Wild markets wreaked havoc on Citigroup's trading desks last quarter, and 'everything' took a hit

Alex Morrell

Jan 15, 2019, 00:38 IST

Wild markets wreaked havoc on Citigroup's trading desks last quarter, and 'everything' took a hit

REUTERS/Lang Lang

Bad volatility took a cleaver to Citi's trading revenues.

Traders usually long for market volatility.
But the volatility that materialized in the fourth quarter was the bad kind - spooking investors from participating rather then spurring more action.
That wreaked havoc on Citi's trading businesses in the fourth quarter, and other banks are bracing for trading losses, too.

Wall Street traders usually long for market volatility, which tends to drum up business as their clients feel more compelled to make make moves and try and capitalize on the swings.

Traders got what they asked for in the fourth quarter of 2018 - but they got the "bad" kind of volatility, and it's already wreaking havoc on quarterly earnings results.

Citigroup, the first of the big banks to report earnings, said Monday it suffered a 14% loss in markets revenues compared with the fourth quarter of 2017. That contributed to an overall revenue decline of 2% for the quarter, despite beating net profit expectations.

Citi CFO John Gerspach, in calls with journalists and analysts, pitted most of the blame on market volatility "creating a challenging trading environment."

Unlike the volatility traders sought, the wild market gyrations in December spooked investors from participating in the market - bad volatility. Clients scaled back risk, reducing liquidity and taking a cleaver to Citi's trading revenues.

"What happens when you see that come through, is basically investors move the sidelines," Brian Kleinhanzl, a managing director in banking equity research at Keefe, Bruyette, and Woods, told Business Insider. "They simply don't trade for the most part. So basically what you get is gridlock, with nothing happening."

That means bank trading revenues are subject to whichever way the markets are moving, he said, and in the latter half of the quarter that meant a precipitous drop.

"That's really what we saw in the fourth quarter. The volatility was so much that people didn't know where to jump in, so people just stayed on the sidelines," Gerspach told analysts, several of which probed for more color about the fixed-income losses on the earnings call.

The bank's fixed-income business was the epicenter of the struggles, as the division's revenues fell 21% to $1.9 billion.

Problem signs emerged in early December when Gerspach noted at a financial conference that third-quarter momentum in rates and currencies failed to translate to fourth quarter and that trading revenues were likely to dip. A couple weeks later it came out that Citi's foreign exchange business was facing up to $180 million in losses on loans gone sour to an Asian hedge fund.

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But even without that single loss, the fixed-income division would have been down in the mid-teens as a percentage, Gerspach said.

When asked to describe which businesses were hit hardest, he said: "How would I describe it? Everything."

Within fixed-income, Citi's rates and currencies business fell 26%, while spread products declined 3%.

It wasn't just fixed-income trading that struggled, despite the ugly top-line loss.

Citi's equities business grew 18%, but that's distorted by an extraordinary single loss last year. Bad loans to the owner of South African retailer Steinhoff International inflicted hundreds of millions in losses at banks during the fourth quarter of 2017, Citi among them.

On an underlying basis, equities revenues were actually slightly down, Gerspach said.

While markets have improved in January, Gerspach said that it's still early and conditions have yet to fully recover.

Competitors may not report as deep of losses, given the additional losses Citi suffered on hedge-fund loans, but fixed-income trading is expected to take a hit at all the big banks. We'll get a clearer picture of how Citi's performance compares as its peers report earnings this week.

"We're not really expecting strong results from any bank this quarter," Kleinhanzl said. "It was a tough environment and difficult for any one bank to outperform."

JPMorgan reports Tuesday, Bank of America Merrill Lynch and Goldman Sachs report on Wednesday, and Morgan Stanley reports on Thursday.