Over the summer, as the U.S. stock market wobbled and then plunged 4 percent in a day, Citigroup made a tough choice: to dial down risk-taking in the bank’s capital markets group.
Phil Drury and Doug Adams, then co-heads of U.S. equity capital markets focused on block trading, a corner of the trading business where razor-thin margins can quickly turn to big losses when markets sour, according to people close to the matter.
Citi plunged in the rankings for that part of the market during the third quarter to number eight, according to data provider Ipreo. The previously unreported numbers mark a big drop for a bank that has topped the list for U.S. block trading in seven of the last 11 quarters.
Citigroup’s (C.N) decision may have been prescient. The Standard & Poor’s 500 index .SPX dropped 7 percent during the quarter, and the market’s lurches and twists were often terrifying for investors. Between August 15 and August 25, The S&P fell 11 percent.
Such declines can prove costly for block trading businesses, where banks buy millions of shares from a company or an investor at just below the market price, and then try to quickly sell the shares to others at somewhere closer to their current market value. Block trades can bring in a million dollars or so in quick profits, but if the market suddenly turns the wrong way a bank can lose a good $20 million.
“People lose far more than they may be admitting to,” said Jonathan Cunningham, co-founder of capital markets advisory firm Aequitas Advisors and a former Jefferies Group head of convertible bond underwriting.
Citigroup’s decision to scale back block trades in the third quarter was not influenced by any trading losses, people familiar with the matter said. Instead, the bank saw potential downside in a business that has helped boost revenue across Wall Street in equities trading and underwriting all year.
Yet some rivals were more willing to try to navigate the tempestuous markets during the quarter, underscoring the tough balancing act bank executives face in weighing market risks against their strategic business goals.
Goldman Sachs Group Inc (GS.N) topped last quarter’s league table for block trades with a 25.6 percent market share of total proceeds, followed by Morgan Stanley (MS.N) and Credit Suisse AG (CSGN.VX) Representatives for the banks declined to comment.
Total proceeds for block trades across all banks held up relatively well during the volatile third quarter, topping $10.3 billion, down just 4 percent from the same period last year.
One reason that not all banks followed Citi in dialing down risk in that quarter could be that block trades help land other business, such as underwriting or merger advisory and also generate more stock trading volume.
“You want to be in the flow, even if you happen to lose.” said Daniel Klausner, who leads the capital market advisory practice at PricewaterhouseCoopers. “If you start losing every single block bid, people stop calling you.”
A spokesman from Citi declined to comment on the bank’s strategy.
Citigroup and other major U.S. banks, such as Bank of America Corp, (BAC.N) and JPMorgan Chase & Co (JPM.N), will probably confess to at least some difficulty in stock and bond trading over the coming days as they post third quarter earnings. Bond trading is likely to suffer the most because of heightened uncertainty when the Federal Reserve might start raising rates has depressed volumes.
For Citigroup, the decision to reduce risk in the third quarter comes at an inopportune time: the bank is trying to build up its stock trading business after years of neglect, through courting hedge funds more aggressively, overhauling its trading technology and hiring key executives, sources told Reuters in August.
As part of those efforts, Drury has moved to London to head up capital markets for Europe, Middle East, and Africa.
Sources familiar with Citigroup said it expected to continue to be aggressive in block trading when the market improves. Even with its pullback in the third quarter, Citi ranks third for U.S. block trades so far this year by volume, behind Credit Suisse and Barclays PLC (BARC.L), Ipreo data show. The ranks first by number of deals.