Other analysts believe further cutbacks are likely as RBS implements the sharper separation between retail and investment banking mandated by U.K. regulators. Id be very surprised if head count is as high as 13,500 in three years time, says Vivek Raja, a banking analyst at Oriel Securities in London.RETRENCHMENT IS THE ORDER OF THE DAY IN THE industry as investment banks adjust to the lower revenues and more-onerous regulatory requirements that currently prevail. According to Freeman & Co., a New Yorkbased research firm, the total European investment banking fee pool fell 13 percent in the fourth quarter of 2011, to $4.2 billion, the lowest level since 2004. Globally, too, there is a sharp downturn. Goldman Sachs Group reported a 34 percent drop in revenue in its vaunted fixed-income, currencies and commodities (FICC) unit last year, and the banks return on equity fell to just 3.7 percent, the lowest level since 1999. Citigroups securities and banking division posted a loss of $163 million in the fourth quarter of 2011, compared with a profit of $212 million a year earlier, while Bank of America Corp.s global banking and markets unit had a loss of $433 million in the quarter, compared with a profit of $724 million a year earlier. JPMorgan saw a 56 percent drop in investment banking revenue in the fourth quarter. Although virtually every investment bank has announced significant job cuts in recent months, weaker players are doing much more than trimming at the margins. UBS, which received a big bailout of its own from the Swiss government following massive subprime losses, announced 1,800 job cuts at its investment bank last fall and is withdrawing from several business lines, including FICC macro trading and equity proprietary trading (see story, page 26). Frances Société Générale is cutting 1,600 investment banking jobs and has announced that it will focus on European clients and no longer seek to compete against global bulge-bracket players. Italys UniCredit pulled out of sales, trading and research in Western European equities in November, with a loss of 130 jobs. For RBS the cutbacks are all the more painful because they represent a repudiation of the banks once-towering ambitions. The bank was a latecomer to the investment banking party, gaining entrée with its daring acquisition in 2000 of much larger rival National Westminster Bank, which had a big presence in the U.S. bond market through its Greenwich Capital Markets subsidiary. Then-CEO Fred Goodwin made GBM his main growth vehicle as he sought to compete globally with Barclays Capital and HSBC Holdings. That thinking motivated his pursuit of Dutch bank ABN Amro, which ranks as the largest banking acquisition ever. The combination of corporate overreach and a global financial crisis proved disastrous. In 2008, RBS posted the largest loss in U.K. corporate history, an astounding £40.7 billion. Four fifths of that total reflected the write-down of intangible assets, mostly goodwill on the ABN Amro deal, but RBS also suffered £7.8 billion of credit losses, the bulk of it on U.S. residential-mortgage-backed securities held by the investment bank. At the time, GBM contained 54 percent of RBSs total assets of £1.6 trillion, and market concerns about potential losses in credit-trading activities undermined confidence in the bank, causing it to collapse into the arms of the state. Goodwin resigned at the end of 2008, taking a retirement package valued at more than £8 million. Public anger at the lack of any legal or regulatory sanctions prompted the government to withdraw Goodwins knighthood this January, a rare rebuke. To replace him, the board recruited Hester, a onetime investment banker at Credit Suisse, from his post as CEO of real estate company British Land. Johnny Cameron, who had led GBM through its heady growth years, resigned in October 2008 and was replaced by Hourican. Hester launched a strategic review of the bank, including GBM, and executives considered all options, including a possible sale or winding down of the investment bank. There were no sacred cows, says Hourican. We clinically looked at everything. Many in the market believed that the RBS brand had been irredeemably tainted by the banks implosion. The review identified £258 billion of bad assets and shifted them into a noncore division for eventual disposal. Fully 90 percent of those assets had been held by the investment banking arm. It was something of a surprise that GBM was retained in 2009, says Simon Adamson, a senior analyst at CreditSights, a New Yorkbased research firm. But retain it RBS did, because Hester regarded the investment banking division as critical to the banks future. It didnt hurt that the division was capable of generating substantial profits when capital markets thawed in 2009. If you look at what has been delivered since 2009, you have to be pleased with the retention strategy, says Hourican. It was a pretty good decision. GBM produced operating profits of £3.4 billion in 2010, or 45 percent of the total for RBSs core businesses. Those figures fell to £1.6 billion and 25 percent of core operating profits last year as GBM was hit by the global decline in investment banking revenue. The unit posted a £95 million loss in the fourth quarter, a dismal period for the industry that saw the investment banking arms of Bank of America, BNP Paribas, Citigroup, Crédit Agricole, Credit Suisse, Deutsche Bank, Morgan Stanley, SocGen and UBS all go into the red. An Irish national who trained as an accountant with PricewaterhouseCoopers in Dublin, Hourican joined RBS as an associate director in leveraged finance in 1997, then worked his way up the ranks to become COO of GBM. He was a popular choice among colleagues when the board offered him the top job. He had a combination of intelligence, technical capability and ready wit which, allied with the ability to get on well with people at all levels in the organization, marked him out as a likely highflier, says Jeffrey Thornton, former head of project finance, who left RBS in 2007. Houricans priority these days is to restructure and shrink his business instead of building and hiring. His careful language reflects corporate circumspection rather than any large-scale vision, and he has a limited profile outside the bank, giving few media interviews and only occasionally briefing analysts. From 2009 to 2011, Hourican cut his staff by 7,000 jobs, to roughly 17,000, and reduced the investment banks assets by nearly 60 percent, to £362 billion. As part of the banks de-risking efforts, he abandoned leveraged and project finance in 2009. Now GBM faces a fresh downsizing, which will include a withdrawal from cash equities, corporate brokerage and M&A, and reduce the payroll by 20 percent over the next three years. RBS is also restructuring the operation, creating a new markets division that consists mainly of the fixed-income, currencies and derivatives businesses, and moving the corporate lending activities of GBM into a new international banking division that Hourican will oversee. The moves effectively bring an end to any pretensions of competing across the board with Barclays Capital. As Hourican puts it, Were not trying to be the worlds premier investment bank. The executive plays down the withdrawal from equities and M&A, saying those activities have always taken second place at RBS. The bank ranked a lowly 29th in European equity capital markets revenue last year and 15th in European M&A, according to data provider Dealogic. It fared somewhat better in equity trading, finishing the year in tenth place, according to Coalition. Although RBS is dialing back, the bank has a strong position in the core fixed-income and currency businesses its retaining, even if it is seldom one of the top three players in any market. The bank came in sixth place as a book runner in European debt capital markets last year, trailing JPMorgan and Barclays Capital but finishing ahead of UBS and Citi, according to Dealogic; RBS worked on 494 deals worth a combined $92 billion. The bank ranked fifth in European syndicated loans. In the U.S., RBS ranked in the top ten in both categories; globally, it finished in tenth place by debt capital markets revenue. It finished as one of the top three players in European investment-grade debt and fourth in European securitization. In the latter market it has started 2012 strongly, lead-managing the $1.6 billion whole business securitization of U.K. holiday village operator Center Parcs. Despite all the obituaries at the beginning of 2009, our franchise has held up well, and we have the very realistic objective of being one of the top five financing houses globally, says Richard Bartlett, head of debt capital markets and corporate risk solutions in Europe. The bank arranged debt deals last year for such prominent companies as France Telecom, Johnson & Johnson, Verizon Communications and Volkswagen, and for the governments of France, Germany and the U.K. In September, RBS was the lead manager for a $5 billion offering of covered bonds by Toronto-Dominion Bank the largest such issue ever in North America. Were winning prestigious new mandates all the time, says William Fall, head of RBSs financial institutions group. The big challenge, of course, is whether the bank can continue to rack up mandates and compete effectively against bond giants Barclays Capital, Deutsche Bank and JPMorgan, even as it reduces the investment banks balance sheet and faces continuing political pressure. Seeking to fend off public complaints about banking compensation, British Prime Minister David Cameron and Chancellor of the Exchequer Osborne have insisted repeatedly that RBS should be a back marker on pay rather than a pacesetter. Hourican contends that our pay for our key staff compares reasonably well to that of other banks. But the pay controversy forced RBSs chairman, Sir Philip Hampton, to bow to public criticism last month. Pay has been too high for too long, particularly for banks, particularly in the investment banks, he told the BBC. Shareholders have done badly and employees have done pretty well in the last ten years. A key test for RBS will involve none other than Hourican himself. The executive could be entitled to a bonus of nearly £6 million in shares next month if he meets certain undisclosed performance targets. Hourican received a total of £6.2 million in compensation in 2010 and £7.7 million the year before. But many analysts doubt that the bank would maintain his pay at a similar level in todays climate. In the wake of the row over Hesters pay, RBS last month reduced the overall bonus pool in the investment bank to £390 million, down 58 percent from a year earlier, after hastily convened talks with UKFI. The bank has raised salaries over the past year, so total compensation for investment bankers fell only 26 percent. Constructing attractive packages for investment bankers is challenging for a bank that is largely state-owned and was the first institution forced to adhere to the U.K.s Remuneration Code. The code requires at least 50 percent of bonus payments to be made in the form of noncash instruments and at least 40 percent to be deferred over three to five years. The code also contains a provision to claw back pay in the event of a downturn in the banks performance. Under the code, banks are required to disclose the number of staff who earn more than £500,000 a year. RBS has said that about 150 employees globally in the investment bank fell into that category in 2010 and that they were paid an average of £1 million. By comparison, Barclays Capital had 231 such staff and paid them an average of £2.4 million, while Deutsche Bank paid its equivalent group of 168 bankers an average of £3.4 million apiece. Notwithstanding the constraints that RBS faces, the group has done surprisingly well so far in attracting and retaining investment banking talent. The bank has lost only two key bankers in sales and trading since the beginning of 2009, says Peter Nielsen, global head of markets. Steve Ashley, head of fixed-income rates trading, resigned in February 2010, and derivatives trader Gary Cottle, who was global head of corporate risk solutions sales, left in April 2011. Those businesses are doing well despite those departures, says Nielsen. Ashleys position is now split between two co-heads, Michael Lyublinsky in the U.S. and Peter Rading in London, while Cottles job has been taken by Bartlett. Other senior managers also insist that staffing has stabilized. Tim Carrington, global head of foreign exchange, says there has been so little turnover among his 400 employees that I can count on the fingers of one hand those who have left of their own volition in the 18 months since I took the job. Outsiders say RBS has been aggressive in trying to keep its critical talent. They do everything they can to hang on to their most valued senior people, offering them attractive packages a number earn £1 million or more, says Timothy Elborne, a London-based consultant at headhunting firm Webber Chase who recruits fixed-income traders. RBS has occasionally ponied up large sums to lure star performers. In 2009 the bank recruited Antonio Polverino from Bank of America Merrill Lynch to become head of institutional FICC sales. The following year the bank lured Kamlani, former European COO of UBSs investment bank, to be president of GBM. Last year RBS hired Tim Skeet, previously head of covered bond origination at Bank of America Merrill Lynch, as a debt capital markets managing director in London. Another big challenge facing Hester and Hourican is the tough new U.K. regulatory regime. The government has committed itself to implementing the recommendation of the Independent Commission on Banking that big banks separate their investment banking activities from their retail and commercial banking operations. Although the exact details and timing of the change have yet to be determined RBS says the consequences might not become clear for several years bankers are bracing for a significant rise in the cost of doing business. Assuming the ring fencing plan is enforced, most likely beginning around 2015, RBSs investment banking division would have to fund itself through the wholesale finance markets and meet Basel III liquidity requirements without the help of its parents ratings and retail deposits. The position of the RBS group looked healthy at the end of 2011, with a core tier-1 capital ratio of 10.6 percent and a buffer of £155 billion worth of safe, liquid securities that could be sold in a crisis. GBM carries riskier and more volatile assets than RBSs retail and commercial divisions, so its credit rating would be lower and its funding spreads would be higher. The extra cost of those spreads or of getting sufficient additional equity capital to prevent a rating downgrade would be about £1.2 billion a year, according to the banking commissions September report. The commission based its estimates on a median of the figures calculated by sell-side equity analysts and the bank itself. RBS estimates the cost at anywhere between £800 million and £1.5 billion a year. Rivals will face a similar rise in operating costs. HSBC estimates that the separation of retail and investment banking will raise its costs by between £300 million and £900 million a year, while Barclays Capital pegs its tab at between £900 million and £1.4 billion. Thats hardly chump change, but both institutions are in a stronger position than RBS. Barclays Capital is bigger and more able to absorb the costs, and it can also afford to be a little less risk-averse and a little more creative in what it does with corporate deposits, says Ian Gordon, a banking analyst at Investec Securities in London. HSBC, meanwhile, is much less dependent on investment banking, and it has the option of redomiciling to avoid the regulation. At a time when most banks face funding difficulties because of the euro zones sovereign debt crisis, raising money through the wholesale markets looks to be a forbidding prospect. As Hester told Parliaments Treasury Committee in November, banks are seen as a dumb investment now. Hourican and Kamlani decline to speculate on the costs of ring fencing but say the whole industry faces problems. Given all the regulatory changes affecting the industry, and renewed macroeconomic pressures, return on equity within investment banking will be challenged for some time to come, says Kamlani. Some senior investment bankers privately say that the industry in Europe could struggle to achieve double-digit returns on equity over the next two years at least. GBMs return slipped to 7.7 percent last year from 16.6 percent in 2010. The current difficult revenue environment does not allow RBS to generate anything like a decent return in its investment bank, James Invine and Philip Richards, banking analysts at Société Générale, said in a recent note to clients. Most analysts, such as Keefe, Bruyette & Woodss Mark Phin and Investecs Gordon, forecast returns in single digits this year and next, before a rise to 10 percent in 2014.
If the revenue environment were all RBS had to deal with, it might have had a stronger outlook for its investment banking operations. Investment banks routinely expand and contract with the markets. But under attack as it is from regulators and politicians, and weighed down with a troubled recent history, RBS will have to shrink further and look back at 200911 as its halcyon days, never to be repeated.