When Lehman Brothers imploded almost 10 years ago, few Wall Street banks were worse placed to withstand the fallout than Citigroup. While most of its rivals had delivered bumper profits in 2007, Citi had already seen its earnings collapse to $3.6bn from $21.5bn after its subprime bets went badly wrong.
Yet, a decade on from the crisis that threatened such devastation, Citi’s investment bank chief James Forese can say without irony: “I don’t think there is much question that we’ve been a winner since the crisis. Even from the [high] of the 2005/06 period to today . . . our franchise is much stronger today than it was back then.”
Mr Forese is not the only one of his peers enjoying the unlikely resurgence of investment banking a decade after the crisis. Indeed, data collected by the Financial Times show that group-wide profits last year of $78.4bn across the top nine investment banks — excluding the much-changed Bank of America — were higher than the $75.4bn recorded in 2007. Industry profits in dollar terms are back to pre-crisis levels.
At JPMorgan, the world’s biggest investment bank by revenue every year since 2010, investment bank head Daniel Pinto sees global growth driving revenue higher in the coming years, while big banks like his deploy technology to cut costs and win clients.
UK-headquartered HSBC has quietly doubled the size of some investment bank businesses in the past decade. Samir Assaf, its global banking and markets chief, says he will continue hiring and outgrowing the market supported by the performance of HSBC’s Asian operations.
Even at Barclays, which has had a turbulent journey through the crisis, their investment bank head Tim Throsby is bullish, speaking of his willingness to row back on some crisis-era cuts if it makes financial sense. “I speak to a lot of young people in our teams and some of them at different stages over the last number of years have wondered . . . are the best days for our industry over?” says Mr Throsby. “I think anything but.”
Investment banks have spent much of the decade under a shadow since the meltdown of the US mortgage market. They have watched private equity firms and hedge funds take their place at the top of the finance food chain. Executives have complained loudly that the regulations put in place after the crisis have hampered their ability to operate.
However, the sector has also benefited from some powerful trends. The last year has brought the American banks higher interest rates and a corporate tax cut that promises to put trillions into the pockets of US companies. Crisis-era mergers, such as Barclays’ assimilation of the US arm of Lehman Brothers, JPMorgan’s purchase of Washington Mutual and the Bank of America-Merrill Lynch deal, have left the surviving banks with greater economies of scale. A succession of cost-cutting plans has made them leaner and an M&A boom has boosted fee income.
Investment banks have also regained their cachet among ambitious graduates. Even the imperilled Deutsche Bank attracted 110,000 applications for its 2018 graduate scheme.
Investment banks 10 years on
James Forese, investment bank chief ‘Even from the [high] of the 2005/06 period . . . our franchise is much stronger today than it was back then’
Samir Assaf, global banking and markets chief ‘We said our advantage is to be capital heavy as long as we know how to price it [capital]’
While the headline figures show robust earnings, the aftermath of the crisis still lingers. Largely as a result of regulatory demands, the nine banks whose finances were analysed by the FT have almost doubled their shareholders’ equity from the end of 2007 to the end of last year. The result has been lower returns. While profits may be back to pre-crisis levels, the return on equity most definitely is not and bankers concede it probably never will be.
“They [investment banks] are not seen as valuable parts of global diversified banks. They are seen as a drag on group profitability and on valuation,” says Sven Oestmann, senior equity analyst at Fidelity, one of the world’s biggest institutional investors.
That ambivalence is partly a reflection of the bailouts that so many banks required a decade ago. Citi, for instance, received $45bn of public funds to prevent it following Lehman’s path.
“In capital markets, Citi is strategically positioned perhaps better than at any time before given its balance sheet strength, more measured expansion and competitor retreat,” says Mike Mayo, a banks analyst at Wells Fargo. “Yet, there is no way to say that Citi is a winner since before the financial crisis when Citi, in our view, effectively failed.”
In Europe, Royal Bank of Scotland and UBS, which were once among the world’s biggest investment banks, were bailed out. Deutsche Bank, Credit Suisse and Barclays avoided rescues but repeatedly went cap in hand to shareholders after trading losses and multibillion-dollar fines.
On top of that, the investment banks have to navigate a very different environment. Regulations have in effect banned them from once-lucrative activities such as trading stocks on their own behalf and co-investing in funds with clients. Areas including trading structured products have all but dried up as clients balked at the collapse in value of some instruments and revelations of widespread manipulation of others, especially mortgage-backed bonds.
Europe’s investment banks have fallen out of the world’s top five since 2015 after a series of exits from Asia, the US and their still fragile home market in continental Europe.
For groups across the world, competitive threats have sprung from sources that would have been unthinkable even a few years ago, as big banks face off against everyone from the likes of Amazon and Apple to two-man online trading shops.
Investment banks 10 years on
Tim Throsby, head of investment banking ‘A lot of young people in our teams have wondered are the best days for our industry over? I think anything but’
Daniel Pinto, investment bank head ‘The market is going to have to grow over the long term because the world will grow’
Mr Forese attributes Citi’s improved fortunes to a “less is more” approach. “The important parts for us were the decisions that we took in the immediate wake of the crisis . . . we became a much more focused and much simpler business model.”
Citi has grown market share with its best clients while jettisoning activities in insurance and non-bank lending. The investment bank was deemed core, but within that Mr Forese’s division now serves “a little over 12,000” clients, less than half the 32,000 it boasted of pre-crisis.
Citi’s biggest success was in fixed income, currencies and commodities, a business that has mainly hit the post-crisis headlines for huge falls in revenue, including Goldman Sachs’ horrendous 2017. Citi made $12.1bn in FICC revenues last year, eclipsing Goldman to become the second biggest trading player after JPMorgan. Citi also grew strongly in debt capital markets, the business of advising companies on selling bonds.
“Who would have thought that the old Salomon Brothers franchise would make this comeback in a different form with different management and added capabilities?” asks Mr Mayo, referring to the 1997 purchase of bond house Salomon Brothers. “There’s been a revival of the legacy franchise in the name of a refurbished and stronger Citi.”
The US investment banks say the problems experienced by some of their European rivals helped them gain share. But they do not expect to have it so easy in the future.
Trading was also at the centre of HSBC’s investment bank growth. HSBC averaged annual trading revenues of $2.32bn in 2006 and 2007. Last year, its trading division drew in $5.4bn and was the fifth largest of the 10 banks.
HSBC’s Mr Assaf believes “one of the best calls” his bank made was around 2014 when others, particularly in Europe, wanted to exit businesses that required a lot of capital under new regulations. “We said no, our advantage is to be capital heavy as long as we know how to price it [capital],” he says.
At Barclays, Mr Throsby must contend with a parent company that is reluctant to grow its investment bank exposure and a shareholder base that remains decidedly hostile to his business. One activist investor is petitioning Barclays to sell the investment bank.
But Mr Throsby, a JPMorgan veteran who joined 17 months ago, argues that despite limited resources Barclays will emerge as the pre-eminent European investment bank. “We’re the only European bank that’s deadly serious
. . . about having a serious transatlantic corporate and investment bank,” he says. “The US is the largest capital market in the world and also the most lucrative.”
With an enlarged Wall Street presence thanks to the acquisition of Lehman’s American business, US revenue makes up 55 per cent of Barclays’ corporate and investment bank, and more than 55 per cent of its profit.
In Asia the bank cut back sales and trading of equities in 2016, in one of its first big strategic decisions after former JPMorgan investment banker Jes Staley became group chief executive. It also withdrew investment bankers from some Asian markets.
“We’ve let people confuse that [pulling out of cash equities in Asia] with either a general lack of enthusiasm for Asia or a more general withdrawal from Asia. Neither of which is the case,” says Mr Throsby. As if to prove a point Barclays has already sent its bankers back into Australia.
Yet despite the recent revival of investment bank fortunes, shareholders in many banks will need a lot of persuasion before they support expansion.
Fidelity’s Mr Oestmann sees big challenges for European groups, which are only allowed to keep their investment banks because it would be too difficult to sell or close them. He says: “The market’s view of US investment banks is more favourable.”
Their insatiable appetite for capital has been one of investors’ biggest concerns about trading businesses. The end of quantitative easing is another risk — when American and European central banks stop flooding their economies with cheap money, no one knows how asset prices, or global growth, will react.
But with President Donald Trump in the White House, bankers believe capital demands have peaked. The administration has already begun easing the Volcker rule, which banned banks from trading on their own behalf. Banks also believe they will reap efficiency gains from the application of new technology.
“We’re not going back to the returns on equity before the crisis,” says Mr Throsby. “But I do think that with effective technology we can have healthy businesses, healthy returns and healthy margins.” That’s a lot more than bankers could have predicted a decade ago.
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