Citigroup Speculation: A Picture Of What's To Come?

Includes: C, IYF
by: John M. Mason

In July, I posted an article titled Wall Street Banks are Back. It was earnings season and I led off with the following:

"In terms of reporting profits, this was a good week for the largest banks in the United States.

The largest six banks in the United States reported earnings of $23.1 billion, which brings them back into the heydays of 2006 and 2007."

I cautioned, however, that:

"What is missing…is that a great deal of the profit being earned by the largest twenty-five domestically chartered banks in the United States is that the earnings of these financial institutions are not coming primarily from the fundamental banking business. The results are being achieved from a multitude of reasons, none of them connected specifically with sustainable business performance."

Well, now we are hearing some caution about the earnings we are about to receive. Tom Braithwaite and Camilla Hall write in the Financial Times, "Citigroup Suffers Revenue Slide."

"Citigroup (NYSE:C) has suffered a significant decline in trading revenues that threatens to depress its earnings, according to people familiar with conversations between investors and the bank in recent days.

With a week to go before the end of the quarter, the US's third-largest bank by assets appears ready to join several of the powerhouses of bond trading in reporting a slide in trading revenues after a sharper-than-expected summer slowdown in markets business."

Seems as if the rise in longer-term interest rates during the summer has resulted in reduced trading within bond trading units and the reduction was great enough to affect third quarter results.

"Some investors believe that revenues will fall by significantly more than 10 percent."

There had been some hope that a Fed "tapering" move might set off greater trading amounts in this last part of September, but that thought fell by the wayside with the Fed's Wednesday announcement that it was not going to "taper" at this time.

Other banks have announced similar impacts. For example, last Friday the Financial Times reported that revenue growth at Deutsche Bank was going to be hurt by the weakness in fixed income trading. And, last week, Barclays indicated "income had fallen 'significantly' in July and August because of lower fixed income revenues." And Credit Suisse has provided a similar report.

The bottom line: these big banks can earn a lot of income from a wide variety of sources, but these sources tend to be highly volatile. One quarter the earnings performance may come from reductions in expenses; the next quarter they may come from a reduction in loan loss allocations; and in a third quarter the earnings rebound from trading profits.

This is what large banks (around the world) do these days. Traditional banking is not the thing that drives profits in these institutions. In this, they are much riskier institutions than they were in the past … and not just because of low capital ratios.

But, this is where the macro-economy drives big bank earnings and it is why the big banks get into all these different types of activities. They can make money there. Investors, however, should not kid themselves by thinking that they are investing in "commercial" banking when they put their money down on these institutions. And, in unstable times like these are, one can question whether or not one should even be considering these behemoths for investing at all. They may just be a vehicle for "trading."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.