It was convenient that both Citigroup and Wells Fargo released their fourth-quarter earnings overnight. Their starkly contrasting results provided an insight into the future of banking as global regulators would prefer it to be.
Wells Fargo’s fourth-quarter earnings were 20 per cent higher than a year earlier and helped the group generate a $US15.9 billion full-year profit, 29 per cent above that earned in 2010. Citi reported fourth quarter earnings of $US1.2 billion against the $US1.3 billion it produced in the same quarter of 2010 and full-year earnings that, at $US11.3 billion, was up six per cent on 2010’s.
The Citi full-year result demonstrated that it is continuing to recover slowly from the ravages of the original outbreak of financial crisis, when it required a $US45 billion taxpayer bailout. It is, however, being held back by the massive pool of legacy assets it is gradually winding down and, more particularly, by its sizeable global investment banking business.
All investment banks, but most particularly the big Wall Street businesses, are struggling because of the weak levels of capital markets and advisory activity, with risk-averse investors and corporates sitting on the sidelines and the regulatory response to the crisis forcing a withdrawal from once very lucrative proprietary trading activities.
Citi, like JP Morgan Chase last week, was hard hit by the stresses within investment banking. JP Morgan’s investment banking earnings were more than halved. In the fourth quarter, Citi’s investment banking revenues were 45 per cent lower than a year ago and its securities and banking business lost $163 million.
Wells Fargo is in many respects the model for what prudential regulators would like their big banks – the banks deemed as too big to fail – to look like. It is essentially a very, very large consumer bank conducting traditional retail banking activities. It is also fundamentally a domestic bank. Its exposure to investment banking activities is relatively small in relation to the size of the group.
Whether it is formalised, as it has been in the UK where the Vickers Commission recommendation that traditional banking activities be ring-fenced from investment and wholesale banking exposures, or a by-product of the tougher capital and liquidity regimes that will be progressively introduced over the rest of this decade, banking regulators are trying to create incentives, or coerce, their systemically important institutions into looking more like Wells Fargo and less like the old Citi, with its global universal banking strategies.
Citi hasn’t abandoned its global ambitions; indeed its extensive exposure to developing economies is seen as a major positive and a major differentiator for it, given the sluggish nature of the US economy. More than two-thirds of the revenues Citi’s core businesses generate are outside the US.
Nor is it exiting investment banking, although like its peers it is gradually reshaping the nature of its investment banking operations, downsizing them and lowering their risk profile both in response to its crisis experiences and in anticipation of impending regulatory change.
For those market-facing businesses to contribute to its performance, however, it needs a return to some level of normality in capital markets, which the eurozone crisis has pushed some distance into the future.
Like its peers with Wall Street exposures, or indeed Macquarie Group in this market, Citi would have a leveraged exposure to a rebound in markets. In fact the performance of the Wall Street investment banks underscores Macquarie’s achievement in remaining consistently profitable while steadily reshaping its businesses and expanding through the crisis. It too, however, needs market activity levels to improve if it is to generate acceptable returns.
The good news for both Wells Fargo and Citi is that the credit experience in their loan portfolios continues to improve and that there are improving signs from within the US economy.
For Citi, still in the midst of a remaking of its business model that may take some years to complete, declining loan losses and some improvement in demand for its traditional banking products – and its activities in Latin America and Asia – will help provide the core profitability that it needs to offset the volatility and the difficult environment its investment bank is experiencing and also manage the winding down of its big inventory of assets now considered non-core.
Europe and the potential for another global banking crisis, of course, remain major concerns for banks with global operations and exposures.
Wells Fargo is in the comfortable position of having no significant exposure to Europe whereas Citi and its universal bank peers (and Macquarie) inevitably do have direct and indirect exposures to the wobbling region and its depressing impacts on markets and therefore have a number of reasons for hoping that its condition can be stabilised.
Regulators might like all banks to look like Wells Fargo – or the Australian and Canadian banks – but the big US bank holding companies and their international peers are too deeply entrenched in global economies and markets, too committed to their universal banking models and too central to the workings of the global financial system for that to happen.