Two London Banks, Similar Situation But Seeking Two Opposite Solutions

Executive pay tightened; employee fired after weak earnings performance

The first day of August this year came with a rude shock for 3000 Barclays investment Bank employees, whose jobs would be on the line during the third quarter of 2019. This follows the Bank's announcement to terminate their employment in an attempt to cut costs amidst a sequentially bad second-quarter earnings performance. Earlier the Bank had announced tightening of compensation for top executives and traders and to bring them in line with their individual contribution and achievements compared to that of the Bank's overall profitability and performance. The move had come after poor earnings performance by the Bank in the first quarter of 2019.

The Bank's performance is nowhere close to what it was a year ago. Last year it had shelled out £2 billion towards a settlement with the US Department of Justice over the vintage era mortgage-backed securities issue pertaining to the 2008-11 financial crisis period. The company on 1st August 2019 also came out with its first-half 2109 results (H1 2109) of the financial year 2019. Revenues for the period were £10.79 billion, which is marginally lower than £10.934 billion for the same reporting period last year (H1 2018). Total operating expenses were, however, significantly lower at £6.872 billion (H12019) compared to £8.716 billion (H1 2018). The Bank's EPS for H1 2019 was 12.1 pence whereas for H1 2018 it was 3.3 pence and the Bank declared a dividend of 3.0 pence per share (H1 2019) whereas it had paid 2.5 pence as a dividend for the same period last year (H1 2018).

The above-mentioned settlement of £2 billion was a one-time expenditure and without it the company's operating expenditure would have been £6.716 billion, and profits would have been £2.561 billion (actual profits for H1 2018 was £ 561 million). Compared with H1 2019 profits of £2.072 billion, it is a decline of 23%. Clearly, the Bank has not performed well for the just completed half-year.

The Bank has drawn a lot of flak from investors lately for its performance over the prior year. Jes Stanley, the Chief executive officer of the Bank, has been fighting a pitched battle with strategic investors who want the investment banking division of the Bank to be scaled down. In the Annual General Meeting of the company concluded on 2 May 2019, he gained the upper hand over the shareholders to back his efforts and bring the bank back to profitability. Edward Bramson of Sherborne Investors (Sherborne Investors Management LP owns 5.5% of Barclays’ equity) had staked claim for a board seat at the Bank in order to scale down its investment banking division to bring it back to green. Jes Stanley however was in no mood of a scale back and pressed for his plan for cost-cutting along with other performance improvement measures, which were implemented meticulously to tide over this rough patch. The Bank's other divisions; consumer banking and business banking are however performing well.

The Bank has been through a restructuring exercise; lately, it had taken over the bankrupt business of erstwhile Lehman brothers during the 2008-11 financial crisis and had to deal with many issues relating to the crisis period and events immediately following it. It had initiated a significant fund-raising exercise post the event from the Qatari investment authority which later became the reason of several investigations by regulatory authorities due to questionable acquisitions made by the Bank. High litigation costs were borne by the Bank to tackle several lawsuits.

The general business environment for the investment banking sector in Europe has not been conducive lately. Almost all businesses in this space are struggling and providing for even tougher times ahead. The impending impact of Brexit is envisaged to hit the investment banking sector the hardest. With the general mood across the Eurozone remaining gloomy, economies in this region might be in for a period of recession. The suggestion forwarded thus by many was to scale back investment banking businesses in Eurozone till better conditions prevail. The Bank, however, on its part, will be resorting to a broad set of austerity measures and strictly disciplined operations and continue working in this difficult environment rather than scale business back. The Bank as a precautionary measure had also borrowed £6 billion from the Bank of England between April and June 2017 to deal with the eventualities after Brexit. The credit facility extended to the Bank is part of the pre-referendum stimulus package announced by the Bank of England in August 2016 to British banks in the run-up to Brexit.

Winds of Change at HSBC

HSBC Holdings Plc parted ways with its Group CEO, John Flint, with the latter holding fort only for eighteen months. The banks' chairman Mark Tucker while commenting on the development said that a change was necessitated to deal with the future challenges and new opportunities for the Bank. John Flint had a 30-year illustrious career at the Bank, starting out as its international officer overseeing the banks growth across Asia, later becoming chief of staff to the Group CEO in 2012, and finally being elevated to CEO designate of HSBC in October 2017. He took up the position on 21 February 2018 and held it for 18 months before this sudden departure was announced. Noel Quinn, the chief executive officer of global commercial banking division of the Bank, has been named as the interim CEO till a suitable replacement is found.

HSBC has a history of elevating people within its ranks to higher positions, with the last five CEOs having spent at least twenty years in different positions before being elevated to the coveted position. However, it is now being felt by the Bank that a different work culture is required at the helm in order to transform the Bank to deal with the changing business environment. The Bank also simultaneously made the announcement that it will cut at least 2 per cent of its workforce, which works out to about 4700 people from its 237,685-member strong work force. The majority of them, however, will be from the senior staff, which will help the Bank to save up to 4 per cent in salary-related expenditure.

The company also came out with its first half-year results on the same day that it announced the departure of its CEO. For the half-year ending 30 June 2019 revenues were £29.372 billion against £27.287 billion for the corresponding previous half-year period ending 30 June 2018. The Company’s profit after tax was £9.937 billion for half-year ending 30 June 2019 whereas it was £8.416 billion for the half-year period ending 30 June 2018. EPS of the Bank stood at 0.42 pence per share for the half-year ending 30 June 2019 growing from 0.36 pence per share for the half-year period ending 30 June 2018. The net interest margin was however lower at 1.61 per cent during the half-year period 30 June 2019, while it was 1.66 per cent for the half-year period ending 30 June 2018.

Despite the strong revenue performance, the company has issued a weaker guidance. As per the prevailing outlook for interest rates and revenue constraints in certain segments, it may not achieve 6 percent RoTE target in the US by 2020. It is to be noted here that for the last year (ended 31 December 2018) the company had achieved a ROTE close to 11 per cent. The company's guidance, thus, can be termed as worrying.

Given the scenario, some investors are finding it difficult to understand the timing of this executive exit. However, banks’ chairman Mark Tucker and the rest of the board in their wisdom, considering that this is perhaps the right time to bring in wholesale changes to the Bank, in the way it functions. John Flint in a way represented the rigid orthodox style of functioning being handed down by generations of executives to their successors, and perhaps the board feels that a transformation can be best-engineered with a fresh face from outside with new ideas, new culture and new work ethics. The whole banking space today is faced with disruptive changes call it technological, regulatory or challenges posed by the general business environment. Most of the other banks are also feeling the effect of these changes, with Deutsche Bank AG cutting down as many as 18,000 positions and Société Générale cutting down nearly 1600 jobs across the hierarchy.

The general business environment in Europe and North America has become particularly challenging partly due to Brexit and partly due to the impending trade war situation between China and the USA. The uncertainties of the medium to long term economic environment is forcing multinational banks to adopt new and unconventional strategies to continue to grow and create value.