4 banking bail-out - the dangers of banking on risks - 5 lessons from the credit market’s downward spiral
| O’Neal lands with $160m parachute and Chuck Prince - 100m or more? |
| Stan O’Neal (Merrill Lynch), Peter Wuffli (UBS), Huw Jenkins (UBS), Clive Standish (UBS), Tom Maheras (Citigroup), Bobby Mehta (HSBC), Chuck Prince (Citibank) are a few among a string of high-profile departures due to the problems that banks have encountered in the US subprime mortgage market. |
| contagion fears grow on subprime writedowns - enormous amounts of stock values have been destroyed - credit agencies are failing investors and the money paid to CEOs of these firms (see above who we mean) makes a mockery out of good corporate governance… |
2 Banking bail-out - Northern Rock - A salutary tale of how confidence, once lost, is hard to restore
3 Banking bail-out - moral hazard or should we have thrown Northern Rock to the wolves?
But WHY SHOULD SHAREHOLDERS PAY EXECUTIVES AND BOARD MEMBERS that have managed to destroy the share price. Prince Alwaleed bin Talal bin Abdulaziz Alsaud (Prince Alwaleed bin Talal) owns 4% of the Citigroup stock and has lost billions in the last three months on this investment alone.
MORE FACTS
Around 2007-11-01 (last week), bank stocks tumbled around the world as investors focused on the continued fallout from the US subprime mortgage crisis.The prospect of further heavy writwedowns on holdings of subprime-linked securities hit stocks such as UBS, Barclays Bank and Morgan Stanley. Even Credit Suisse’s Brady Dougan had to acknowledge that while the bank delivered a record result for the first nine months of the year, it had suffered from the turbulent US subprime markets.
| The Wall Street CEO graveyard (inconmplete list) |
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| # | Name of Bank | Name of Executive | options and share awards | compen- sation and/or severance pay | stock price 52 week change* | stock price change over 5 year period* |
| 1 | Merrill Lynch | Stan O’Neal - 56 - officially retiring from the bank - about 5 years in top position | exercisable stock options about $41-42m unvested shares about $87m equity incentive plan awards worth $9.8pension annuity worth $24.6m | deferred compensation of $4.8m | -27.58% | +62.04% |
| 2 | Citi- group | Chuck Prince ChairmanTom Maheras - head of capital markets busi- nesses | info sketchy, litigation is possible | estimates suggest over 40 mio for Prince
Citibank has Rule of 75 - see its proxy - it says an exec whose service and age add up to 75 receives all of his unvested stock when he resigns - Prince is 57 years old + 29 years service = 86 |
-22.58% | +2.28% |
| 3 | UBS | Peter Wuffli - 49 - left after about 5.5 years as CEO | UBS does not disclose compensation of its CEO as of 2007neither total Stock Options data nor total compensation data have been published for Peter Wuffli | no severance package according to Marcel Ospel (Chairman of the Board of UBS) | -15% | +111.63% |
| 4 | ABN Amro | Rijkman Groenink - left after takeover of ABN by Royal Bank of Scotland - CEO for about 7.5 years | options and share awardsEuro 26m | Euro 4.3m = 22 months’ salary plus a bonus | +87.29% trading stopped 2007-10 -30 due to takeover | +264.03% |
| More information about the string of high-profile departures*Dow Jones Industrial Average over 1 year period is 12.89% andover 5 year period it is + 59.29% as per 2007-10-31 | ||||||
were used without considering that some of the assumptions made in these models are just assumptions, nothing more and nothing less.As well, looking at the above table, Groenink’s payout is minor for what he accomplished for shareholders. Nonetheless, some Dutch analysts feel that it is a complete disgrace. Hence, the above table raises an ethical issue- what is an appropriate reward and what is not?
For instance, compared to Groening’s payout, Check Prince is expected to get more than $100m as a thank you? Maybe so, in fact, he managed to be accountable and responsible for Citigroup loosing around $15billion (probably more), making sure that shareholders lost $102billion within the last 10 months by the falling stock price (i.e. it continues to drop as you read this)As well, in Switzerland rumours have been raised about how secure Chairman Marcel Ospel sits in the UBS saddle after the price continued to fall even Monday 2007-11-0 (price of stock dropped 3.7% that day).
UBS rushed into structured credit trading in its effort to challenge established Wall Street banks. Unfortunately, it lacked rigorous risk management and internal controls. Shareholders are paying for it now.
THE 5 LESSONS
1) Banks used the computer-based risk models (i.e. modern portfolio theory), (Please click on the link, choose Login as guest - click on this link again and voila free access) without taking into careful consideration the assumptions that are made with these models.
These computer-based risk models may reflect current market estimates of securities’ values. Unfortunately, the are not reliable in a crisis as we have now.
2) The industry’s managing of risks and trading seems problematic.
In fact, increasing risk exposure that much is costing investors. While risk exposure can bring nice returns, if it fails to work properly, the banks write off billions. In turn, shareholders pay the price while CEOs, top management and board members seem to ride off into the sunset with their remuneration and stock option packages intact (e.g., see Chuck Prince or Stan O’Neal).
3) Apparently it is impossile for a financial institution’s compensation board to figure out a scheme of remuneration or a labor contract that shifts the burden of proof to the CEO or Chairman.
In practice, this would have to mean looking at the destruction of value in the firm’s stock price as well as the huge write-downs on tranches of debt as happened this time, CEOS, top managers and board members should loose part if not all of previously granted but not yet exercised options. As well, shareholders should be able through the board to get these individuals remove without any severance package coming their way.
Interesting is that banks are perfectly able to shift risks to other parties. Similar rules apply if an online payment goes wrong for the bank’s customer…. the latter has to go through all kinds of pain before he might get reimbursed by the bank for an error that was the latter’s fault in the first place - if you do not believe us, just read the small print in the e-banking service agreement form you signed.
Just if you believe we do not get the picture…. banks are perfectly capable and willing to shift away risks to another party if it is possible. Checked your user agreement regarding e-banking lately, all the onus is put on your shoulders….
All we expect from good governance and the board’s compensation committe is that it establishes remuneration schemes and packages for top management that go as follows:
- if things go well you get paid well
- if things go badly - your bonus is zero and you may loose your job AND just for good measure,
- you have neither the right to sue the firm for illegal dismissal nor receiving severance pay or stock options - take it or leave it.
Hence, good corporate governance means that these issues are addressed when offering Chuck Prince’s replacement a contract. AND NO, buying out Larry Fink’s $400m stake in BlackRock if Merrill Lynch wants the asset manager’s chief executive to succeed Stand O’Neal as chairman does not seem the get us off on the right foot.
4) Once again, the quality of the work done by credit rating agencies such as Fitch, Moody’s and Standard & Poor’s is under scrutiny.
Fitch has just decided to lower Citibank’s rating from an AA+ to an AA and Standard & Poor’s will likely follow suit. How much trust can we put in their work when ratings are adjusted after the fact.
We pointed out during May and even earlier about the problems in subprime mortgages and with the banks overexposure regarding covenant-lite loans ((Please click on the link, Login as guest - click on this link again and voila free access) . Why did credit agencies fail to see it then and adjust ratings accordingly?
Are credit rating agencies out of their depth - risk management 101
Put differently, who rates the quality of the work done by credit rating agencies who rate others’ creditworthiness? Can we trust their work when they get around to adjust ratings afer the media as written about these problems for months? Might as well read this newsboard/blog and be better informed at lower cost 
5) It pays to retire disgracefully.
The only Wall Street chief executive who has not retired is the one who has actually reached retirment age - 73-year-Jimmy Cayne of Bear Stearns. While it sounds more dignified to retire than to resign or to be fired - a more accurate description of what happened to Check Prince and Stan O’Neill - it is a financial manoeuvre. Neither one would have been eligible to collect the restricted shares if they would have been dismissed. As the Rule of 75 for Citibank states (see Table above) Prince will be able to collect all the unvested stock since he resigned and retired - not fired.
If we go down history lane, there is a better way for shareholders how a board can handle this stiuation. We all remember Salomon Brothers, the daredevil bank that is now part of Citigroup. It was responsible for the structured credit blunder, fell apart in the 1991 Treasury bond scandal…. Its new leaders fired John Gutfreund, its risk-taking chief executive.
Salomon’s bosses including Warren Buffett, who stepped in as chief executive, refused Mr Gutfreund any severance pay-off and even blocked him from exercising his options on the bank’s shares. He spent years fruitlessly fighting for the money before losing his claim in the New York Supreme Court in 1995.
TIDBIT 1
Apparently it is easier for a board to refrain from attempting to fire a top executive. This might be especially true after the firm has lost billions due to erronous decisions that could have been authorized by that individual. Why, because firing could lead to a difficult and drawn-out legal battle. In fact, CEOs are likely to only be fired if they have been engaged in some kind of fraud or other malfeasance rather than presiding over a loss resulting in part from difficult market conditions and erronous risk management.
How Citigroup will avoid litigation having fired Tom Maheras is not known at this time. Chuck Prince’s pay-out is exhorbitant considering the stock’s five-year performance. Again, as our 3rd lesson above suggests, we need to improve governance when it comes to writing employment contracts for top executives….
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