There's no question it was a big blow. The departure from Salomon Brothers Inc. of John W. Meriwether in 1991 and his team of bond arbitrageurs in 1993 left a deep hole in the trading bench. Salomon has tried to shrug off the loss. But cracks in the firm's performance are becoming more and more apparent. Earnings from Salomon's proprietary trading group, which trades for the firm's own account, have been lackluster for 1993 and the first half of 1994. A lot of people inside and outside Salomon are asking an important question: Can the firm be as profitable as it was without the "arb boys"?
The firm believes it can. "The impact of their departure is ultimately unknowable," Salomon responded in a written statement. "Losing good people is never a plus; however, we have a good team in place."
SLOW SAG. A centerpiece of the firm's post-Meriwether strategy is Dennis J. Keegan, a Kansan who wears a Dennis the Menace grin every day and a bow tie every Friday. Keegan, who was promoted to head of Salomon's risk-management committee and co-head of the fixed-income department on Aug. 10, is a talented bond trader and a protege of Meriwether. Last October, he replaced Larry E. Hilibrand, who is now working for Meriwether, as head of Salomon's bond arbitrage group. "I'm sorry they left," Keegan says. "I still think we'll make a lot of money."
There's not a lot of evidence of that so far. After making more than $1 billion pretax in 1991 and 1992, the proprietary trading group--which was run by Meriwether and his associates--has lagged. Pretax proprietary profits slumped to $416 million in 1993--low compared with the rest of the Street--and just $93 million in the first half of 1994. "I'm beginning to suspect that their loss of traders may have had more of an impact than I originally thought," says Michael Flanagan, an analyst with Lipper Analytical Securities Inc.
Reducing Salomon's dependence on volatile proprietary trading is the main reason the firm is trying hard to remake itself. Salomon Brothers Chief Executive Deryck C. Maughan is bolstering customer businesses like investment banking and underwriting. But in 1994's first half, customer businesses generated $464 million in pretax losses because the firm got caught with too many bonds that plummeted in value when rates rose.
In hindsight, some Wall Streeters believe Salomon made a huge blunder in allowing Meriwether and his followers to walk away in December, 1993. Salomon, still a bond-trading house at heart, was left without an experienced bond trader at the top. Says one former Salomon insider: "The benefit of having a John Meriwether or a John Gutfreund running the place is they can know when there's a problem. They can look a trader in the eye and tell."
The firm sees Keegan as the person to fill that role. CEO Maughan is considered a skilled manager, but he's not a trader. Keegan got his bachelor's degree and MBA from the University of California at Los Angeles and then spent four years in the army as a tank platoon commander in Germany. He joined Salomon in 1980, spent three years trading foreign exchange, and moved to London in 1983. By 1988, with Meriwether's backing, Keegan set up a London-based bond-arbitrage business with Stephen J.D. Posford, a polished, well-connected Brit whom Meriwether hired. By 1992, Keegan and Posford had become co-CEOs of the London office.
The two men turned around Salomon Brothers' London office, which had been moribund for years. From 1989 to 1993, the unit had record profits, accounting for more than a third of the firm's worldwide earnings in 1992 and 1993.
Now, Keegan and his former mentor are competitors. Keegan and Meriwether do precisely the same type of trading, which relies on mathematical models to find mispricings in the bond markets. The Salomon bond-arbitrage group still numbers around 40 people and includes some PhDs from Massachusetts Institute of Technology. "We are looking at the same mispricings," acknowledges Keegan.
But he and Meriwether are still friends. In early 1994, Keegan and some of his Salomon traders shared a game of liar's poker at Meriwether's Long Term Capital offices in Greenwich. They didn't talk business. "It's not as hard as you think because you're mutually happy not to discuss business," explains Keegan.
What did Keegan learn from Meriwether? "How to ask the right questions and always to hire people who are smarter than you are." Salomon Brothers hopes Keegan will do both.