Few bankers like to describe what happened to their firms during and after the crisis years of 2008 and 2009, but Citigroup’s Conor Davis shows no such reticence. His giant bank tottered precariously on the verge of failure in late 2008, was forced to take a $45 billion bailout from the U.S. Troubled Asset Relief Program and subsequently had to sack 50,000 employees worldwide to stay afloat. Those measures were incredibly painful at the time, Davis acknowledges, but they positioned Citi’s European fixed-income business — where he works as a senior executive — to benefit from the market’s recovery.
“In some ways the crisis helped us,” says Davis, the bank’s London-based head of investor sales for Europe, the Middle East and Africa. “We were able to internally reorganize and get the architecture right to compete properly. We were forced to do that before anyone else.”
The financial pressure required Citi to focus its fixed-income business more narrowly, on its strongest areas, so the bank moved resources from Latin America and Asia to Europe, Davis says. In the fall of 2008, as the crisis was in full swing, the bank began selectively hiring key players from competitors in the European rates business, which trades government bonds and their derivatives. Among some 40 hires, Citi recruited Andrew Morton, a Canadian who once ran Lehman Brothers Holding’s European fixed-income division, to lead its European rates business.
As Citi was strengthening its fixed-income presence, its European competitors — most of which avoided big cutbacks in the immediate aftermath of the crisis — began taking a knife to their operations. Over the past two to three years, European investment banks have been retrenching in a big way in response to higher capital charges, weak economic conditions and a regulatory and political backlash to some of their own misdeeds. The result has been the surprising ascendance of American investment banks in Europe, something few would have predicted when the financial crisis erupted in the U.S. more than six years ago.
“I’m not trying to tell you that the reason why we’ve come from the depths of despair to the top three or four is because Citi has these amazing superstars,” Davis says. “We certainly have strong people, but unquestionably other banks are pulling back.”
In the most recent survey of investors by research firm Greenwich Associates, Citi tied for third place in overall European fixed income, behind the U.K.’s Barclays and Germany’s Deutsche Bank. That survey was conducted last winter, however, before Barclays announced it would cut its investment bank staff by a quarter and shrink its fixed-income business in response to tighter regulations and weak profitability.
In the Greenwich survey Citi also ranked third in credit and tied for third place in rates, along with HSBC Holdings and JPMorgan Chase & Co. When Coalition, a U.K. research and analytics firm, began publishing investment banking league tables in 2013, Citi and Bank of America Merrill Lynch were identified as the “two strongest performers” by revenue in both European investment banking and European fixed income, currencies and commodities (FICC).
Citi’s success is not a flash in the pan. Over the past five years, as Barclays and Royal Bank of Scotland in the U.K., UBS and Credit Suisse in Switzerland and even Deutsche Bank have pared back their investment banking activities, U.S. banks have powered ahead in the European arena in just about every sector, including the all-important FICC and M&A advisory categories.
According to market researcher Dealogic, in 2014 JPMorgan overtook Deutsche Bank in total European investment banking fees from equity capital markets, debt capital markets, M&A advisory and loans. JPMorgan pulled in $1.656 billion in fees, good for a 7.7 percent market share, compared with $1.652 billion in fees and a 7.6 percent share for Deutsche, which had led the European league table for the previous four years. Goldman Sachs Group came in third, with $1.346 billion in fees and a 6.2 percent share, followed by Morgan Stanley ($1.046 billion) and Citi ($1.037 billion). Four of the top five banks were American. By contrast, four years earlier three of the top five banks were European.
“On an aggregate level there has been a shift in market share across a number of different investment bank sectors from the European banks to U.S. banks,” says Steven Lewis, practice leader for banks and capital markets at Ernst & Young in London.
To be sure, American banks have made cutbacks of their own in response to increased regulatory scrutiny and profitability pressures. Last month BofA Merrill, Citi, Goldman Sachs and JPMorgan reported earnings declines of 6.6 to 86 percent in the fourth quarter, driven in large part by significant drops in trading revenue, especially in their FICC businesses. JPMorgan boss Jamie Dimon complained that banks were “under assault” from regulators that are pursuing costly settlements for everything from the sales of bad mortgage bonds to the alleged fixing of foreign exchange prices, and ratcheting up capital requirements with measures like a new leverage ratio and a capital surcharge for systemically important financial institutions. Yet U.S. banks have thrived more than their European counterparts in the postcrisis years.
The main reason U.S. banks are in the ascendant is that they benefited from an earlier and more aggressive regulatory response to the crisis, bankers and analysts say. U.S. authorities conducted stress tests of major banks in 2009 to ensure they had enough capital to withstand a fresh shock. Those tests prompted a massive round of capital-raising. The Federal Reserve estimates that since 2009 the top 30 U.S. bank holding companies have raised $511 billion in tier-1 capital.
By contrast, European authorities were much slower in forcing their banks to strengthen their balance sheets. The European Banking Authority conducted stress tests in 2010 and 2011, but they failed to inspire market confidence. Within months of earning passing grades in the 2011 tests, for instance, Belgian-French bank Dexia and Spain’s Bankia effectively failed, requiring multibillion-euro government bailouts and forcing Spain to seek assistance from the European Union’s European Stability Mechanism. The situation didn’t stabilize until last year, when the European Central Bank conducted a comprehensive assessment of the euro area’s banking system, prompting scores of institutions to raise billions in fresh capital. In 2013, Barclays raised $12 billion with a rights issue and a bond offering; Deutsche raised $9.9 billion last year.
Europe’s economic weakness, exacerbated by the euro area debt crisis, also has hampered the competitiveness of European banks relative to their American rivals. U.S. consumers basically stopped deleveraging in 2013, corporate earnings have been growing at a healthy pace, and capital markets activity — bond and equity issuance, and mergers — has rebounded strongly; all of this has helped banks restore their profitability. Europe’s banks have seen no such broad-based upturn in activity. Barclays estimates that the return on equity for the investment banking divisions of Europe’s major banks has effectively been halved, from roughly 21 to 25 percent in 2008 to about 10 to 12 percent in 2013. ?As a result, European banks have been pruning their operations more aggressively than their U.S. rivals have. “There has been a conscious decision by a number of European banks to focus their activity on particular aspects of banking and pull out of others,” Ernst & Young’s Lewis says.
Last, U.S. banks enjoy the advantage of scale. They have become global leaders, and a “lot of the fixed costs are now manageable from a scalability basis at a global level,” says Kian Abouhossein, a bank analyst at JPMorgan in London. European banks never really succeeded in getting a good foothold in the U.S. fixed-income market, and thus they were never able to reach the level of global dominance that players such as JPMorgan, Citi and BofA Merrill have.
“Scalability is very important because there are so many fixed costs,” Abouhossein says. “This is the key reason why players like Barclays, RBS and UBS, and to some extent Credit Suisse, are retreating.”
Historically, only Deutsche Bank, Credit Suisse and UBS ever managed to achieve a global presence commensurate with that of Wall Street’s giants. The Swiss banks have been forced to cut back by the Swiss National Bank, which imposed far higher capital requirements than either U.S. or European authorities in a bid to combat the too-big-to-fail problem.
Barclays briefly achieved global scale in a number of key market segments after the bank opportunistically bought the U.S. broker-dealer arm of Lehman Brothers after its bankruptcy filing in September 2008. At its peak the investment banking unit, Barclays Capital, generated 85 percent of the group’s profits. But the architect of Barclays’ investment banking push, Robert Diamond, was forced to resign as CEO in 2012 over allegations that the bank had colluded in efforts to fix Libor, a key lending benchmark. Barclays also was vulnerable because it was more highly leveraged than its U.S. peers: Total assets in 2012 were 23 times tangible equity, compared with 11 times for Goldman Sachs. Diamond’s successor, Antony Jenkins, has been shrinking the group’s investment bank to focus more on commercial and consumer banking (see “Can Barclays’s Shrunken Investment Bank Still Compete?”).
“The investment bank is too exposed to volatility in fixed income, currencies and commodities, and the group is too exposed to volatility in the investment bank,” Jenkins told analysts in a May 2014 conference call to explain the investment bank cutbacks. In July, Barclays reported a 49 percent decline in pretax profits at its investment bank for the first half of 2014, to $1 billion.
Royal Bank of Scotland, which the British government saved during the crisis by taking a 78 percent stake, has dramatically reduced its investment bank, getting out of equities, commodities and M&A advisory altogether. The bank has slashed its balance sheet by more than half, from $3.7 trillion in assets in 2007 to $1.7 trillion in 2014. Bloomberg reported in January that the bank’s CEO, Ross McEwan, held a series of meetings in Singapore with a view to closing its Asian corporate business, which has 2,000 employees. Any such retreat would be part of a broader effort to shed much of the group’s global investment banking business, cutting costs by a massive $6 billion and refocusing RBS on U.K. consumer and commercial banking.
“It’s entirely likely that Barclays and RBS are making major shifts out of any European presence apart from the U.K.,” says Christopher Wheeler, London-based banking analyst at research house Atlantic Equities.
Switzerland’s big banks are also in retreat. Since becoming chief executive at UBS in September 2011, Sergio Ermotti has cut back the investment bank, slashing its rates and credit businesses, which had posted heavy losses, and focusing on its M&A advisory, equity trading and foreign exchange units. As part of the overhaul, the bank shed 10,000 employees, or more than 15 percent of its staff. In the third quarter of 2014, UBS’s investment bank posted a pretax loss of Sf1.28 billion ($1.5 billion) after taking Sf1.7 billion in litigation charges. Rival Credit Suisse reported that investment bank revenue doubled in the third quarter, to $1.52 billion, boosted by underwriting fees from the IPO of Chinese e-commerce giant Alibaba Group Holding. The bank exited the rates-trading and commodities businesses in October 2013; last October it announced that it would cut its balance sheet by a further $68 billion.
Even mighty Deutsche Bank has been trimming its sails. The bank announced in November that it would end its business of trading single-company credit default swaps, one of the most profitable parts of the investment bank business before the financial crisis and an activity that helped fuel the career of Deutsche’s Anshu Jain.
Jain and his co-CEO, Jürgen Fitschen, told employees in a New Year’s memo earlier this month that they will release a new strategic plan in the second quarter and indicated that Deutsche would need to shift from its long-standing reliance on securities trading. “The past year has been one of great changes in our sector and for us,” they wrote. “A mixed outlook for European growth, low interest rates and changing regulation have been some of the factors that challenged us and appear set to persist.”
It can be difficult to track how much each bank makes from specific activities in particular regions. Banks typically report their revenues and earnings globally by sector and give geographic breakdowns, but they don’t provide geographic results by business lines.
Jeffrey Nassof, an analyst who follows European banks at Freeman & Co., a boutique, New York–based M&A advisory firm, estimates that European investment banks saw their share of the investment banking fee pool in Europe decline from 62 percent in 2007 to 55 percent in 2014.
According to Dealogic, JPMorgan led the European M&A advisory rankings last year, with $467 million in fees, followed by Goldman Sachs, with $458 million; JPMorgan also topped the equity capital markets league table, with fees of $510 million, ahead of No. 2 Morgan Stanley, with $385 million. Deutsche Bank led the debt capital markets ranking, with fees of $538 million, followed by JPMorgan, with $436 million. Deutsche was No. 1 in the European rankings in syndicated loans, with $352 million in fees; No. 2 JPMorgan had $228 million.
Greenwich Associates determines market share through interviews with bankers and institutional investors in Europe. By this measure, Barclays continued to dominate the fixed-income business last year, although its market share declined to 11.9 percent from 13.3 percent in 2012. Deutsche followed in second place, with a share of 9.7 percent, down 2.2 percentage points from 2012. JPMorgan was third, with an 8.9 percent share, up half a point from 2012, and Citi was No. 4, with 8.6 percent, up 2.4 points from 2012. JPMorgan led in credit while Barclays led in rates.
“Europe’s biggest fixed-income dealers are putting in place strategies that direct new costly capital toward their best clients,” Greenwich Associates said in an annual survey. “The results: intense competition for the business of a relatively small group of preferred customers, and the shedding of less profitable client relationships by many large dealers.”
According to Frank Feenstra, a market director at Greenwich’s Stamford, Connecticut, headquarters, the European bank activity hit hardest has been the rates business of trading government bonds. “The revenue pool on rates has declined quite a bit, and there is not as much money to be made,” Feenstra says. “At the same time, the cost of doing business has gone up because of higher capital requirements. They just don’t have enough balance sheet to hold as much inventory as in the past.”
Viswas Raghavan, head of EMEA banking for JPMorgan, contends that his bank has been one of the prime beneficiaries of what he calls a flight to quality among institutional clients. “The wallet for investment banking fees has had modest growth, but our share of the wallet has grown much more than that,” Raghavan says.
JPMorgan has bolstered its position in the U.K. market — Europe’s largest for investment banking activities — through its acquisition of Cazenove. JPMorgan bought 50 percent of that firm, famously known as “the Queen’s broker,” in 2005 and acquired the remainder five years later. Last year JPMorgan led the U.K. market with $500 million in fees and a 10.4 percent share, well ahead of Barclays’ $449 million and 7 percent share. Two years earlier Barclays had led with an 8.8 percent share of total fees, compared with JPMorgan’s 6.8 percent.
Raghavan has been on a hiring spree. In July 2014 he poached Dorothee Blessing from Goldman Sachs, where she had worked for 20 years, to become JPMorgan’s head of investment banking for German-speaking Europe. Blessing’s husband, Martin, is CEO of Commerzbank, Germany’s second-largest lender after Deutsche. Reporting to Blessing is Anton Ulmer, whom JPMorgan hired from Morgan Stanley in February 2014 to head investment banking in Austria.
Goldman Sachs is also enjoying growth in Europe. According to a note on the company’s 10-Q filing with the U.S. Securities and Exchange Commission, Goldman’s EMEA revenue rose 20 percent, to $7.55 billion, in the first nine months of 2014, the latest period for which such detail is available.
M&A has been the firm’s strong suit of late: Goldman ranked second in M&A advisory in Europe last year, with a 7.9 percent share of fees. Among its major deals, the firm advised Dublin-based Covidien on a $45.9 billion takeover by Medtronic and Switzerland’s Novartis on the $5.1 billion sale of its animal-health unit to Eli Lilly and Co. Goldman has been “at the forefront of risk-taking in a situation where other banks have been a bit less aggressive than we are,” says Gilberto Pozzi, the bank’s London-based head of European M&A.
Lazard has also gained share in European M&A. Kenneth Jacobs, the firm’s CEO, says U.S. banks are doing well because the weak European economy has led to an increase in merger activity between U.S. and European companies. Last year Lazard was one of three banks advising General Electric Co. on its $17 billion acquisition of the energy business of France’s Alstom. New York–based Centerview Partners and Credit Suisse also advised GE on the deal. Lazard advised TRW Automotive Holdings Corp. on a $13.5 billion acquisition by German auto-parts maker ZF Friedrichshafen.
“With the resurgence of larger deals above $5 billion, you’ve seen our market position strengthen,” says Jacobs, whose bank, ranked No. 10 in European M&A advisory in 2012, with $100 billion in deals, shot to fourth place last year, with $342 billion. “To execute on deals of this size, you have to have very strong local teams and be part of a broader effort globally that leverages off of the different geographies and industry groups.”
The big question for American banks and their European rivals is whether the U.S. inroads are cyclical in nature or likely to be permanent. Today’s loser may be tomorrow’s winner, as Citi has so ably demonstrated.
JPMorgan’s Abouhossein believes it will be hard for European banks to regain lost ground. For banks that have abandoned certain business lines, such as UBS, Barclays and even Deutsche Bank with its exit from single-company credit swaps, getting back in could be difficult.
“History shows that once you exit a business — and we clearly saw that in the technology, media and telecoms crash in 2001 — it is extremely difficult to come back because the hurdle rate of building the business up again is massive,” Abouhossein says.
Adds Atlantic Equities’ Wheeler: “It seems to me that after the crash new regulations and European government issues opened the door for American investment banks to repeat what happened after the Big Bang in the U.K. They came into the European market and became the market leaders.” • •
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