Bloomberg News

Nomura Reeling From Lehman Hangover as Shibata Vows No Retreat

February 28, 2012

At 8 a.m. on Jan. 10, Takumi Shibata, chief operating officer of Nomura Holdings Inc. (8604), walked into the firm’s London boardroom overlooking the River Thames to try to salvage the 2008 acquisition of the European and Asian units of bankrupt Lehman Brothers Holdings Inc. (LEHMQ)

Shibata, who had flown in from Tokyo, assembled senior executives at Nomura’s wholesale business, which includes investment banking and sales and trading, Bloomberg Markets magazine reports in its April issue.

The unit’s head, Jesse Bhattal, Shibata’s handpicked deputy and putative successor, was on videoconference from Singapore with news: He was stepping down. Before the meeting, Shibata had told Bhattal’s lieutenant, Tarun Jotwani, the former Lehman trader running global markets from London, that his position was being eliminated, according to three people familiar with the situation who asked not to be identified because the company hasn’t made the information public.

The departure of the top two former Lehman executives was the culmination of a clash with Nomura’s old guard over competing visions for the future of Japan’s largest brokerage, the people say. Bhattal argued for an aggressive approach to businesses that weren’t generating high returns. His bosses in Tokyo wanted to stay the course to build an international investment-banking franchise.

The dispute emerged as the wholesale division suffered $1.1 billion in pretax losses in the six months ended on Sept. 30. While the unit recovered late last year, Nomura Holdings had a 10.5 billion yen ($140 million) net loss for the nine months through the end of 2011.

Fourth Foray

For the 86-year-old firm, which is making its fourth attempt to emerge on the global financial stage, things aren’t going well: Since the Lehman deal, its shares have fallen about 70 percent, reaching a 37-year low on Nov. 24. The stock today fell as much as 2.7 percent before closing at 383 yen, erasing earlier losses to end the day up 1.3 percent.

To steer Nomura toward profitability, Bhattal, 55, wanted big cuts in equities, investment banking and the firm’s U.S. business -- as much as $1.6 billion, the people say. At the same time, he saw opportunities to buy assets being unloaded by European banks to meet tougher capital rules. Executives in Tokyo balked, saying it would be a retreat from the firm’s international ambitions and could erode capital reserves.

After Bhattal said goodbye during the January conference call, Shibata spent 10 minutes explaining that Nomura’s strategy of becoming a global player wouldn’t change and that he would take over the wholesale business, a job he had given to Bhattal less than a year before.

“Nomura remains committed to being a global, Asia-based investment bank,” Shibata, 59, says he told the group.

Jotwani and Bhattal declined to comment for this story.

Opera-Loving Lifer

The firm’s future now rests largely in the hands of Shibata, an opera-loving Nomura lifer with a degree from Harvard Business School. If he fails to rescue the deal he championed, the Lehman acquisition will go down as yet another doomed attempt to compete with the top firms of Wall Street and London.

Nomura has had big ambitions for decades. It expanded abroad in the 1980s, only to retreat to Tokyo as Japan’s economy faltered. Attempts in the mid-1990s and mid-2000s foundered as well. Calling the acquisition of Lehman’s international units a “once-in-a-generation opportunity,” Nomura Group Chief Executive Officer Kenichi Watanabe and Shibata scooped up Lehman’s European operations for just $2 and the Asian franchise for $225 million in what was supposed to be a game-changing bid to compete head-on with Wall Street banks weakened by the financial crisis.

‘Inability to Implement’

Once the world’s biggest securities firm with a market value of $76 billion in 1987, Nomura has a market value of $18.2 billion, one-third that of Goldman Sachs Group Inc. (GS)

“The firm’s ambition has been to be the Japanese Morgan Stanley or Goldman Sachs -- a major global player,” says William Overholt, chief regional strategist at Nomura in Hong Kong until 2001 and now a senior fellow at Harvard University’s Kennedy School of Government. “It has suffered from an inability to implement its strategy.”

Now, after taking on 8,000 Lehman employees and building its U.S. presence from scratch, Nomura is tinkering with its strategy rather than embarking on a radical shift. It scaled back commodities trading, real-estate securities and prime brokerage services for hedge funds. It’s considering reducing Eastern European currencies trading and investment banking in Russia. On Nov. 1, the firm announced it would triple the cost cuts announced in July to $1.2 billion. By the end of December, it had cut 764 jobs out of 35,700 worldwide.

Too Little

It may be too little, too late, says Ichiro Takamatsu, a fund manager who helps oversee $2 billion at Tokyo-based Bayview Asset Management Co.

“The speed of the cost cuts has failed to catch up with the changes in the market,” says Takamatsu, who formerly held Nomura shares. “Either Watanabe or Shibata should resign to take responsibility for the failure.”

The cuts didn’t satisfy Moody’s Investors Service, which said on Nov. 9 it would review whether to lower Nomura’s credit rating to one level above junk or worse. The firm said at the time that it was “disappointed” with the decision because a cost-cutting program was under way.

Moody’s on Feb. 16 said that Nomura’s possible downgrade would be no more than one level, and that the review period was being extended.

Shares of Nomura are down 26 percent in the past 12 months, compared with a 8.5 percent drop for the Nikkei 225 Stock Average. They have gained 53 percent since the Jan. 10 management shake-up. Nomura on Feb. 1 reported an unexpected 17.8 billion-yen profit for the quarter ended on Dec. 31.

‘Survive the Storm’

While Europe’s prospects look bleak for the next two to three years, Nomura isn’t retreating, Shibata says during an interview at Zurich Airport in January after attending the World Economic Forum in Davos, Switzerland. The firm remains committed to equities and investment banking, including the U.S. business.

“We need to make sure we survive the storm, but we have no intention of going into hibernation,” he says. “We cut out the fat without much of a strategic change.”

Shibata, dressed in khakis, a blue blazer and a red tie with a blue-boat pattern, says he expects to remain CEO of the wholesale business for one to three years and hopes to find his replacement from within Nomura’s ranks.

“We are still going for dominance in Japan, no question,” he says. “Outside of Japan, we will focus on a narrower range of activities, but where we are active, we want to be very deep.”

Nomura Rankings

Nomura’s grip on Japan remains strong. It ranked No. 1 there in underwriting equities and advising on mergers and acquisitions last year, according to data compiled by Bloomberg.

Globally, Nomura has struggled to break into the top tier. Last year in Europe, it ranked 13th in underwriting equities and 15th in advising on mergers. It was No. 24 in underwriting equity offerings in Asia outside of Japan. In the U.S., Nomura ranks a distant 22nd in advising on mergers. The firm is No. 11 in Bloomberg Markets’ annual ranking of the best-paid investment banks by total fees.

Shibata says Nomura will build on areas of strength, such as helping financial firms raise capital and advising natural resource companies. It’s one of five advisers to Xstrata Plc in its $37 billion takeover by Glencore International Plc.

When Lehman went bust, Shibata was banking on an opening in the market for a broker-dealer such as Nomura. With Bear Stearns Cos. acquired by JPMorgan Chase & Co. (JPM) and other banks hobbled by government bailouts, he figured Nomura could make headway.

“I was wrong,” Shibata says. “I thought in 2008 we were going to a world where European banks would go back to being commercial banks. If they were to receive taxpayers’ money, taxpayers would demand the money be used for transactions in that country.”

Slimmed-Down World

Shibata isn’t the only one now trying to steer an investment bank through the newly slimmed-down financial world, in which capital requirements are rising, trading volumes have collapsed and banks are deleveraging. European sovereign-debt woes and capital constraints imposed by regulators following the financial crisis are making it harder to generate returns.

Financial firms worldwide announced more than 230,000 job cuts last year as they tried to trim costs, according to data compiled by Bloomberg.

In Japan, Nomura’s rivals are faring worse. Daiwa Securities Group Inc. (8601) lost 50.4 billion yen in the nine months to Dec. 31, while Mizuho Securities Co. (8411) lost 63.4 billion yen in the same period.

Ahead of Rivals

After raising $9 billion in two share offerings in 2009, Nomura is ahead of rivals in meeting new capital rules that take effect starting in 2015. It has a Tier 1 capital ratio of 12.9 percent of risk-weighted assets, more than the 8.5 percent required under Basel III rules adopted by the Basel Committee on Banking Supervision. Bhattal’s plan to use that capital to buy risk-weighted assets met with opposition.

“We don’t feel now is the right time to reduce that cushion,” says David Benson, a Briton who is Nomura’s vice chairman and who worked at the firm for about a decade until 2007 before rejoining post-Lehman. “Instinctively, as a trader I’d like to be on the other side of the banks in their deleveraging, but we need to be smart with our capital.”

Shibata and Watanabe, 59, worried that focusing on fixed income would undermine their goal of building a global client- based franchise, people familiar with the strategy clash say. Reducing the equities division also would strike a blow to Nomura’s heritage as Japan’s dominant broker and might look like a retreat after buying Lehman.

Savile Row Suits

Many Nomura bankers had expected Bhattal, an Indian-born Rhodes Scholar with a taste for Savile Row suits, to leave the firm after he moved from Hong Kong to Singapore last summer. One banker close to Bhattal says he didn’t see eye to eye with the board and became frustrated that he couldn’t set strategy.

The announcement that Jotwani also was going came as more of a shock, the people familiar with the departures say. His fixed-income unit accounted for 47 percent of the wholesale division’s revenue of 396.7 billion yen in the nine months ended on Dec. 31, making it one of the more profitable areas of the firm’s investment-banking push.

Outside Japan, the Lehman deal amounted to a reverse takeover, with “gaijin,” or foreigners, running most of the businesses. To integrate, Nomura embarked on a Lehman deprogramming campaign. When senior executives uttered the “L” word during meetings in London, they had to toss a 5-pound note into a box, people familiar with the rule say.

Transformative Deal

The Lehman acquisition was transformative. Within three months, Nomura’s trading volumes had swelled 10-fold. The franchise was sizable: In 2007, Lehman made $1.3 billion in pretax profit in Asia and $2.1 billion in Europe and the Middle East -- more than half of its total profit before taxes.

The deal helped Nomura strengthen its hold on Japan’s financial markets. The firm has the largest share of stocks traded on the Tokyo Stock Exchange, accounting for 14 percent of volume, up from about 7 percent before the Lehman purchase.

It also enabled Nomura to win fees from Japanese companies doing deals overseas, Shibata says. Nomura’s market share in advising Japanese firms making acquisitions abroad increased to 25 percent in 2011 from about 10 percent in 2007, Bloomberg data show. While the largest share of Nomura’s revenue now comes from wholesale banking, the firm earns more from retail brokerage services and asset management in Japan.

Wholesale banking generated 38 percent of the company’s 1 trillion yen of revenue in the nine months ended on Dec. 31 compared with 25 percent from retail. Losses at the wholesale unit totaled 50.1 billion yen, erasing retail’s pretax profit of 42.8 billion yen during the same period. Nomura had to rely on its private-equity sale of restaurant chain Skylark Co. for about 128 billion yen to report profit increase in the three months ended Dec. 31.

No Turning Back

Two years ago, with markets recovering from the financial crisis, the wholesale division looked like a gold mine. It earned 175.2 billion yen before taxes in the year ended on March 31, 2010 -- more than retail.

That’s when Nomura, having lost out on Lehman’s U.S. operation to Barclays Plc (BARC), decided to crack Wall Street. It embarked on a hiring spree, boosting head count in the U.S. to 2,500 from about 1,000 in 2009.

There’s no plan to turn back now, especially with signs of a modest U.S. recovery. Late last year, Nomura signed a 20-year lease for 20 floors at Worldwide Plaza in midtown Manhattan.

“It’s simplistic to say they can’t be overseas, but they can’t be in all markets,” says Paul Heaton, who manages a Japanese portfolio at London-based Pyrford International Ltd., which invests $3.5 billion globally. “They’ll have to rethink the extent of the global presence they want.”

Baseball, Economics

The firm has had international ambitions since it was founded by Tokushichi Nomura II in 1925. Two years later, it became the first Japanese securities house to open a branch in New York, which it shut in 1936 in the run-up to World War II. The family lost control afterward, and since then, Nomura’s fortunes largely have tracked the ups and downs of the Nikkei index.

While the company has been a magnet for Japan’s best and brightest, Shibata wasn’t a typical trainee-broker. Born in the Japanese port city of Yokohama, he’s the son of a merchant seaman who survived several attacks during World War II. He learned English playing baseball with an American neighbor and joined Nomura in 1976 after getting a degree in economics at Keio University. He was offered a job in the international department, a position he says he declined because he wanted to work as a broker cold-calling clients to understand the business.

Samurai Bonds

In 1981, before the Japanese bull market took off, Nomura sent Shibata to Harvard Business School, where he completed a Master of Business Administration. His class included future executives such as Rob Kapito, president and one of the founders of BlackRock Inc. (BLK), and Paul Edgerley, managing director at Boston-based private-equity firm Bain Capital LLC.

After returning to Tokyo, Shibata rose through Nomura’s ranks. He ran the American desk of the international finance department -- handling Samurai and euroyen bonds and non- Japanese equity issues -- and then moved to London as head of debt and equity syndication before leading investment banking.

To gain a presence on Wall Street in the 1980s, Nomura lured top bond traders with the excitement of working for the world’s largest securities firm and selling U.S. Treasuries to hungry Japanese investors. The 1987 stock market crash and the 1989 bursting of the Japanese bubble led Nomura to scale back its ambitions. In 1990, its stock fell almost 50 percent.

Hiring Hands

The firm tried another overseas foray, hiring Guy Hands from Goldman Sachs in London to make Nomura a private-equity giant and Ethan Penner, a pioneer of U.S. commercial-mortgage- backed securities, in New York. Nomura later exited both businesses.

“Net-net, the firm made a decent return on its capital from these niches,” Nomura’s Benson says. “What it didn’t do was build a sustainable investment-banking culture.”

In the mid-2000s, Nomura expanded in the U.S. again, this time building a $5.5 billion residential-mortgage-securities portfolio. Nomura began liquidating it in 2007, earlier than rivals and before the worst of the subprime crisis hit. The firm reported $2.4 billion in credit losses and writedowns by mid-2008, modest compared with other Wall Street banks.

Guaranteed Bonuses

It was in a relatively healthy position when Lehman collapsed in September of that year. Even with the bargain price tag, the cost of the Lehman acquisition was high. Nomura guaranteed multimillion-dollar bonuses for top bankers for two years, locking in pre-crisis compensation.

When the last of the two-year bonuses was paid in 2010, at least a dozen Lehman rainmakers walked out, including Christian Meissner, deputy head of global investment banking who’s now in charge of investment banking at Bank of America Corp.

In March 2010, Shibata handed the keys to Bhattal, naming him president and chief operating officer of a newly created wholesale division joining investment banking with fixed income and equities. Bhattal, a 15-year Lehman veteran, had been CEO of the U.S. firm’s Asian business since 2000.

“Bhattal was one of the most highly regarded guys at Lehman,” says Lawrence McDonald, a former Lehman trader and author of “A Colossal Failure of Common Sense” (Crown Business, 2009), a book about the firm’s collapse. “Some executives were lightweight. He was heavyweight.”

Bhattal Takes Charge

In his first year as president, Bhattal brought order to the fragmented house of Nomura. He created an executive committee that met weekly to review costs, revenue and positions. He and Shibata agreed on a hiring freeze. It looked like the right call as markets weakened.

In April 2011, Shibata promoted Bhattal to CEO of the division, a job Shibata had been doing himself. Nomura gave Jotwani a new role as head of global markets, merging equities and fixed income. Shibata says he was looking to Bhattal to replace him and at Jotwani to succeed Bhattal.

By the end of July, with the European debt crisis intensifying, Nomura announced it would trim $400 million in costs from the wholesale unit. In September, Shibata and Bhattal agreed that another round of cuts was needed, with Bhattal pushing for deeper reductions.

He didn’t get his way. With their strategic differences growing, Shibata and Bhattal met in Tokyo in mid-December and agreed to part ways.

‘Too Many Things’

Now that Bhattal and Jotwani are out, the only Lehman alumni left running global businesses are William Vereker, 45, who runs investment banking from London, and 46-year-old Benoit Savoret, global head of equities in London. In January, Nomura named Steve Ashley, 44, a former Royal Bank of Scotland Group Plc trader, as head of fixed income to replace Jotwani.

A leaner Nomura means more-modest ambitions.

“We were trying to do too many things, with too many clients, in too many places too much of the time,” says Vereker, a Briton who joined Lehman in 2005 from Morgan Stanley. (MS) “No firm can be all things to all people, especially when you’re building a business.”

Harvard’s Overholt wonders whether history is repeating itself.

“They’ve been on a three-year cycle in London, New York and Hong Kong,” he says. “They put in a huge amount of money, and the first year there’s a celebration about how successful they’re going to be. The second year it’s OK, and the third year they crash.”

With 4,100 staff in Europe, most of them in a new 81,800- square-meter (880,000-square-foot) glass building in London overlooking St. Paul’s Cathedral, Nomura executives aren’t packing their bags and heading back to Tokyo. This time, Nomura may be too big to contemplate failure.

Editors: Sheridan Prasso, Robert Friedman

To contact the reporters on this story: Stephanie Baker in London at stebaker@bloomberg.net; Takahiko Hyuga in Tokyo at thyuga@bloomberg.net

To contact the editors responsible for this story: Michael Serrill at mserrill@bloomberg.net; Chitra Somayaji at csomayaji@bloomberg.net


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