Questions Linger over Nomura's Lehman Acquisition

A press conference with CEO Watanabe fails to allay doubts about how Nomura will squeeze profits out of its acquisition of Lehman Brothers

By Dan Slater

At the end of a 90-minute press conference at the Tokyo Foreign Correspondents' Club on Wednesday, it was still not clear how Nomura plans to squeeze synergies and profits out of its acquisition of former powerhouse brokerage Lehman Brothers. Lehman was taken over by Nomura in late September in a deal which Nomura CEO and president Kenichi Watanabe described as "the opportunity of a lifetime".

However, journalists were left scratching their heads as Watanabe persistently evaded the questions lobbed at him by reporters. These questions referred to the morale-sapping fact that Japanese bankers will be getting paid less than foreign bankers; that a core Lehman client base, namely hedge funds, is under enormous stress; that Nomura is under financial pressure; and many others. But whether it was the Nomura interpreter fluffing his lines, or the chairman refusing to answer directly, the upshot to all the questions was the same: a lack of quality information.

One member of the club, a distinguished writer and long-term observer of Japan, said that any Western investment banker present would not have been motivated to work for an organisation which insisted on being so vague and non-communicative. "It is the first time a Nomura president has spoken to the Foreign Correspondents Club in Japan in over 10 years, but it was like a flashback to the way Japanese companies interacted with the press 30 years ago," he said. "It should have been the showcase of a transparent and articulate strategy, but it was the opposite."

This hits the nail on the head, because the problem is that the takeover of Lehman does not make sense in some fundamental ways. How can Nomura buy an investment bank and expect that model to be profitable, when the model appears broken? The bones of Merrill Lynch, Lehman Brothers and Bear Stearns litter the financial desert. Morgan Stanley and Goldman Sachs are facing tremendous share price pressure even after converting to bank holding companies. That would seem to indicate that the model has been discredited.

It was a model that thrived on cheap debt and rising asset prices. But it was destroyed by a characteristic common to investors in rising markets: the temptation to hold on to assets to make capital gains. So despite all the fancy tricks for moving risk off the balance sheet, such as securitisations, many investment banks moved further and further away from their agency role and piled risk on to their books. They combined the underwriting and arranging of financial instruments with investments in the same instruments, including collateralised debt obligations (CDOs) and commercial mortgage-backed securities (CMBSs).

Clearly, cheap debt and rising asset prices are no longer with us, at least for the time being. Liquidity has been created by the numerous interventions of the Federal Reserve Board, but investor sentiment has turned risk averse, and stockmarkets around the world are down, often more than 50% from their peaks. Many banks that were players in the game of 'raising debt and pushing up asset prices' have become nationalised. It's unlikely their new owners will allow them to be as blasé with risking other people's money as they were in the past.

The idea that Nomura will use Lehman to continue to invest directly into assets, and juice the returns through leverage, therefore seems highly unlikely. But if that's not likely to happen, why pay guaranteed bonuses to the top 500 Lehman staff in Asia for two years? Other staff have also been promised one-year bonuses. What are these employees supposed to do? In Japan, for example, Lehman has amassed a considerable real estate portfolio and was an active player in the CMBS market. Now the CMBS market is dead and real estate prices are beginning to go down.

The fact that bonuses have been guaranteed at the level of 2007 also sends out the wrong messages. The bonus culture was one of the problems which undermined investment banking, for reasons we are familiar with by now. It encouraged bankers to take high risk without considering the long-term consequences.