Hugo Dixon

By Hugo Dixon and Peter Thal Larsen

Deutsche Bank is killing two birds with one cash call. The official reason for the planned 8-9 billion euro ($10-11 billion) rights issue will be to complete the acquisition of Postbank, the German retail bank. But the fundraising also provides cover for jumping to the front of the queue of German banks that will need to top up their capital as a result of upcoming tighter regulation.

Deutsche was proud of the fact that it was one of few major western banks to avoid a big capital call during the financial crisis. And since then, the bank has argued that it would not raise capital, except to finance acquisitions.
But Josef Ackermann, Deutsche’s chief executive, still cannot crow. The Postbank acquisition was a bad one, at least financially. Bulking up in German retail banking may make sense strategically as it will help reduce Deutsche’s reliance on its investment bank. But Ackermann agreed on a high price for a 62 percent stake in the bank just before Lehman Brothers went bust in September 2008.

What’s more, that multi-stage transaction carried extra liabilities. Deutsche was always going to have to make an offer for the rest of Postbank no later than 2012. The good news is that by moving now, it will be allowed under German takeover rules to offer a rather low price. But that still involves doling out cash. Second, Postbank itself is undercapitalised — just squeaking in above the European Union’s stress test levels in July. So Deutsche will need to fill up its new subsidiary’s coffers too.

Not that Deutsche itself is awash with capital, either. Its core Tier 1 ratio of capital to assets at the end of June was just 7.5 percent, perilously close to the minimum regulators are likely to agree this weekend, and lower than the likes of Credit Suisse and Goldman Sachs. So raising extra cash is helpful here too.

If Deutsche’s spin on its capital-raising will need deconstruction, its tactics can’t be faulted. Assuming the new Basel III global bank capital rules are forthcoming this weekend, they are likely to require other German banks to raise cash. Getting out in front of the pack makes good sense.

LONDON, Aug 3 (Reuters) – Lloyds Banking Group (LLOY.L: Quote, Profile, Research, Stock Buzz) has
started formal succession planning for its chief executive Eric
Daniels although no date has been set for his departure, a
person familiar with the situation has told Reuters
Breakingviews.

The process is a contingency planning exercise to identify
successors to Daniels in the event that he stands down, and the
board is not actively recruiting a new CEO.

Lloyds has retained a headhunter and held discussions at
board level, which have included Daniels and the head of human
resources. The aim is to complete the plan by the end of this
year.

Daniels, 58, has been heavily criticised over the bank’s
acquisition of HBOS, the UK mortgage lender, shortly after
Lehman Brothers went bankrupt in September 2008.

That deal led to the resignation of Victor Blank, the
chairman, amid pressure from shareholders including UKFI, the
government body which owns 41 percent of Lloyds.

However, Daniels has been unapologetic about the HBOS
acquisition and is expected to use Lloyds’ first-half results on
Aug. 4 to argue that the deal is on track to deliver value for
shareholders.
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For a Reuters Breakingviews column, click on [ID:nLDE6720MI]
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Lloyds is expected to post pre-tax profit before
exceptionals of 772 million pounds, according to Reuters
consensus estimates, compared with a pre-tax, pre-exceptional
loss of 4 billion pounds in the first half of last year.

Winfried Bischoff, who took over as Lloyds’ chairman from
Blank last year, has told a number of shareholders that the bank
is involved in a succession planning process.

Both the board and UKFI believe that Daniels is doing a good
job integrating Lloyds and HBOS and is the right person to run
the bank at present, according to people familiar with their
thinking.

However, there has been less unanimity that Daniels is the
right person for the long run.

Earlier this year, Bischoff sounded out Mervyn Davies,
former chairman of Standard Chartered, on whether he might be
interested in becoming Lloyds’ CEO. Davies, who at was a
government minister the time, said he was not.

Other potential successors include: Sandy Flockhart,
chairman of HSBC’s personal, commercial banking and insurance
businesses; Naguib Kheraj, former CEO of JPMorgan Cazenove and
former finance director of Barclays; and Antonio Horta-Osorio,
chief executive of Santander’s UK business.

Officials at Lloyds could not be immediately reached to
comment.
(Editing by David Cowell)

Is Goldman Sachs rebasing compensation at a lower level? For the second quarter in a row the investment bank’s compensation ratio has been only 43 percent. In the past, Goldman paid out around 50 percent of revenue to staff. For ordinary mortals, the numbers are still staggering: on an annualised basis, $545,000 is being set aside for each of the firm’s employees. But it does look like Goldman may finally be listening to its critics.

At the end of what was a blow-out first quarter, it was unclear how to interpret Goldman’s relative parsimony. The bumper results meant Goldman could still accrue huge sums for employees despite the lower-than-normal percentage rate. One senior executive said then that it would be reasonable to increase the accrual ratio only if trading in subsequent quarters was poor. Well, the second quarter was rotten. But the ratio didn’t budge.

Part of the explanation seems to be that Goldman has understood how past greed contributed to its recent public relations disaster. It would have been insensitive to jack up the accrual rate just days after paying a $550 million fine in connection with Abacus, a dodgy structured product it sold investors in the boom. Goldman’s failure to show restraint on pay this time last year helped sow the seeds of the backlash inflicted on the industry at the end of 2009 — leading to a UK bank bonus tax which is now costing the firm $600 million.

Sceptics will argue that Goldman will revert to type as soon as politicians take their eyes off the ball. There will certainly be a strong tendency to do so. But new regulations are being introduced around the world which will hardwire more restrained compensation practices: cash bonuses will be smaller and traders will have to repay bonuses when the profits behind them prove unsustainable. Beyond that, it will be down to shareholders to lock in lower pay — with the flipside of higher earnings and dividends.

By Hugo Dixon and George Hay

What’s a bonus really worth? Under new European rules, bankers will see part of their bonuses retained, another chunk deferred and some may also be clawed back. The present value of a $1 million bonus could be cut to less than $800,000, according to Reuters Breakingviews calculations.

The starting point is how much the banker gets immediately in cash. The new rules specify that 40-60 percent of the bonus must be deferred for three to five years and at least half of the non-deferred portion must be non-cash. That means there’s a maximum of 30 percent upfront cash. But for bankers on big bonuses — and $1 million would presumably be in that category — at least 60 percent must be deferred. The cap on upfront cash, therefore, is 20 percent, or $200,000.

The next step is to see how much cash the banker will get in future. For our big swinging dick, the deferred bonus is $600,000, of which as much as half, $300,000, can be paid in cash. This sum, though, has to be discounted to reflect the risk of a clawback for bad performance and the delay in receiving it. Assume there’s a 5 percent risk of clawback each year and take a 4 percent discount rate for the time value of money. Over a four-year period, that shrinks the banker’s $300,000 to $213,000.

Now look at the non-cash half of the bonus. The immediate portion, $200,000, will be paid in the form of contingent capital — a debt-like instrument that converts into equity in a crisis — which cannot be cashed in for an unspecified period. The deferred $300,000 is likely to come in the form of common shares.

Bankers are unlikely to find either form of non-cash terribly appealing. Not only is there the risk of loss; its value is much less certain than cash. Assume therefore that two discounts, each of 5 percent a year, are applied. If the contingent capital has to be held for two years, it is worth only $165,000. The shares, which are deferred for four years, have a present value of $205,000.

Tot it all up and the banker’s bonus has miraculously shrunk to only $783,000. Most ordinary people will still think that’s a lot. But bankers will undoubtedly feel hard done by.

EUROPEAN BANK BONUS CALCULATOR:

Pop in your expected headline bonus here, make some assumptions about how much will be non-cash, what proportion will be deferred and various discount rates. Our calculator works out the bonus’ real value to you.

– Hugo Dixon is a Reuters Breakingviews columnist. The opinions expressed are his own –

The new UK coalition deserves 7 out of 10. The pact between the Conservative and Liberal Democrat parties, led by David Cameron as the new prime minister, seems determined to address the country’s most important problem — the deficit. This is vital given that the euro zone debt crisis could still prove contagious. It should also be positive for sterling.

Some good ideas are also emerging on tax and spending. But other plans for tax and banks look odd — and there are doubts about whether these bedfellows will be able to work together. After all, Britain has not had a coalition government since World War Two.

Some will be disappointed that George Osborne, who has not been impressive as the Tories’ finance spokesman, will be Chancellor of the Exchequer. But the overall policy stance looks promising. The new government clearly sees dealing with the mess in the public finances as its top priority. The LibDems, led by Nick Clegg, have signed up to Cameron’s plan to find 6 billion pounds in efficiency savings in the current financial year.

This is, of course, only a pin prick given that the deficit is expected to top 160 billion pounds, or 11 percent of GDP. But it is reinforced by several other measures: an as-yet vague promise to significantly accelerate action on borrowing; an emergency budget within 50 days; and plans to involve both the Bank of England and a new Office of Budget Responsibility in vetting budget plans. Asking a bunch of technocrats for advice could give the new government the necessary alibi to implement more savage cuts than the Tories indicated during the election campaign.

The specifics on tax — insofar as they have been revealed — are more mixed. On the positive side, there will be a move to equalise capital gains and income tax rates. That will both raise cash and prevent the tax arbitrage encouraged by the current system. The Tories have also downgraded a promise to increase inheritance tax thresholds.

Unfortunately, there are also several expensive tax promises. In the horse-trading over the coalition, the LibDems have won backing for their plan to raise the income tax threshold to 10,000 pounds. Meanwhile, the Tories are sticking to their plan to scrap the former government’s decision to raise employers’ national income contributions (NIC). The best thing that can be said about these plans is that the former will be phased in while the Tories are at least keeping the planned NIC increase for workers.

Nobody likes tax. But the country simply cannot afford tax cuts at present. And though the coalition has rightly agreed that the bulk of future fiscal adjustments will come from spending cuts rather than tax rises, these particular tax cuts will mean that other taxes — probably Value Added Tax — will have to rise.

Banks will be worried that Vince Cable, the LibDem treasury spokesman who has been particularly vocal in his attacks on the City of London, seems likely to be given responsibility for financial services. Some of his more extreme ideas, such as capping cash bonuses at 2,500 pounds, may not survive. But there will be a commission to look into structural changes in the industry, including separating retail banks from “casino-style” investment banks. The hope must be that the commission will realise that the City could be badly hurt if these ideas were pursued without international agreement.

Unfortunately, it looks like the government will move ahead unilaterally with a levy on bank liabilities. The idea of imposing such a tax multilaterally is an excellent one — and there is quite a good chance that other countries will do it. But this is not certain. If others demur, a go-it-alone tax would damage the UK’s most important industry.

On the positive side, the coalition does seem to have provided an excuse for the Tories to abandon their bad idea of breaking up the Financial Services Authority and giving its powers over banking regulation to the BoE. Instead, there is what looks like a sensible plan to give the BoE responsibility for “macro-prudential” regulation — essentially the business of spotting and preventing bubbles — while leaving the FSA in day-to-day charge of regulating individual banks, albeit under some sort of BoE oversight.

Of course, the biggest uncertainty is whether the new government can hang together. The Conservatives and LibDems have committed themselves to a fixed parliament. If they fall out, the next five years could be messy. Investors will have to hope that the grown-up behaviour displayed in the past few days continues.

– Hugo Dixon is a Reuters Breakingviews columnist. The opinions expressed are his own –

Gordon Brown may go down in history as the flawed saviour of the global financial system. Brown had many faults including overseeing a public spending splurge in his decade as the nation’s finance minister. But he did make one big contribution. He galvanised other leaders to save the bank system during the post-Lehman <LEHMQ.PK> meltdown.

Brown, along with Tony Blair, was the main architect of New Labour — an initiative that dragged the former socialist party away from the fringes and towards the centre-left of the political spectrum. After New Labour took power in 1997, Brown devoted himself to the economy. His main achievement as finance minister was to give independence to the Bank of England. That depoliticised monetary policy.

Unfortunately, Brown didn’t have nearly as responsible an approach to fiscal policy. Despite telling the country in numerous budgets that he was pursuing “prudence with a purpose”, he actually allowed state spending to balloon — with the result that, when the credit crunch hit, Britain’s finances were not as strong as they should have been.

After Brown became prime minister, he dithered when depositors started a run on Northern Rock. That said, after Lehman went bust in September 2008 and the banking industry faced Armageddon, Brown was fast to move. Washington failed initially to provide leadership, largely because George Bush was a lame duck president who didn’t appear to on top of the issues. Meanwhile, Germany’s Angela Merkel was slow to recognise that there was a problem. Brown, by contrast, understood the issues and was able to persuade other leaders to put together well-crafted bank rescues.

Brown also helped persuade his fellow leaders in the G20 to engage in coordinated fiscal stimulus. Although this helped avoid the recession becoming as deep as it might have, it also landed governments with bigger fiscal deficits — something that has contributed to the sovereign debt crisis now roiling markets. Yet again, Brown allowed his achievements on financial and monetary policy to be neutralised by his failings on the fiscal front.

– Hugo Dixon is a Reuters Breakingviews columnist. The opinions expressed are his own –

Breaking up the banks is no silver bullet. Politicians on both sides of the Atlantic — including two of the party leaders fighting the UK election — want to separate so-called casino investment banks from utility lenders. But such simple rules would create arbitrage opportunities and rigidities without curbing excess risk-taking.

In the last of the UK’s election debates, the Liberal Democrat and Conservative leaders vied with one another to see who could be tougher on banks. As a soundbite, the notion that nasty, risky investment banking should be split from nice, safe retail banking may well be a winner. Gordon Brown, the Labour leader who has a more nuanced position, was left looking like a defender of big banks.

The politics are similar in the United States, where the Obama administration has proposed the so-called Volcker rule, which would prevent banks from engaging in proprietary trading. Some version of this rule may yet emerge in the financial regulation bill now going through Congress.

But these initiatives ignore the fact that excess risk-taking was a feature of all types of financial institutions during the credit bubble. Utility lenders — such as the UK’s Northern Rock or Washington Mutual of the United States — bit the dust. So did casinos like Lehman Brothers.

Politicians also risk missing the main target. Take the Volcker rule. It wouldn’t do anything to curb “non-proprietary” trading, where banks trade but not on their own account. What’s more, as soon as the regulators define proprietary trading, banks will find ways of doing the same business under a different nomenclature.

The other problem with structural separation is that it would create rigidities. This is most obvious in the type of “narrow banking” proposed by John Kay, the British economist. Under his scheme, deposit-taking institutions would only be allowed to invest in government securities. While this might appeal to governments that need to fund their deficits, it could gum up the flow of savings to industry — and it won’t give savers a good deal either.

Once the political grandstanding is over, these ideas will hopefully fade into the background. Politicians and regulators should then focus on combating risk-taking across the board by jacking up the capital banks have to hold against all types of risky positions.

Why do markets still pay attention to what rating agencies have to say? Following their appalling record predicting the subprime mortgage crisis, it is astonishing and sad that investors still seem to quake when Standard & Poor’s junks Greece and downgrades Spain.

An arriving Martian would find it hard to understand why anybody gives any credence at all to S&P and its rivals Moody’s or Fitch. It’s not just that they were pumping up the U.S. subprime market — for example giving a triple-A rating to Abacus, Goldman Sachs’ now-notorious synthetic collateralised debt obligation — after smart investors saw trouble in the market.

They were late in spotting the wave of corporate debt defaults, including Enron’s, in the early part of the century. And they have been dilatory in calling attention to the current euro zone sovereign debt crisis. Even after S&P’s downgrade of Spain, Moody’s and Fitch, the other big agency, are still rating the country’s debt at triple-A. Ratings agencies are consistently behind the curve.

So why do they still wield influence? There are at least two reasons. One is because they are embedded in the way markets operate. Some investors, for example, are only allowed to buy investment-grade securities. That means they have to sell securities when they are junked. Similarly, ratings are used in determining the riskiness of a bank’s balance sheet and how much capital it needs to set aside.

Ratings are also common in deciding how big a haircut is required when banks and investors pledge collateral. One saving grace in the euro zone crisis is that the European Central Bank has stopped saying that only the highest rated sovereign debt can be pledged as collateral. But ratings are still far too entrenched.

The other reason why markets pay attention when the agencies bark is what could be called the “megaphone” effect. S&P and Moody’s may not be the smartest observers in the market; but they do make a big noise. It’s a bit like shouting fire in a crowded cinema. The agencies aren’t the first to spot the problem; but they sure help create a panic.

It is high time regulators and investors dethroned them from their privileged status.

LONDON/TURIN, Italy (Reuters) – Italian industrial group Fiat SpA <FIA.MI> will spin off its auto business under a new strategic plan, a source said on Tuesday, and shares surged almost 9 percent on the possibility of a demerger.

Analysts said a spin-off would give the Italian carmaker more flexibility to join the consolidation drive in a sector emerging from the worst downturn in decades.

FiatLuca Cordero di Montezemolo also said he would resign after six years as chairman of Europe’s fifth-biggest car maker. The announcement came a day ahead of Fiat’s strategy presentation, its first since teaming up with U.S. car maker Chrysler.

Fiat’s board will vote on making Vice Chairman John Elkann, the grandson of Fiat patriarch Gianni Agnelli, chairman on Wednesday morning, Chief Executive Sergio Marchionne told a hastily-called news conference. Elkann has long been seen as Montezemolo’s successor.

A person familiar with Fiat’s thinking said the company was planning to split off its automotive arm as part of the restructuring.

Fiat, Italy’s biggest industrial group, also will set out plans for the two demerged companies until 2014, said the source, who spoke on condition of anonymity.

Marchionne, respected in the struggling auto industry for his turnaround of Fiat, has said a spin-off will be touched on at the strategy presentation.

THREE-MONTH HIGH

Fiat shares were up 8.86 percent at 10.38 euros at 1549 GMT and hit a three-month high of 10.45 euros before paring gains. The STOXX Europe 600 auto sector index <.SXAP> was up 5.38 percent, driven by positive results from Germany’s Daimler AG <DAIGn.DE>.

A Milan fund manager said Fiat’s shares were boosted by market speculation the company would announce the spin-off on Wednesday.

“A big hedge fund was buying Fiat all day yesterday and that has helped boost speculation about the spin-off,” he said.

A trader said speculation that Ferrari could be included in the spin-off was also helping the shares.

Industry Minister Claudio Scajola said he had spoken to Marchionne about the plan. The center-right government will support it and “unions will do their part” to improve productivity, he said in a statement.

Although best known for its autos, Fiat’s holdings include farm equipment maker CNH Global NV <CNH.N>, the Iveco truck unit and Turin newspaper La Stampa.

Montezemolo said he was resigning since his task as chairman was finished and the move was unrelated to the possible spin-off. [ID:nWEB0835] He will stay on as a Fiat board member and chairman of Ferrari, Fiat’s luxury sports brand.

Montezemolo, one of Italy’s best-known business figures and the former head of business lobby Confindustria, denied speculation he would enter politics.

(Additional reporting by Stefano Rebaudo, Nigel Tutt, Ian Simpson and Stephen Jewkes; Writing by Ian Simpson; Editing by David Cowell)

By Hugo Dixon and Richard Beales

Were the investors who lost $1 billion by buying a fearfully complex product sold by Goldman Sachs in the dying days of the credit boom fools or victims? That’s the key distinction on which the U.S. Securities and Exchange Commission’s fraud charges, which roiled the investment bank when they were unveiled on Friday, hinge.

Back in 2007, Goldman sold investors a $1 billion synthetic collateralised debt obligation (CDO). A CDO is a pool of securities, in this case 90 subprime residential mortgage backed securities. A synthetic CDO is based on a pool of derivatives that reference securities rather than the securities themselves.

The SEC’s key allegation is that Goldman marketed this synthetic CDO to investors without telling them that Paulson & Co, the hedge fund, had been involved in selecting the securities that were subject to the bet. What’s more, it didn’t tell investors — or ACA, an independent firm that officially selected the underlying securities — that Paulson was simultaneously placing bets with Goldman that these securities would fall in value.

Goldman’s defence has four elements. First, that it lost $90 million on the transaction. This shows, it says, that “we did not structure a portfolio that was designed to lose money”.

However, the firm has not said how it lost the $90 million. Did it intend to retain a long position or did it just get stuck with it? The answer to the question is crucial in judging the defense. The SEC has produced an email from Fabrice Tourre, the Goldman vice-president who handled the deal, in which the self-christened “fabulous Fab”, said: “The whole building is about to collapse anytime now”. This, at least, suggests that Goldman wasn’t gung-ho about the market. But on the other hand, the fact that the firm went long at all does undermine suggestions it knew the CDO would lose money.

Goldman’s second line of defence is that “extensive disclosure was provided”. It points out that these investors also understood that a “synthetic CDO transaction necessarily included both a long and short side”. The suggestion is that these were big boys who should have done their own homework.

But the SEC alleges a key fact – that Paulson was both betting against the CDO and heavily involved in selecting the underlying securities – was omitted.

This is where Goldman’s third defence kicks in. It admits that Paulson was involved in discussions about the selection but says this was “entirely typical of these types of transactions”. What’s more, ACA – as well as selecting the securities – was exposed to the transaction to the tune of $951 million. As such, according to Goldman, it had an “obligation and every incentive to select appropriate securities.” Paulson, which has not been charged, also says ACA had authority over the selection.

But again there are counterpoints. For a start, Paulson’s involvement, according the SEC, was pretty intimate. In one email, the Fabulous Fab said the portfolio had been “selected by ACA/Paulson”. In another, he says “I am at this ACA Paulson meeting, this is surreal” – a comment that raises the possibility that this type of meeting wasn’t typical.

The SEC also says Goldman knew that a key investor IKB, a bank which ultimately had to be rescued by the German state, would not invest in synthetic CDOs unless there was an independent agent selecting the underlying securities.

The regulator further alleges that ACA believed that Paulson was going to be a long investor in the synthetic CDO. As such, ACA arguably did not mind when Paulson helped it select the underlying securities.

This is where Goldman’s final line of defence — so far — comes in. It says it “never represented to ACA that Paulson was going to be a long investor”. The SEC, however, puts a different gloss on things. It has dug up an email from ACA to Goldman which makes clear that it believed Paulson was going long. The SEC says the Fabulous Fab knew or was reckless in not knowing that ACA had been misled about the matter.

Goldman’s defenders reckon the timing of the charges was motivated more by political considerations than the completeness of the SEC’s case. Be that as it may, the SEC and Goldman are now set to fight this out in court. But even if the charges don’t stick, they will be expensive in terms of time, money and reputation for the investment bank.