Making and losing money in US money centre banks
The ‘annus horribilis’ for Wall Street’s (and the world’s) biggest banks was 2008, a year I will never forget. Lehman Brothers failed, Citigroup was bailed out by Uncle Sam, Bear Stearns and Merrill Lynch disappeared via shotgun marriages into the ample wombs of JPMorgan and Bank of America, UBS (the world’s largest wealth manager, LOL) lost $50 billion of its own money and only survived due to a secret Swiss-Fed central bank swap line. The trauma of 2008-09 has reshaped the ecosystem of global banking and even the nature, scale and velocity of financial intermediation itself.
Yet 2017 was an annus mirabilis for Wall Street’s money centre bank shares. Donald Trump selected Steve Mnuchin, a secondgeneration Goldman Sachs partner as treasury secretary and Jay Powell, an ex-Carlyle partner, as Fed chairman. The top two financial policymakers in the US are aligned on an aggressive rollback of regulation (Dodd Frank, the Volcker Rule, the anti-derivatives Gestapo, etc) for the first time in the modern history of Wall Street.
Banks are also huge beneficiaries of higher interest rates, higher infrastructure spending, higher loan growth, global merger mania and Trump’s tax cuts. I would not be surprised to see the earnings of America’s top money centre banks to rise 15-17 per cent in 2018 even as returns on equity rise by 150 to 200 basis points. This, ipso facto, is a compelling argument for a valuation rerating.
Readers of this column know I have made no secret of my enthusiasm for Citicorp since 2012, the year an ex Solly bond trader named Mike Corbat replaced Vikram Pandit as CEO. Citi was in terrible shape in 2012, with the loss of dozens of businesses, 50,000 staff and $500 billion in assets in the “bad bank” (Citi Holdings), a fraud in its Mexican Banamex subsidiary, later an embarrassing failure in the annual Fed mandated CCAR stress tests. The shares were trading at 25 when I wrote column after column arguing that Citi was grossly undervalued relative to its earnings potential I thought Citi would be a double bagger for my own family and client portfolios. I was wrong. Citi was not a double-bagger; it was a triple-bagger, now 75.
I lost a few powerful friends in Morgan Stanley’s New York, London and DIFC offices because I recommended investors short the shares of John Mack’s go-go, bond trading-obsessed investment bank in March 2008, when The Bear died (and we all knew the Gorilla at Lehman was toast). Morgan Stanley shares plummeted 50 per cent before John Mack got his chums in Washington to ban short selling and became a bank to access the Fed’s discount window. Then Jamie Gorman replaced Mack as Morgan Stanley CEO, clinched the Smith Barney venture from Citigroup, slashed risk budgets in the trading room (and axed at least a dozen buddies who were managing directors in Manhattan or Canary Wharf) and accumulated $2 trillion in wealth assets. The result? Morgan shares have risen from 10 to 53 in one of the epic money making opportunities in banking.
2018 presents me with a dilemma. Should I take my chips off American banks, load up on banks in Europe, Japan or even emerging markets like Russia, Brazil and South Korea? I am certain that prominent sell side Street bank analysts will raise their estimates for the six biggest banks. I also know that the Powell Fed is behind “the inflation curve” even before poor Jerome has been anointed king of the Fed’s white marble palazzo on Constitution Avenue. This could mean an epic bond market bloodbath and a 20-25 per cent correction in US bank shares. Remember August 2015 to February 2016? China mismanaged its yuan devaluation and Citi shares lost 30 per cent of their value in New York while HSBC lost 40 per cent of its value in Hong Kong and London Then there are the black swans that have triggered banking crises throughout history, from the Florentine Renaissance to Creditanstalt/6,000 US bank failures in the Great Depression to Continental Illinois (history’s first electronic bank run) to the post-Lehman dominoes of 2008.
Yet the Cassandra in me cannot ignore the flattest yield curve in a decade, the spike in deposit betas and the Fed’s liquidity pump’s sputter (adieu, QE!) and Mifid/Basel Three are beyond even Mnuchin’s power to fix and bank mergers pose acquirer deal risk. This means 2018 will be the year to make big money or lose it in US bank shares.