05 October 2006

HSBC Stumbles in Bid to Become Global Deal Maker

The Wall Street Journal, Carrick Mollenkamp, 5 October 2006

Just before Christmas 2004, John Studzinski, the co-head of HSBC Holdings PLC's new investment bank, warned his bankers how intensely they needed to chase big deals to transform the company into a top global player.

"There has to be an element of urgency, an element of guilt, an element of competition, an element of 'I'm responsible,'" said the banker, known in London financial circles as Studs, according to a video recording of the event.

Less than two years later, HSBC has pulled back its ambitions dramatically. Mr. Studzinski and some senior bankers he hired are gone, and HSBC remains in the lower tier of investment banking. Meanwhile, top investment banks increasingly threaten to steal business from HSBC and other conventional banks.

HSBC's struggle illustrates the upheavals in global banking, as the big-money, high-risk culture of Wall Street forces traditional banks to compete on new ground. Big bank mergers have created multinational institutions able to provide plain-vanilla banking such as corporate and consumer loans and cash management. Those services are now so commonplace that they command only the slimmest of profits. So traditional banks like HSBC are scouting for new sources of revenue, often investment banking.

Meanwhile investment banks Morgan Stanley, Merrill Lynch & Co., Credit Suisse Group and Goldman Sachs Group are expanding into some lucrative overseas markets, such as Brazil, Russia, India and China. "A lot of our competitors, European and American banks, have moved into effectively what has been the homeland of HSBC," Stuart Gulliver, then co-head of HSBC's investment-banking and capital-markets division with Mr. Studzinski, told investors in May. "They've built up in the Middle East, they've built up in Asia-Pacific, they've got China fever."

Also in the December 2004 presentation, John Studzinski and Stuart Gulliver, co-heads of HSBC's investment-banking business, talked about strategy.

HSBC stumbled as it tried to catch up to big investment banks by aggressively seeking major deals all across the globe, while hesitating to loosen its tight lending standards and or bust budgets hiring new personnel. The bank's new platoon of merger advisers were stymied because HSBC balked at services that deal customers demanded, such as riskier financing. When costs soared but merger and advisory business didn't follow, the bank started scaling back.

For most of HSBC's 141-year history, its international reach was enough. Founded in Hong Kong by Scottish shipping superintendent Thomas Sutherland in 1865 to finance trade between Europe, China and India, HSBC's banking business paralleled the British Empire and then kept growing. It now offers loans and money-management services to companies and branch-banking, loans and credit cards to consumers in 76 countries.

But in 2003, with its global advantage shrinking, then-chairman Sir John Bond began to push HSBC into investment banking -- advising on mergers, underwriting stocks and bonds, and issuing more complex derivatives. Sir John, whose 45 years in HSBC banking and mane of white hair gave him a patrician presence, signed off on a bold departure: a five-year investment-banking expansion plan and a budget of at least $800 million for the first two years.

To lead the charge, he turned to Mr. Studzinski, an American banker who had helped lead Morgan Stanley's European investment bank. Announcing the move, Sir John acknowledged that HSBC rarely hired for such a senior position from the outside. He called Mr. Studzinski, who was born in Boston, a "very natural fit." Mr. Studzinski, 50 years old, was paired at the helm with Mr. Gulliver, a 26-year HSBC veteran steeped in the bank's culture of cost-control, who had managed the bank's trading operation in Asia.

It wasn't an obvious match. Mr. Studzinski, active in London society and U.K. charities, earlier this year held a 50th birthday party for himself at Salzburg's Leopoldskron Palace, which was used as the von Trapp family residence in "The Sound of Music." The celebration included a choral work commissioned by an arts foundation Mr. Studzinski founded. It describes the choral piece, performed at a nearby church, as "a contemplation about the universal presence of angels in all our lives."

The 47-year-old Mr. Gulliver, who is partial to the rock bands U2 and Santana, carries the tough-guy demeanor of a lifelong trader. His recent reading included a book by a British army officer titled, "Rules of Engagement: A Life in Conflict."

Mr. Studzinski was in charge of the merger and advisory business and the business of helping companies sell stock and debt. Mr. Gulliver was responsible for expanding sales and trading, and for beefing up the bank's ability to offer derivatives and other specialized financial products to corporate clients.

At the outset, they both spent lavishly, especially Mr. Studzinski as he raided competitors to build a team from scratch. In March 2004, Mr. Studzinski hired a European technology banker from Credit Suisse. The next month he raided Credit Suisse and Goldman Sachs for consumer and retail bankers. In July, he hired a health-care banker from Lazard Frères.

In some cases, Mr. Studzinski offered bankers guaranteed bonuses for two years, an unusual step in an industry where annual bonuses typically are determined by financial performance the same year. In all, he and Mr. Gulliver hired some 2,000 people in a little more than a year.

At the end of 2004, Messrs. Studzinski, Gulliver and Sir John were upbeat at a gathering for their investment bankers. Sir John clinked his glass to hush the room and told the bankers of his "absolute conviction" that they were building "the premier investment-banking and markets business in the world," according to the video. He added, "I don't care how fast we get there as long as we do it right."

Mr. Gulliver brashly suggested HSBC could benefit because of regulatory problems that a big competitor, Citigroup Inc., was facing. He joked Citigroup might have problems paying staff, "given the extent to which it hasn't got any money because of the fines it's paid."

But HSBC's bankers struggled to win deals, and the bank stood at 16th in the 2004 global merger-advisory rankings by deal value, compiled by the markets data provider Dealogic. Meanwhile, the aggressive hiring pushed the investment bank's costs up 32% from the year before, to $5.8 billion.

Mr. Gulliver, despite his initial spending, grew increasingly unhappy about the escalating expenses, people familiar with the matter say. He privately complained to others about Mr. Studzinski's strategy and the amount of spending, according to a former senior HSBC employee. Messrs. Gulliver and Studzinski declined to comment. On his side of the business, Mr. Gulliver began pulling back on costs. For instance, consulting firm A.T. Kearney had delivered a 200-page plan for expanding HSBC's equities business. Mr. Gulliver called for scaling the plan back by about 30%.

Meanwhile, HSBC lacked heft in other areas crucial to winning merger business. Leveraged finance -- loans accompanied by high-yield or "junk" bonds -- was in high demand amid a surge of private-equity investment. But the bank didn't quickly hire a team to handle that. The bank was concerned about risky debt and wanted an experienced team, but worries about costs delayed hiring decisions, said people familiar with the situation. When HSBC bankers asked for help arranging leveraged-finance deals, they were told to be patient. This spring, HSBC finally hired two leveraged-finance bankers from Morgan Stanley.

Some of the newly hired merger bankers found the bank's lending process also slowed them down and put them at a disadvantage. At HSBC, bankers had to fill out a form and send it to the credit department at headquarters in London's Canary Wharf financial district, according to one former executive. Typically, in arranging financing for deals, investment bankers make their case in person to a credit committee that understands the investment-banking business and can make a quick decision. Pierre Goad, an HSBC spokesman, said, "We regard our independent credit department as a strength, not a weakness."

Some of the new investment bankers chafed because they worked from cramped cubicles or desk areas, as was usual at HSBC, rather than individual offices. Bankers making millions had to go to a conference room to have a private phone call.

Meanwhile, cooperation suffered between HSBC's new investment bankers and its traditional bankers in each country, who could provide on-the-ground intelligence and valuable introductions for the investment bankers. A former banker said officials observed tensions between Mr. Studzinski and Mike Smith, the CEO of HSBC's Asia-Pacific operations. This person said Mr. Smith felt Mr. Studzinski was encroaching on his turf. A bank spokesman declined to comment on behalf of Mr. Smith. Through a spokesman, Mr. Studzinski also declined to comment.

HSBC struggled to add research to its offerings. Mr. Studzinski wanted to do it, but Mr. Gulliver and others found it problematic because it is an expense that they didn't think would produce revenue.

In one case, an investment banker sought to influence an HSBC researcher's investment analysis, something U.S. banks had agreed to stop in 2003 as part of their settlement with New York Attorney General Eliot Spitzer and U.S. regulators. (HSBC wasn't part of that agreement because it had virtually no equity research at the time.) In August 2005, an HSBC banker emailed a research analyst, instructing him to not publish an opinion critical of an important banking client, Emirates Airline, according to a copy of the email reviewed by The Wall Street Journal. "I am aware of the concerns that the note has raised within [Emirates] and wish to avoid creating relationship damage," the email said.

HSBC's Mr. Goad said the analyst's opinion was published and the email was brought to the attention of HSBC's compliance department. Mr. Goad said the sender of the email was told it was inappropriate but no disciplinary action was taken.

By mid-2005, concern over the unit's ever-rising expenses was forcing the bank's hand. In the first half of the year, total operating income for the business rose just 3.6% from the year-earlier period, but costs rose another 24% to $3.32 billion. Pre-tax profit at the unit fell by 18%.

HSBC's chief executive Stephen Green began taking a hard line on new spending. He started vetting investment-banking hires himself and some job offers were put on hold, according to a person familiar with the situation. Through a spokesman, Mr. Green declined to comment.

On Aug. 1, 2005, Sir John and Mr. Green unexpectedly announced that most of the expenditures to build up the investment bank had been made. "Future cost growth will consequently be lower," Sir John wrote in a report to investors. It was two years into what the bank had flagged as a five-year plan. The 2005 budget for the research department was sliced by about $35 million, or 17%, to $165 million. Sir John declined to comment.

In November, Sir John announced he would retire the following May, shortly before he turned 65. The move was long-planned, but it removed Mr. Studzinski's chief supporter among senior management. Sir John's successor as chairman was Mr. Green.

In February, Mr. Studzinski was relieved of many of his responsibilities, which were given to Mr. Gulliver. In May, Mr. Studzinski announced he would leave in September to become a mergers and acquisitions adviser at New York-based private-equity firm Blackstone Group. There was no dramatic ending or "Arthur Miller" moment, he said in an interview at the time. "This was not 'Death of a Salesman.'"

Last month, Mr. Studzinski organized his going-away party, attended by HSBC executives, at the 175-year-old London theatrical club called The Garrick Club, once the scene of a famous quarrel between Charles Dickens and William Makepeace Thackeray. This week, his 20th-floor office became a meeting room.

Others hired by Mr. Studzinski have headed for the exits. Bankers for telecommunications, retail, and technology -- all of them hired as part of the investment-banking push -- have left. The bank calls the turnover normal. "During the same period, how many people left Goldman? How many people left Morgan Stanley?" says Mr. Gulliver. "'Tis the nature of the business."

HSBC has been an adviser on a number of big acquisitions recently, but mostly in a secondary role providing extra financing. For example, it is one of six banks advising Mittal Steel Co. NV in its acquisition of Arcelor SA, valued at about $30 billion, helping boost its place in Dealogic's investment-banking rankings by deal value to 13th for the first nine months of this year. But Goldman Sachs is the lead adviser on that deal, and those lower down the pecking order get paid far less.

The unit's most-recent results, pre-tax profits for the first half of 2006, rose 37% compared to the first half of 2005, to $3.14 billion, helped by the sale of derivatives. Mr. Gulliver says that shows that as the sole head of the division, he's going in the right direction. "My job has been to build something that works for HSBC," he says.