Questions Linger over Nomura's Lehman Acquisition

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With the CEO at Goldman Sachs setting a welcome precedent by not taking a bonus this year, Nomura should have taken the opportunity to revamp the incentive structure, instead of sending the message that it's 'business as usual'.

Nomura has traditionally combined the roles of retail broker and advisor to Japanese blue-chips. In other words, the firm has had a clear agency bias, rather than a principal bias. It was the principal bias of many US investment firms which created the losses, since they were sitting on dud real investments worth billions of dollars when the markets started falling. A traditional agency broker would have been immune, since such a firm would be satisfied with the straight commission business. Yet, just as the rest of the industry is turning risk averse, Nomura is getting into the high-risk business.

In addition, Nomura appears to have made its move at a time when both the agency business and the principal business are in trouble. The problems of the principal business have been discussed above, but the agency business is also in a bad state. According to data firm Dealogic, equity issuance in Japan halved in 2007 from the record levels of 2006, and have halved again year-to-date. The issuance of Samurai bonds, which prospered before the current crisis because of the huge pools of liquidity in Japan, shut down after the bankruptcy of Lehman Brothers, a frequent issuer, and difficulties faced by other global banks, including a clutch of Icelandic issuers (such as Kaupthing Bank) and several US commercial and investment banks. Samurai bond investors, notorious for preferring the 'branded' blue-chips like Goldman and Citi, have received an unpleasant shock.

There was one 'jewel' in Lehman's operations, but Nomura has failed to get it. This was the electronics trading team, which has decamped to Mizuho. Electronic trading is growing faster in Japan than any other country in Asia, accelerated by the growth of exchanges set up by the investment banks. This permits them to trade with each other and with their clients, while avoiding the high fees and old technology of the Tokyo Stock Exchange.

Nomura has an additional weakness. It is the last independent investment bank without links to a commercial bank. Nomura maintains the top position in Japanese M&A despite that. But domestic firms which are interested in acquiring foreign assets in a downturn may eventually want their investment bank to provide the financing as well. This has become increasingly common in markets outside Japan.

The final issue is how much longer Nomura can bleed as it beds down its takeover of Lehman. Nomura's finances are in a weakened state. A Credit Suisse report dated October 28 states that "if conditions continue as they are, we believe the company's full-year losses could balloon to ¥500 billion ($5.1 billion) or more". The report states that Nomura's pre-tax second quarter losses were "greater than anticipated at ¥69.3 billion". Contributing to full-year losses are Nomura's $425 million position in Icelandic banks and the unrealised valuation loss of $460 million in Fortress Investment Group.

Although positive about the takeover of Lehman in the long term, Credit Suisse states that it expects "succession costs at Lehman Brothers of around $2 billion...in the current environment we believe it will be very difficult to turn Lehman into the black". The bank concluded with an interesting observation, namely that Nomura "did not provide sufficient detail about actual expense levels and measures being taken to turn the company into the black in future". The journalists at the Foreign Correspondents' Club would certainly agree with that.