April 29, 2008
The Swiss take great pride in their banks, so it's no surprise that when
UBS blew nearly $40-billion (U.S.) on subprime mortgages, the country's
bank regulator wanted to know why. Last week, investigators delivered
their report. One conclusion: The investment bank was so obsessed with
increasing revenue that it mismanaged risk.
No one's ever going to confuse Vancouver's Canaccord Capital Inc. with a
large Swiss bank. Even so, there's one similarity: a stellar growth
rate, followed by trouble. To what extent will the executives step up
and share the pain?
Inquiring minds want to know, as do the company's shareholders, who,
like UBS's, have little to show for the past several years of expansion.
Canaccord went public at $10.25 (Canadian) a share nearly four years
ago, and it's back to where it started after the market carved the stock
in half, and then some. The culprit, of course, is asset-backed
commercial paper, which Canaccord sold to some 1,450 clients.
The firm had to bail them out, necessitating a $36.8-million writedown -
no small hit for a company that has never earned $100-million in a year
- which was soon followed by a dilutive sale of new stock. It's safe to
say that everyone at the firm will be thrilled when the dirty initials
ABCP mercifully disappears from the business pages.
The so-called relief program, which is designed to give most of its ABCP-owning
clients their money back, will help fix relations with customers.
Canaccord now faces a credibility test with its owners. Very few
shareholders will complain about executive pay when profits and share
prices are going up. In harder times, the scrutiny starts.
Here's a question for you: Which of the following executives do you
think earned the most in fiscal 2007? Choose from: (a) Chuck Winograd,
head of RBC Dominion Securities, the largest investment bank; (b)
Canaccord boss Paul Reynolds; or (c) Kevin Sullivan, top executive at
GMP Capital? If you chose (b), you win hearty congratulations and 11.2
million pieces of pocket lint, or one for every dollar Mr. Reynolds was
paid in 2007.
Then again, so what? Financial executives make big dough. Nothing new
about that. The real issue isn't the size of the paycheques, it's the
size of the paycheques relative to the size and profitability of the
company - and how they are determined.
Canaccord habitually gives about 50 per cent of its revenue back to
employees in the form of bonuses. Another 7 or 8 per cent goes to
salaries and benefits. On this point, the company stays quite
consistent: For as long as it has been a public company, its total pay
has been somewhere between 55 and 60 per cent of revenue - even as
revenue has doubled, through acquisition and booming markets.
There's nothing scandalous about that, though the numbers seem too high.
GMP, perhaps the most comparable publicly traded investment dealer in
Canada, paid 48 per cent of revenue to staff last year.
And GMP, it must be said, runs a vastly better business, earning more
money on less revenue than Canaccord does. GMP is actually among the
most profitable investment banks, per dollar of equity, in North
America: Last year it made nearly $53 for every $100 the shareholders
had at risk in the business, according to data from S&P/Capital IQ.
Astonishing. Canaccord's returns, while still impressive, were half that
- and that was before the ABCP hit. (Part of this gap is because of a
different business mix: Canaccord earns more through retail brokers,
whose pay is determined mainly by a fixed schedule of commissions.)
If you pay your staff based on revenue, guess what? Revenue will grow.
That might be fine if you're selling auto parts. It's more dangerous in
financial services, where too much focus on revenue growth usually leads
to silly risk taking (see: UBS, Citigroup, et al.). A better way is to
focus on profitability or return on equity. Canaccord's writeoffs on
ABCP hurt the bottom line, but will have only a modest impact on
revenue. How fair would it be to let the employees continue taking 55 or
60 per cent of sales while shareholders take it in the chops?
Canaccord's brain trust, Mr. Reynolds included, deserve credit. They
took what was once considered a Howe Street operation and fashioned it
into a mainstream firm. But in four years as a public company, they've
never faced bad markets or losses, so their alignment with public owners
has never really been tested. Now it will be. "[The ABCP writeoff] will
have a significant compensation impact," promises Canaccord spokesman
Scott Davidson. How much, he can't say. "We're still working through the
[bonus] pools right now." The fourth-quarter results are due in June.
Watch this space.