Focused Banks and Buffett Bonds

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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One less Main.

What is the meaning of Citigroup's decision to "sell its large U.S. subprime-lending business, OneMain Financial, to Springleaf Holdings Inc., a nontraditional lender majority-owned by private-equity firm Fortress Investment Group LLC"? Here's the Wall Street Journal:

Since the financial crisis, big banks have looked to exit businesses that don’t generate a high enough return, in part because of tougher capital rules that reflect regulators’ views that certain activities are too risky. Lending to lower-income consumers fell into that bucket for Citigroup.

But here are some numbers:

OneMain had $3.34 billion in shareholder’s equity and $9.72 billion in assets at the end of September, according to a filing issued as part of its proposed IPO. The firm generated $415 million in profit on $1.67 billion in revenue in the first nine months of 2014. 

Annualize that casually to $550 million or so and you get a return on assets of about 5.7 percent, and a return on book equity of more than 16 percent, both pretty pretty good for Citigroup. Breakingviews gets into more numbers, estimating that selling OneMain will free up $1 billion of capital. But you can turn earnings into capital! Just owning it for two more years would generate more capital than that, plus then you still own it. Obviously part of the story is that Citi gets to book a nice one-time gain on the sale, but the bigger story just seems to be one of focus: Modern banks want to do the things they do well, and not be all things to all people. Owning a unit for, feh, "consolidating high-rate debt to paying for home improvements, medical bills or vacations" made sense before the crisis, but seems a bit embarrassing now: "The business did not fit with Citigroup’s long-term plan to focus on providing banking services to more affluent customers in the United States." Though obviously the affluent customers are less profitable, which is its own lesson about banking.

Layoffs watch: RBS.

Speaking of focus, everyone at RBS is fired:

Royal Bank of Scotland Group Plc may cut more than two thirds of its investment-bank jobs as part of a plan to shrink the securities unit and focus on the U.K. consumer market, a person with knowledge of the matter said.

That's as many as 14,000 jobs, out of a total of "16,000 to 18,000" in the corporate and institutional bank. Gulp. Will those 14,000 people get new jobs at the other banks that are taking the opposite tack from RBS and re-focusing on securities trading? Umm, which banks would those be? Particularly in the U.K.? Barclays is also shrinking its investment bank, as its chief executive officer said that he is "not a very patient person" with respect to investment-bank profitability:

The moves underline how two of the UK’s once once mighty global investment banks are facing questions about their future, leaving the country reliant on foreign groups to provide access to capital markets.

“There will come a time when we need liquidity in this country and we won’t have a British broker-dealer so we will have to rely on JPMorgan and that is a problem,” said Chirantan Barua, banking analyst at Bernstein.

 Meanwhile at least Standard Chartered isn't raising equity.

Elsewhere in England.

I don't exactly know what to make of the Bank of England's head of currency dealing, Martin Mallett, who "was dismissed after at least 20 violations of the institution’s internal policies were unearthed amid a review into whether central bank staff knew about currency rigging." Here are the findings of that review, which is actually fairly sympathetic to Mallett. Mallett had lots of conversations with currency dealers about the weird mechanics of the foreign exchange fixings, and was on board with a certain amount of ... I guess you'd call it collusion? front-running? maybe just good business? ... to reduce the banks' risk and get clients an orderly execution at the fix. As a judgment call about market structure, that was not obviously wrong; at least some of what looked like manipulation in the FX cases was really just accepted risk management. But these were all gray areas, and he had conversations with banks that veered into pretty dark-gray territory:

Mallett: … what troubles me is your, um, your accusation that there could actually be some, ummm…

Trader: It’s not an, well, accusation is probably a strong word, there’s stuff going through that probably…

Mallett: Doesn't exist…

Trader: … doesn’t exist and it’s kind of…

Mallett: Well yeah…

Trader: … it's being, it's being exaggerated shall we put…

Mallett: Well that’s market manipulation isn’t it?

Trader: Yep absolutely.

Hmm yes you have to tell someone about that. Mallett's problem is that he didn't.

Buffett bonds!

"Berkshire Hathaway Inc., looks set to join the euro bonds craze, with the firm drawing up plans to sell its debut debt in the European currency," and do you think they can do the new deal at negative rates? Berkshire issued a 5-year last year (due August 2019) with a 2.1 percent coupon that's now yielding about 1.7 percent; I see 5-year swaps at about 1.6 percent in dollars and about 0.3 percent in euros. So I guess not, but maybe they'll find a way. A fun fact about Berkshire Hathaway is that it claims to have issued the world's first negative-coupon bond, the euphoniously named SQUARZ, back in 2002. SQUARZ, pronounced "squares," was a weird convertible structure in the form of a bond plus a warrant; investors paid 3.75 percent per year for the warrant and got back 3 percent on the bonds, making the overall structure negative-coupon. Here's Floyd Norris at the time, complaining that no one said what SQUARZ stood for, which is true. Here's the prospectus, which says that "SQUARZ is a service mark of Goldman, Sachs & Co.," but does not spell it out. Disclosure: I used to work at Goldman, on the desk that did the SQUARZ deal (before my time) and still talked about it fondly, but I don't think I ever learned what it stood for either. "Z" is usually for "zero," but what is the zero here? And "Q" is a total mystery.

Elsewhere in bonds, Actavis sold a colossal hunk of them, doing $21 billion at tighter spreads than it had initially marketed, and the bonds traded even tighter after issuance. Hedge funds are raising money to buy energy debt. Chinese asset-backed bond sales are booming. And Pimco's biggest bond fund is losing investors at its slowest pace since Bill Gross left, which is progress.

A good paragraph.

From Todd Haugh via Doug Berman:

Drawing from the fields of criminology and behavioral ethics, this Article makes the case that overcriminalization actually increases the commission of criminal acts themselves, particularly by white collar offenders. This occurs because overcriminalization, by delegitimatizing the criminal law, fuels offender rationalizations. Rationalizations are part of the psychological process necessary for the commission of crime -- they allow offenders to square their self-perception as “good people” with the illegal behavior they are contemplating, thereby allowing the behavior to go forward. Overcriminalization, then, is more than a post-act concern. It is inherently criminogenic because it facilitates some of the most prevalent and powerful rationalizations used by would-be offenders. Put simply, overcriminalization is fostering the very conduct it seeks to eliminate. 

JPMorgan had another mortgage settlement yesterday. Here is Janet Yellen on banker ethics. And here is Craig Pirrong on the Clayton Rule ("The word ‘manipulation’ ... in its use is so broad as to include any operation of the cotton market that does not suit the gentleman who is speaking at the moment"):

The problem here inheres in large part in the inductive nature of legal reasoning, which generalizes from specific cases and relies heavily on analogy. With such reasoning there is always a danger that a necessary condition (“all spoofing strategies involve high rates of order cancellation”) morphs into a sufficient condition (“high rates of order cancellation indicate manipulation”). This danger is particularly acute in complex environments in which subtle differences in strategies that are difficult for laymen to grasp (and may even be difficult for the strategist or experts to explain) can lead to very different conclusions about their legitimacy.

The potential for a regulatory dragnet directed against spoofing catching legitimate strategies by mistake is probably the greatest near-term concern that traders should have, because such a dragnet is underway. But the widespread misunderstanding and suspicion of HFT more generally means that over the medium to long term, the scope of the Clayton Rule may expand dramatically.

Don't leave voicemail.

Here is a claim that the best way to follow up after a job interview is by leaving a voicemail for your interviewer. This claim is wrong.

Things happen.

The 25-year-old short seller who's going after Lumber Liquidators. Landlord loans. Last look. Local social networking. The pizza lobby. The math on the private equity investors' profit on the Freescale sale. Are the Federal Reserve’s Stress Test Results Predictable? U.S. companies keep a lot of cash abroad to avoid taxes. "We find that marriages and divorces are associated with significantly lower fund alpha, during the six-month period surrounding the event and for up to two years after the event." Some stock photos. "Instructions on how to ask a VC for coffee." Kanye West at Oxford. Conrad Hilton on a plane. The CEO Hierarchy of Needs. Music for cats. A pelican.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net