Cheerio, British Investment Banks

Barclays' BZW is the latest to quit amid fierce competition

British investment banks are going the way of the dodo. On Oct. 3, Barclays Bank PLC put a big chunk of its investment-banking operation on the block. Americans or Europeans are thought to be possible buyers. The news came just two months after National Westminster Bank PLC downsized its own troubled investment bank, NatWest Markets. And it wasn't that long ago, in 1995, that four major British investment banks were sold to foreign companies. In fact, Barclays' BZW unit was the only British investment bank still making a pretense of battling it out on a global scale with the major U.S. and Continental houses.

Why the wholesale retreat? The British banks just weren't up to competing with their U.S. cousins (table). But it wasn't always that way. British houses such as Morgan Grenfell and Barings virtually invented what evolved into investment banking. Their latter-day successors, however, don't seem to have what it takes to make it in the major leagues.

BIGGER IS BETTER. The writing on the wall was the May marriage of Morgan Stanley & Co. and Dean Witter Reynolds Inc., followed by Travelers Group Inc.'s Sept. 24 announcement that it would acquire Salomon Brothers Inc. The message: The bigger the investment bank, the better its chances for survival. To build up BZW, Barclays would have had to invest "hugely and riskily," says Martin Taylor, chief executive of Barclays. Added Taylor: "I wouldn't invest my own money in such a venture, so I wouldn't expect my shareholders to."

Indeed, British investment banks typically have been more timid than their U.S. counterparts when it comes to risking capital. U.S. investment banks are making so much money at home that they have billions to plow into overseas expansion. The British banks can't feed off such a vibrant domestic market. They also come up short in risk-taking and identifying new market niches, notes Samuel L. Hayes, Harvard business school investment-banking professor. "Mixing classical commercial banking with entrepreneurial investment banking is almost like mixing oil and water," he says.

Britain can trace its investment-banking problems back to 1986, when Prime Minister Margaret Thatcher unleashed her "Big Bang," deregulating the country's financial industry. Several investment banks, including BZW and NatWest, were cobbled together by giant lenders. But lately, British banks have been making so much money lending to retail and business clients that investment banking came to be viewed as a drag on profits. U.S. investment banks such as Goldman Sachs & Co. and Morgan Stanley, meanwhile, built huge operations in London, snapping up talented Britons and other Europeans.

BRAIN DRAIN. Faced with an accelerating brain drain, BZW and Natwest were forced to spend even more to compete. In 1996, Barclays spent $72 million on "upgrading costs," such as guarantees for new recruits. But institutional shareholders were unhappy. With retail banking in Britain's hot economy generating average annual returns on equity of around 25%, the Brits began asking themselves why they should waste money on investment banking operations earning half of that.

So Taylor made the decision to sell off its equity underwriting and brokerage operations, along with BZW's mergers and acquisitions unit. Barclays will keep some businesses, including bond trading, foreign exchange, money markets, and structured finance. These operations accounted for $790 million of the $1.1 billion in revenue the investment bank generated in the first half of this year.

For now, Barclays' main concern is finding a buyer before BZW is devalued by top employees jumping ship. Barclays is believed to be willing to shell out $40 million to convince key employees to stay. Among possible buyers are Germany's Commerzbank, which has expressed its keen interest in expanding into investment banking. And France's Banque Paribas is looking at BZW's businesses. Other possibilities include Holland's ING Barings and Credit Suisse First Boston. Analysts figure the business could fetch between $550 million and $950 million.

Indeed, even as British companies pull out, the Continentals have been rushing in. In 1995, Dresdner Bank bought Kleinwort Benson, Swiss Bank Corp. acquired S.G. Warburg, and ING took over Barings. Deutsche Bank has poured money into Deutsche Morgan Grenfell, the investment bank it bought for $1.5 billion in 1989.

SIGN OF A SHAKEOUT? The City's attraction to European companies is understandable. Continental banks earn about half the return on equity at home their British counterparts do, so they're satisfied with more modest profits. Barclays, on the other hand, made a nearly 25% return on equity in 1996, while BZW brought in only 8%. Although that shot up to 12% in the first half of this year, BZW faced the prospect of making huge investments--and diminished profits--just to stay in the game.

Although Barclays' departure from investment banking was long rumored, competitors still have taken note. "It's an indication that not everyone who thought they'd make it in investment banking in Europe will," says Ralph Lynch, who heads Lehman Brothers Inc.'s European mergers and acquisitions team. Observers now wonder whether Barclays' exit is the precursor of a European shakeout when the investment banking industry eventually cools down. "We think just two or three European banks will succeed," says John Aitken, head of European banking research at UBS Ltd. If so, they'll have fared better than the British.

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