Lehman effect boosts and reduces Nomura's Q1 profit

Ex-Lehman bankers boost global trading, but personnel expenses drag down investment banking as Nomura finally returns to the black.

Nomura Holdings climbed back into the black in the first quarter of its 2009 financial year after five quarters in the red. Three of its five divisions (retail, global markets and asset management) posted profits, while merchant banking and investment banking reported losses.

Overall, net revenue jumped 121% year-on-year to ¥298.4 billion ($3.1 billion) in the April to June quarter, with pre-tax income coming in at ¥31.4 billion. Net income was ¥11.4 billion. But return-on-equity was only 3%, a far cry from the management's stated target of 10%-15%.

For the previous fiscal year, which ended March 31, 2009, the bank posted a record loss of ¥700 billion. The loss was due to almost every single bet Nomura made going wrong: private equity investments, Icelandic banks, the US subprime operations and a heavy cost associated with retaining the Lehman Brothers bankers who joined Nomura last year.

But Nomura regained its breath this past quarter. The Lehman acquisition can be credited for a massive boost to its global markets division; but at the same time, personnel costs associated with ex-Lehman bankers continued to drag down the investment banking division, despite one of the strongest rallies in global stocks for many quarters.

The results show Nomura is indeed becoming more international and diversified. However, the core of its operations is still in Japan, which contributed ¥54.2 billion to pre-tax profit, followed by Europe with ¥15.4 billion. Asia contributed just ¥100 million and the US lost ¥3.6 billion.

The great performance in global markets was certainly a godsend to a management desperate to show the benefits of the Lehman acquisition. The division brought pre-tax income of ¥62.3 billion and was by far the largest contributor to profitability for the firm overall. It also played a big role in the bank's swing back to the black. Global market's net revenue increased by a spectacular 17 times quarter-on-quarter. Nomura also took the number one spot for client-driven market share in UK equities.

"If you look at Nomura's trading volumes in a number of different asset classes after the Lehman acquisition, you can see that Lehman bankers made a big difference," said an analyst at a foreign house in Tokyo.

Retail, which is essentially its domestic Japanese retail brokerage operations (thus, the input from Lehman is relatively small), was also a big success with pre-tax income jumping 72.2% to ¥27.9 billion. Retail is Nomura's second-largest contributor to revenue and to the bottom line and the bank clearly benefited from strong equity markets in Japan in the first quarter.

The performance of the investment banking division was the major disappointment, with a ¥5.4 billion loss, compared with a ¥12.6 billion pre-tax gain in the first quarter the previous year. The idea was that hot-shot Lehman bankers would boost the international franchise. They have done that to some extent, but they have boosted costs more, with non-interest expenses up 90% year-on-year.

"A negative (emerging from the results) is that Nomura benefited from a very strong rebound in ECM underwriting, but it still lost money in its investment banking division. It still needs to shed costs," said Yuri Yoshida, the primary Nomura analyst at Standard and Poor's in Tokyo.

The analyst quoted earlier added that "Nomura has to turn around investment banking before the bankers walk out the door".

Comparing Japan with the offshore regions, a picture emerges of a superb domestic investment banking operation, and a stunted international one. According to Dealogic, Nomura is top in all mergers and acquisitions in Japan year-to-date, but 12th worldwide; top in all ECM in Japan, but 40th worldwide; second in all domestic DCM, but 36th worldwide

Of course, things will change, but the cost of improving the franchise is a concern. Nomura will continue to pump money into building its European operations, and also its US operations, to which it has just dispatched senior Tokyo banker Takeo Sumino to take on the COO role.

Azumo Ohno, the Nomura analyst at Credit Suisse in Tokyo, believes Nomura could rack up ¥39 billion in net profit for the full year. "Costs are a concern, but only in investment banking. They can save money on their real estate holdings (Nomura is still paying the rent on the former Lehman office in Tokyo), and global markets is very positive," he told FinanceAsia.

Yoshida at Standard and Poor's is less optimistic though. "The profitability looks very temporary. Some factors won't be repeated, such as the massive capital raising exercises in the Japanese banking sector (which boosted underwriting revenue)," she said. Yoshida added that several highly profitable activities, such as selling very complex financial products and over-the-counter IPO sales to investors, have simply disappeared.

The management's targets of 10%-15% return-on-equity and ¥500 billion in annual pre-tax profit certainly still looks a long way away.

¬ Haymarket Media Limited. All rights reserved.
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