trader in both London and Tokyo and had client relationships with the leading corporations in Europe and Asia, which would open the door to deals a Japanese bank like Nomura could only dream of.

"This sort of opportunity doesn't happen in normal circumstances,” Shibata told the Financial Times at the time. "It would have been foolish for us not to jump on the opportunity.” What is more, the financial crisis had severely weakened many of its competitors, offering Nomura an opportunity to step into the void.

"When the flood recedes, Nomura won't be just a survivor, we'll be a leader,” Watanabe told an investor conference at the end of 2008. In the first year or so after the acquisition it appeared Nomura's bet on Lehman would pay off. Nomura was able to win prestigious mandates that would have been out of its reach, had it not been for the Lehman bankers it took on, particularly in Europe.

Nomura bankers are particularly pleased with their role as one of five financial advisers to Xstrata in its attempted takeover by Glencore. Between April, 2009 and March, 2010 – the first year after the Lehman operations were consolidated – the global wholesale division, which includes the overseas operations, generated pre-tax profit of ¥175bn, more than the domestic retail business, which had been Nomura's main profit-earner.

Things appeared to be going well for Nomura and its COO, Shibata, who was responsible for the overseas operations. A fluent English speaker who spent much of his career overseas, Shibata was widely seen as one of the few Japanese bankers capable of managing a global organisation.

During a stint in London, Shibata, who attended Harvard Business School in the early 1980s, acquired a taste for the opera and ballet, as well as fine food. Not only was he able to crack jokes in English – an accomplishment that earned him the nicknames, "alien” and "spaceman” – Shibata adopted a pragmatic approach that some believed was what was needed to succeed globally.

Nomura in Japan had a tendency to take an emotional, some would even say, sentimental, approach to business, wining and dining even clients who showed no signs of bringing in more business, just to keep the relationship intact.

But Shibata and Watanabe were made of different stuff and shunned the traditional Japanese approach to business, according to a former Nomura executive.

In early 2010, Shibata proclaimed Nomura was on its way to becoming "a world class organisation”.

But then the eurozone debt crisis struck and changed everything.

Trading in European equities collapsed, leading to heavy losses for Nomura, which had more than doubled headcount in the region, to 4,292, as a result of the Lehman acquisition.

Nomura has been particularly vulnerable to the slowdown in equities, because it hardly trades on its own account, says Makoto Kasai, analyst at Citigroup in Tokyo.

"Unless they can get customer orders they can't make money. So, Nomura withers when trading declines,” he says. Nomura also made strategic miscalculations which compounded its woes.

For one thing, the regulatory clampdown that was supposed to weaken the competition and give Nomura its big break, never turned out as expected.

Even with the Lehman acquisition, Nomura is still tiny compared with the leading US and European banks and, with a credit rating from Moody's that is one notch above "junk” status, it can hardly compete.

For example, Nomura is virtually shut out of the US and European primary market for investment grade bonds, which is dominated by the big banks, says Kasai.

Shibata's failure to secure Lehman Brothers' US arm – which was instead acquired, to far greater effect, by Barclays – was another mistake, bankers say.

"Lehman's European investment banking business existed because of their base in the US. So, without the US, it can't generate the deal flow necessary to maintain a team of that size,” says one former Nomura executive. Nomura's top management also underestimated the frictions of integrating the Lehman bankers with Japanese staff.

In an effort to convince the Lehman bankers to stay on, Nomura offered generous bonus guarantees.

Shibata elevated Jesse Bhattal, Lehman's former Asia head, to chief executive of the global wholesale division, in what insiders say was an effort to retain key Lehman bankers.

Other key middle-management posts were dominated by legacy Lehman employees, to the chagrin of the Japanese staff.

Yet, despite retaining Lehman's expensive investment bankers, Nomura's ranking in the global IB league table in terms of fees, fell from 13th in 2008 to 16th last year and in the first six months of this year, according to Thomson Reuters.

As the overseas losses mounted, those who worked in Nomura's retail division on a fraction of the pay of ex-Lehman investment bankers, became increasingly vocal in their criticism, insiders say.

By the beginning of this year, Bhattal was gone, along with many of the "Lehmanites” who had received generous incentives to stay on, including Tarun Jotwani, former global head of fixed income and earlier, and Meissner, leaving only a handful of senior Lehman bankers.

The management turmoil reignited concerns that Japanese banks struggle to harness aggressive western investment bankers. People who know him say Shibata's love of western culture might have blinded him to the shortcomings of Nomura's non-Japanese bankers.

"His admiration of western culture is too strong and maybe that made him soft towards the foreigners,” says a former senior executive. "Just being fluent in English doesn't mean you can manage the foreigners,” he says.

Other insiders say Shibata's determination to establish Nomura as a global player prevented it from adapting to changes quickly enough.

Shareholder revolt

Even as its revenues plunged, Nomura's leadership resisted pulling out of lossmaking overseas businesses, according to Nomura insiders.

"Shibata wants to expand things. He hasn't been able to balance the accelerator and the brakes,” says one former senior executive.

"Management is not his forte. He is a bit of a dreamer,” says another former executive. Shibata is also stubborn, by his own admission.

Although Nomura finally implemented a $US1.2 billion cost-cutting programme late last year, the benefits of that exercise have been limited since the cuts were not focused on lossmaking areas.

As it became increasingly clear Nomura's overseas strategy was failing and as the bank's share price hovered near long-time lows, Nomura's investors began to lose patience.

At their annual general meeting in June, in an unprecedented revolt, more than a third of shareholders voted against the re-election of Watanabe.

The situation was compounded by the insider trading scandal, which angered many of Nomura's institutional clients, and lost the bank a number of important mandates, such as the government's sale of shares in Japan Tobacco. Pressure also mounted on Watanabe and Shibata from Japan's financial regulator.

"Officials at the Financial Services Agency will not say out loud that they want Watanabe to resign but you can read between the lines of what they do say,” says the former senior executive.

One senior banker says that in the days leading up to the resignation of the bank's top duo, Japanese blue-chip clients had ceased trading bonds with the bank en masse, under direction from regulators.

Strategic withdrawal

The question now is how extreme Nagai's retreat will be from the global ambitions of his predecessors.

Senior insiders expect a withdrawal from areas such as equities and investment banking, with a sharpened focus on bond trading, the one uniformly profitable area of the group's global operations.

Bankers in London warn the uncertainty could persuade Nomura's best remaining staff to defect to rivals.

Investors have welcomed the prospect that losses will be contained and Nomura's shares have gained 13 per cent since the day before the management reshuffle was announced.

If the new direction signals a slowdown of the group's international growth strategy, "that could ease some of the pressures on the group's ratings,” writes Miki Murakami-Chia, director of financial institutions at Fitch Ratings in Tokyo.

But focusing on Asia hardly guarantees that it will be able to return to sustainable profits. Nomura has been making losses there and ranked a distant 52nd among banks in investment banking fees so far this year, according to Thomson Reuters.

"Nomura is in a squeezed position. Within the industry there is more of a polarisation towards the very large players and the niche players,” says Elisabeth Rudman, European banking analyst at Moody's. "Our view is that Nomura lies somewhere in the middle, and that is a difficult place to be.”

Optimists in London believe there is a good case for maintaining a strong presence outside Japan as a source for investments that can be distributed to the bank's domestic retail customers. They will argue their case at meetings with Tokyo bosses next week.

Nagai faces the challenging task of rethinking a strategy for Nomura, which is struggling to generate sufficient revenues overseas to cover its costs but cannot rely entirely on the shrinking domestic market for future growth – one of the key reasons behind the acquisition of the Lehman assets in the first place.

Nomura's ordeal provides lessons for the many other Japanese financial institutions – such as Mitsubishi UFJ, which acquired a 20 per cent stake in Morgan Stanley, and Sumitomo Mitsui, which bought RBS Aviation – which are also navigating unfamiliar territory where long-held business practices can sometimes be an obstacle to success.

Critics are convinced Nomura has made the mistake of returning to just those kinds of practices. "By giving up on the global strategy now, they are retreating to what they know in Japan,” says one embittered executive.

"But it leaves them with no answer to the conundrum of the stagnating domestic market.”

Copyright The Financial Times Limited 2012.