Conventional wisdom suggests that 7% of market capitalization is the median cost of an adverse reputational event. UBS only wishes its losses would be no worse. On Thursday, according to Reuters (Howley and Thomasson, 16 Sept), Swiss bank UBS said it had lost around $2 billion due to rogue dealing by a London-based trader at the Swiss bank. UBS stock ended the day down 10.8 percent, its lowest close since March 2009, after the bank said it might post a third-quarter loss due to the trading , a huge blow as it struggles to rebuild credibility after years of crises.

Bloomberg reports (Buhayar, 15 Sept) that UBS AG  had its credit ratings put under review for possible downgrade by Standard & Poor’s and Moody’s Investors Service. The examination “will center on ongoing weaknesses in the group’s risk management and controls that have become evident again,” Moody’s analysts led by Robert Thomas said yesterday in a statement. S&P said in a statement today it will make a decision on the ratings “once further details emerge on the scale of the loss and the risk management lapses that enabled it to occur.”

Turning to the Steel City Re Corporate Reputation Index, among the 45 companies in the Financial Conglomerates sector, over the trailing twelve months UBS's ranking has slid from the 64th to the 34th percentile. Its most recent exponential weighted moving average reputation index volatility is at 60%, and the 12 week reputation velocity and vector are both negative at -23% and -5.3%.


Over the past few weeks, the median reputational index ranking of the sector dropped below 50% and the intra-sector volatility has been climbing. Returning to UBS, its intangible asset fraction has be deteriorating and is approaching the median of its peer group which today is about zero (0%) percent.

 

There is a lesson. Reputation risk management means entails the management of different types of risks in different commercial sectors. In financial services, the business processes that need risk management for the purposes of protecting reputation are ethics, quality, and innovation. In this instance, the quality of the trading processes was subverted by an unethical trader.

Reputation is an expectation held by stakeholders. Those expectations can vary over time, but at the end of the day, they are what drive commercially relevant behaviors among the stakeholders that create value -- 9% rise in enterprise value on the occasion of an investment in Bank of America by Warren Buffet -- or or destroy value, as in the present case of rogue trading at UBS.

As an iconic firm with a damaged reputation, you should expect to be in the cross hairs when stakeholders need to make a point. This is especially true when the stakeholders are elected officials. Such was the case with British Pinata, and apparently so with Goldman Sachs.

According to the daily newsletter of the National Association of Corporate Directors (15 April 2011), TheStreet.com (April 15, Woelfel) confirms that the SEC "is in talks with several major Wall Street banks to settle fraud allegations related to mortgage-bond deals that helped begin the financial crisis," with some of these settlements to be reached as early as next week. Others, meanwhile, could take months. The banks in the negotiations range from JPMorgan Chase and Citigroup to Morgan Stanley and Merrill Lynch. According to the website, "The SEC is aiming to reach a series of settlements with individual firms over the sales of the investments, rather than a big industry-wide deal." The settlements will likely vary significantly among banks. Few, if any though, are expected to be more than the $550 million penalty Goldman Sachs paid out in 2010 to settle SEC charges.

The newsletter adds an observation from the Wall Street Journal (April 15, Eaglesham), that "The cases highlight the aggressive tactics banks used to sell these securities to investors who suffered big losses. They also show how the banks' desire to keep the $1 trillion mortgage securities business going helped fuel the housing bubble." According to the newspaper, the settlements come amidst "mounting political pressure on the law-enforcement agencies to take more aggressive action against Wall Street over the financial crisis." Considering the damage done to Goldman's share price when the securities firm was sued by the SEC last year, the various banks will likely be keen to reach deals rather than get involved in an extended public fight with the agency.

Reuters (April 15, Prasad) concludes, adds the newsletter, "The regulator's decision to go for individual settlements reflects substantial differences in the nature of the civil fraud allegations faced by each bank." All of the banks named in the report have so far declined to comment.

But the stakeholders are commenting, and the metric that captures those comments is 'Reputation.' The Steel City Re Corporate Reputation Index Rankings show that over the trailing twelve months, Goldman Sach's reputation ranking dropped just a hair from the 94th percentile to the 93rd percentile relative to the 231 peers comprising the integrated Multi-bank Holding and Security Brokerages sector.  Of course, still visible is the short-term catastrophic drop in reputation to below the 50th percentile nearly one year ago. But such resilience. Note that the exponentially weighted moving average volatility of Goldman Sachs' reputation is less than 1%.

Goldman's been in the cross hairs for a year, and stakeholders are no longer worried about surprises. JP Morgan, one member of the list of "others," is relatively new to this particular game (though no babe in woods by Wall Street standards). Over the trailing twelve months, its reputation index ranking has dropped from the 90th percentile to the 76th percentile relative to this same group of peers, and its exponentially weighted moving average of index volatility is only now calming down to around 3%, although over this past week, its reputation vector went negative hinting at more volatility.


Reputation is linked to economic performance, of course, but it is not synonymous with either net cash flow nor balance sheet size (or intangible asset fraction) -- rather, reputation provides measurable additional juice, all other things being equal.

 Over the trailing twelve months, Goldman's superior reputation did not prevent the company from underperforming its peers by 10% -- a number attributable in part to the $0.5B fine the company paid for the alleged aggressive behavior noted above. JP Morgan, on the other hand, outperformed it peers by less than 1%.

With respect to the intangible asset fraction of enterprise value, Goldman Sachs' valuation is supported by a few more book assets (read, lower intangible asset fraction) relative to the median of the peer group as of late, while JP Morgan is on the other side of the mean with a greater intangible asset fraction value.



 

“We are committed to retaining the reputation and integrity of BBA Libor, which continues to be the authoritative benchmark of the wholesale money market,” said a spokesman for the British Bankers’ Association, according to the Financial Times. 

That there should even be a question about the  London interbank offered rate's -- Libor’s -- integrity is problematic. As the Financial Times explains, Libor is used as a reference rate for about $350,000bn in financial products.

Regulators in the US, Japan and UK are investigating whether some of the biggest banks conspired to “manipulate” this benchmark interest rate. The investigation centres on the panel of 16 banks that help the British Bankers’ Association set  Libor – the estimated cost of borrowing for banks between each other.

The probe came to light on Tuesday when the Swiss bank UBS (NYSE:UBS) disclosed in its annual report that it had received subpoenas from three US agencies and an information demand from the Japanese Financial Supervisory Agency. The other banks on the panel are: Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, HSBC, JPMorgan Chase, Lloyds, Rabobank, Royal Bank of Canada, Bank of Tokyo-Mitsubishi, Norinchukin Bank, Royal Bank of Scotland and West LB.

As to the Libor calculation algorithm, “…it is fully transparent – all of the data inputted by the contributor banks is publicly available, as is our methodology,” said the BBA.

Goldman Sachs (NYSE:GS) is back. As reported by the Dow Jones wire service Monday 27 September 2010, Goldman Sachs has retained its coveted position at the top of the league table of M&A advisers by both revenue and number of deals globally, and for the U.S. and Europe, during the first nine months of 2010, figures from Dealogic show Monday. Goldman's dominance in the coveted list--only twice broken in the past ten years--is unchanged compared with a year ago on a global basis for the first nine months of the year, reinforcing the idea that the investment bank continues to see little fallout from the negative publicity it has garnered this year.

On a global basis, Goldman advised on 225 deals, with a total value of $401.6 billion, Dealogic figures show, giving them a market share of just over 20%. Goldman generated $961 million in revenue from its global M&A advisory. It also topped the rankings according both to deal value and advisory revenue in the U.S. In Europe, although it took the top position measured by deal value, it fell to fifth position according to advisory fee revenue, beaten by Morgan Stanley (MS), Rothschild, JP Morgan and Deutsche Bank AG (DB). In Asia Pacific excluding Japan, however, Bank of America Merrill Lynch topped the M&A ranking, according to value of deals, with a nearly 20% market share. UBS A.G. (UBS) topped the Asia Pacific ranking measured according to the M&A fees ranking, Dealogic says. For Japan, Nomura (9716.TO) dominated the rankings over the same period for both criteria.

The reputation metrics indicate that Goldman Sachs has retained its position at a cost. The Steel City Re Corporate Reputation Index™ ranking for the Company has dropped a net 9 percentile points over the trailing twelve months from the 98th percentile to the 89th percentile as shown in the top chart. Concurrently, the reputation rankings for the entire industry improved, as shown in the 4th chart, with little change in the inter-sector variance. Goldman Sachs' return on equity, in the top chart, and its fractional intangible asset value, shown in the last chart, reveal under performance by 19% and a persistent material loss of intangible asset fractional value.

When we last looked at the Company's metrics, we speculated that the equity markets were not appreciating the Company's value. With the benefit of hindsight, we see that the markets were underpricing the Company relative to its reputation ranking, but were nevertheless sensing real expected loss. A loss of pricing power. We interpret these metrics, in the aggregate, to suggest that Goldman Sachs has had to yield a bit on price. We believe customers want Goldman Sachs for their intellectual prowesss, but sense that they can squeeze Goldman on price. A bit, anyway. For now.  And so it goes.

The New York Times reports today  that major lenders are backing off from companies that present the potential for material environmental risks. It's a reputational thing.

According to the report by Tom Zeller, "After years of legal entanglements arising from environmental messes and increased scrutiny of banks that finance the dirtiest industries, several large commercial lenders are taking a stand on industry practices that they regard as risky to their reputations and bottom lines." Major financial institutions now factoring sustainability issues into their lending decisions include Wells Fargo (NYSE:WFC), Credit Suisse (NYSE:CS), Morgan Stanley (NYSE:MS), JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), Citibank (NYSE:C), HSBC (NYSE:HBC), and Rabobank (AMS:ROBA).

In the parlance of the Society, it appears that sustainability policies and practices are emerging as material credit risk factors. And for those of you who were wondering what all the fuss is about at the Society, this is an example of what we mean by "intangible asset finance."

The Securities and Exchange Commission’s fraud lawsuit against Goldman Sachs (NYSE:GS) is over. The SEC said the firm’s main offense was telling the German bank IKB that a company called ACA had selected the portfolio of mortgage-related investments underlying the deal, when actually the selection process was heavily influenced by Paulson & Co., a hedge fund that later made $1 billion shorting Abacus. Bloomberg reports that there is significant misinformation circulating, and the market is confused.

The reputation metrics confirm the apparent market confusion. First, the Steel City Re Corporate Reputation Index™ shows evidence of significant resilience. Goldman Sachs entered this period with a reputation rank of .97 and is currently at .94. A drop, for sure, but relative to the precipitous fall earlier this year, a remarkable return when compared to the 38 firms in the capital markets sector.

The equity markets are more sanguine and have the firm underperforming the median of its peers by 22%.

In fact, overall the firm has lost a significant amount of enterprise value. Remember that this value, according to Goldman Sachs, comprises its people, capital and reputation. Which leads us to conclude that the equity market is not appreciating the reputational value that other stakeholders see. Are the reputation data suggesting that the company is underpriced?

Perhaps. Stay tuned when next week on Monday we roll out RepuStars II, a new composite index whose constituents, numbering up to 57 companies, are selected on the basis of both reputational and fundamental metrics.

In its annual meeting held on May 21, 2010, a majority of shareholders considered the executive compensation plan at KeyCorp (NYSE:KEY) and channeled Nancy Reagan. They just said no.

KeyCorp, headquartered in Cleveland, Ohio, is one of the nation's largest bank-based financial services companies, with consolidated total assets of approximately $95 billion. KeyCorp is the third U.S. company after Motorola Inc. (NYSE:MOT) and Occidental Petroleum Corporation (NYSE:OXY) that failed to get a majority support during a management-sponsored "say on pay" vote.

In the last fiscal year, KeyCorp's CEO Henry Meyer III saw a boost of 40.8% in his annual compensation to $8.7 million. For the corresponding period, the company reported a net loss of $1.335 billion. The raise in pay package came from an increase in the value of stock option grants and a large salary stock increase.

The company’s reputation has been in the doldrums. KeyCorp is a constituent of the S&P500 Composite Index. Compared to 283 other companies that are constituents of the S&P500 Composite Index – and have market capitalizations between $7 and 67 billion – the company’s Steel City Re Corporate Reputation Index ranking touches bottom.

Not surprisingly, there is no measurable intangible asset value in the company. As shown in the graph below, while the average S&P500 company’s value is about 82% intangible, KeyCorp has very little of that stuff. 

Many, such as Weber Shandwick’s Chief Reputation Strategist, Dr. Leslie Gaines Ross, have opined that the CEO is the focal point for corporate reputation. If this is the case, Mr. Meyer has some catch up work to do, quickly, for the pressure is building. On Tuesday 8 June, an investigation was announced on behalf of the long-term investors of KeyCorp alleging possible violations in fiduciary duty related to the past and future compensation of senior officers of the company.

It is water under the bridge, of course, but it is worth noting that insiders at Lehman (NYSE:LEH) thought that Repo 105 reeked of “headline risk.” And headline risk, as we have observed before, can snowball.

According to Jennifer Hughes writing in today’s Financial Times, Martin Kelly, global financial controller, warned his bosses about the “headline risk” to Lehman’s reputation if the deals were to become public. And now that the issue is public, it is snowballing.

Ms. Hughes further writes, “Lehman’s Repo 105s have attracted attention because attempts to hide assets by shifting them off the balance sheet are associated with dodgy accounting and best known for the interminable tangle of vehicles created by Enron, the failed US energy group, to hide its debts. But the reason this issue keeps rearing its head in so many guises is that the question lies at the very heart of accounting, which was originally intended to give a company’s owners a fair report of its business activities. Therefore, what goes on, and what stays off, the books is a permanent area of debate.”

Perhaps. But there is also a reputation angle to this story. In our opinion, the reason this issue is rearing its head and snowballing with the inevitable pile on of ‘litigators, regulators and Mommy bloggers’ is that it speaks to a central driver of market liquidity—trust. As former Fed Chairman Greenspan noted in October 2008, in a market system based upon trust, reputation has significant value. Linking ‘trust’ to ‘reputation’ is the ephemeral intangible asset of ‘ethics,’ for which accountants have yet to find a home.

Which is not to say that ‘ethics’ does not impact financial statements. As reported in the Intangible Asset Finance Society’s latest book, Mission: Intangible, companies with superior reputations deliver superior long-term shareholder returns by enabling (i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta and (v) lower credit costs. And as for companies that do not foster conformance with ethical best practices, there are always alternatives to being a going concern. Just ask Lehman.

Reputation is the collective perception held by stakeholders of how a company manages its intangible assets. In the 74-member Capital Markets sector, those intangible assets underlying reputation comprise three types of risk management—operational, market and credit. “In a market system based on trust, reputation has a significant economic value,” noted Alan Greenspan, a former chair of the US Federal Reserve Board. In the absence of trust following the loss of reputation, liquidity is at risk. During the 2007-2009 financial crises, stakeholders perceived failures in one or more of those risk management processes and precipitated the liquidity crisis. We look at some exemplary reputation data.





As described in great detail in the forthcoming book, Mission: Intangible. Managing risk and reputation to create enterprise value, the data show that there is a strong association between reputation and long-term economic returns. The rank order of 3-year returns for BlackRock (NYSE:BLK), Goldman Sachs (NYSE:GS), Deutsche Bank (NYSE:DB), and Morgan Stanley (NYSE:MS) shown in the chart above adapted from bigcharts.com correspond to their rank order Steel City Re Corporate Reputation Index metrics and inversely to the volatility value and vector of that metric.



The data also show, as illustrated in the above chart that also shows Morgan Stanley's acute reputation drop, that the Capital Markets sector as a group experienced a reputation rise this past year, but that the variance within this group also increased.

Last, as described previously, the data show that the short term distortions of extraordinary returns following extraordinary losses do not skew the reputation metrics. Firms that have superior reputations are more resilient, will fall more slowly in periods of upheaval, and therefore have less ground to regain. The bright side of this relative lack of short-term upside is that the lower volatility translates to lower cost of capital.

Let's turn briefly to reputation restoration efforts at Goldman Sachs (NYSE:GS). Lloyd Blankfein’s decision to withhold cash bonuses from himself and Goldman Sachs’ 30-person management committee reflects a child rearing philosophy that we share not. This is why. Allowing a child to send himself to bed without supper does not rectify the wrong; nor does it foster desired behavior. To paraphrase, “it is a tale told by Blankfein, full of sound and fury, signifying nothing.

As we have argued repeatedly, and now provide the business case in the Society's new book, Mission: Intangible. Managing risk and reputation to create enterprise value, the path to reputation restoration begins with changes in business processes. Excessive risk taking requiring parental bailout was the transgression. A commitment never to repeat the offense affirmed by evidence of substantive business process changes is the only acceptable penitence. The desired behaviors Mr. Blankfein should demonstrate are (1) institution of policies and procedures to better govern the actors that individually contributed to the collective risk and (2) deployment of methods to foster conformance with them.