BZW's pounds 6m man needs to produce some results fast

Bill Harrison, recently appointed chief executive at Barclays' investment banking arm, BZW, is a man in a hurry. And well he needs to be, for according to banking analysts, BZW remains a comparatively poorly performing investment bank, even after a boom year in capital markets which has seen many City traders transformed into millionaires.

Suggestions in the City that he has already had one business plan torn up and thrown back in his face are vehemently denied both by Barclays and BZW. But this has failed to bury rumours of growing concern at Barclays head office over poor returns and strategy in investment banking.

Mr Harrison, a 48-year-old plain-talking Brummie, was lured from Robert Fleming, the merchant bank, this summer on a pay deal worth pounds 6m over five years. He arrived just after Bob Diamond, the other key recruit in the new-look BZW. Mr Diamond runs global markets in return for a pay deal which is rumoured almost to match that of Mr Harrison.

So far progress has been slow. John Leonard, a top banking analyst at Salomon Brothers, has cut his pre-tax profits forecast for BZW in the second half of 1996 to pounds 118m, despite the fact that most other investment banks in the City are on track for a record year.

In the first half, before Mr Harrison took the helm after the death of David Band, BZW made profits of pounds 157m, a figure which disappointed some analysts at the time.

According to Mr Leonard, the new regime has so far been financially negative in its impact - rising costs and falling revenues. Mr Diamond is rumoured to have fired as many as 130 staff and hired the same number again, quite possibly on higher pay deals.

According to insiders, staff have been so busy watching their backs that they have not had time to go out and win business At the same time key personnel who had developed good relationships with clients have been fired.

Mr Diamond has ousted senior figures such as Klaus-Peter Moeritz, head of foreign exchange trading in the UK and Europe, and Alex von Ungem-Stemberg, deputy chief executive of the markets division. Others who have gone include Yann Gindre, head of debt origination, Nick Carter, head of swaps marketing, Paul Ellis, head of structured products, and Rob Jolliffe and Steve Hones, joint heads of debt syndicate.

Mr Harrison, meanwhile, has been busy instilling fear in his staff with his phenomenal appetite for work. He claims, apparently seriously, that time spent at home is a wasted marketing opportunity.

"The personnel changes in BZW's fixed income unit may have at least temporary revenue implications as well as adding to costs," Mr Leonard said in recent research. However, while he has trimmed his forecasts for the entire Barclays group for 1996, he is confident about the bank's performance in 1997 and 1998.

Robert Law, banking analyst at Lehman Brothers, the US investment bank, also expects costs to rise at BZW. He forecasts a rise of 10 per cent, which will account for most of the cost enhancement of the entire Barclays group.

Costs are also rising because BZW is in the process of moving to new premises in Canary Wharf, analysts point out. All points to a picture of rapidly escalating costs and poor return on capital. But although there may be special factors at work at BZW, this is by no means a unique set of circumstances.

Boom market conditions are leading to record bonuses. That in turn has meant such a rapid escalation in costs that shareholders have found it difficult to benefit from the boom in markets.

According to a recent stock exchange report: "As staff costs are by far the largest single cost element and overall revenue is highly sensitive to changes in dealing profit, the implication is that benign market conditions will easily reduce member firms' profit levels."

The Stock Exchange said that staff costs increased significantly during the year to June 1996. While its figures are confined to equities, equities derivatives, bonds and money market instruments, observers believe them representative of investment banking more generally.

After remaining flat the previous year, staff costs among the exchange's 250 member firms grew by nine percent to an average pounds 362m per quarter. Bonuses and profit sharing soared by almost pounds 100m to a record pounds 315m and profits were at a record pounds 719m.

But, significantly for the shareholders of these firms, return on capital failed to match this vibrant performance. The average return on capital did rise to above its long-term average - a mere six per cent - but at just 10 per cent, the return is still poor by most standards.

"Despite the recent favourable market conditions, the modest return over the past years would be lower still if the firms in aggregate had not reduced the amount of capital employed," the Stock Exchange said.

In the first part of 1996 the Stock Exchange said firms were able to cut back on the amount of capital they set aside to cover their business because of a new directive from Europe, the Capital Adequacy Directive, and because of restructuring in the industry.

Some investment bankers are eager to counter this claim, arguing that banks and securities houses tend towards caution when it comes to setting aside capital. "We set aside more than is required," said one banker.

This hides the true return on equity, he argues. "It could be the return on equity masks the true success of investment banking business because the firms want to be cautious about the amount of capital they set aside even though they have better technology to measure the amount of capital required," said another banker.

He said banks typically used sophisticated measuring tools known as Value at Risk (VAR) to determine the amount of capital they need to cover volatility in the markets. This regularly leads to banks setting aside more capital than regulators require, he said.

Many see this as little more than another excuse for poor returns. "Risk management may explain high capital needs and consequent poor returns, but it does not excuse them or make this the type of business you would want to invest in," said one City investor.

One analyst pointed to data which showed that as banks moved further into investment banking they gave a lower and lower share of their returns to their shareholders compared with staff.

In ordinary banking, according to this analyst, only 60 per cent of any excess profit tends to end up with staff. As the bank pushes into investment banking, he said citing recent examples, that proportion quickly rises to 85 per cent or more.

Influential research by McKinsey, the management consultancy firm, concludes that employees of investment banks always do better than shareholders, regardless of market conditions.

"While compensation has risen steadily over the years, volatility in business performance has been absorbed by the shareholders," McKinsey said in its research.

From analysis of the top 10 US investment banks, McKinsey calculates that employees maintained high returns throughout the period from 1980 to 1994, despite a steadily falling return to shareholders. This was even the case in 1994 when the return for shareholders turned negative.