Citigroup once again was on the receiving end of bad press when it was named as one of the 17 organizations sued by the U.S. government over losses in subprime mortgage bonds. The negative publicity was out of proportion to Citigroup’s exposure, which was $3.5 billion. Of the 17 organizations named in the lawsuits only four others were sued for less.
The lawsuits were filed by the Federal Housing Finance Agency (FHFA), which is the government entity that oversees Fannie Mae and Freddie Mac. The lawsuits allege the named organizations sold bonds backed by mortgages that should have never been packaged into securities. The lawsuits cover a total of $196.165 billion in securities.
In contrast to Citigroup, Bank of America was sued for a total of $57.453 billion (BAC $6 billion, Countrywide $26.6 billion, Merrill Lynch $24.853 billion) and JPMorgan Chase was sued for $33 billion.
The following is a listing of the 17 named in the lawsuits and the dollar amount (in billions) of securities in question.
• Ally Financial $6
• Bank of America $6
• Countrywide (unit of BofA) $26.6
• Merrill Lynch (unit of BofA) $24.853
• Barclays Plc $4.9
• Citigroup $3.5
• Credit Suisse $14.1
• Deutsche Bank AG $14.2
• First Horizon National Corp. $0.883
• General Electric Co. $0.549
• Goldman Sachs Group $11.1
• HSBC $6.2
• JPMorgan Chase & Co. $33
• Morgan Stanley $10.58
• Nomura Holdings Inc. $2
• Royal Bank of Scotland $30.4
• Societe Generale $1.3
• Total: $196.165
Disclosure: I am long Citigroup
Saturday, September 3, 2011
Thursday, July 21, 2011
Citigroup’s Technical Pattern Indicates Upside Potential
A review of Citigroup’s (C) closing stock prices for the past 24 months reveals an interesting pattern. In a two month period from 12/17/2009 through 2/12/2010 Citigroup tested a floor price of $31.49 five times. Closing prices were $31.99 on 12/17/2009, $31.49 on 1/26/2010, $31.79 on 2/4/2010, $31.49 on 2/8/2010, and $31.79 on 2/12/2010. Within three months of its fifth test of its low closing price, Citigroup rose to $49.49 on 4/20/2010.
The stock then nosedived and within a month it had fallen to a low of $36.29 on 5/20/2010. That closing low would then be tested four times which were on 6/7/2010 at $36.39, on 6/29/2010 at $37.29, on 8/26/2010 at $36.59, and on 6/8/2011 at $36.81. Like during the earlier period, Citigroup has withstood five tests of its most recent low.
If Citigroup responds to this fifth test of its low as it did the last time then investors can expect C to challenge the $50 price level within the next several months. On four occasions during the past two years Citigroup has approached or exceeded that price. On 8/28/2009 it closed at $52.29, on 10/14/2009 it reached $49.99, on 4/20/2010 it hit $49.69, and on 1/14/2011 it closed at $51.29.
This data strongly suggests that Citigroup’s current stock price offers much more upside potential than downside risk.
Disclosure: I am long Citigroup common stock
Friday, July 15, 2011
Citigroup (C) Declines After Earnings
Before the stock market opened on July 15 Citigroup (C) reported a 21% earnings per share increase in second quarter above the comparable 2010 quarter . Its stock surged $1.37 or 3.5% at the opening to $40.39 . This rise in price was accompanied by heavy volume and seemed to offer a glimmer of hope to long suffering shareholders. By noon, however, Citigroup (C) had lost all its gains. During the afternoon (C) fell as low as $38.12 before ultimately finishing the day off $0.64 or 1.64% at $38.38.
The dispiriting price action for Citigroup was accompanied by price declines in JP Morgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC). The percentage decline at (C) was greater than at these other large banks.
It seems clear that in the current environment market participants will always be able to find something disturbing with bank financials that will outweigh any improvements cited by management. In the case of Citi the decline in net interest margin (NIM) to 2.82% in the second quarter of 2011 from 2.88% the previous quarter was particulary unwelcome news. During the second quarter of 2010 Citi had reported a NIM of 3.15%; therefore, NIM declined by 33 basis points or 10.5% in one year. Wall Street hates declines in margins and has a long history of punishing companies and/or industries that experience such declines.
An examination of the decline in net interest margin at Citi reveals it was largely attributable to a very pronounced decline in the yield on its investment portfolio. The yield on that portfolio was 2.79% during the quarter just ended, while it was 3.17% during the first quarter of 2011 and 3.89% during the second quarter of 2010. This is a remarkable and worrisome decline in yield on an investment portfolio that averaged $318 billion during the second quarter of 2011, $320 billion in the prior quarter and $311 billion during the second quarter of 2010.
Adding further selling pressure to (C) was the fact that Citigroup increased its staff by 2% or 3,000 people during the second quarter. The fact that it increased staff while margins were under pressure is a source of concern even though its total staff is the same as it was the year before. Investors generally expect payroll reductions, not additions, when margins are under pressure.
On a positive note it should be mentioned that loans outstanding rose slightly in the second quarter versus the prior quarter and the average loan yield rose 13 basis points to 7.93%. Loans outstanding still remain well below the level of the prior year.
The positive impact that would result from redeploying funds from investments yielding 2.79% and deposits with other banks yielding 1.06% into quality loans yielding 7.93% is obvious. Citi needs to accelerate its lending if it expects to meaningfully increase its income by reversing the decline in its net interest margin, and it must do so without compromising credit quality. If its lending staff cannot generate quality loans then Citi will have to start acquiring fixed and floating rate corporate obligations with the ample funds it currently has available.
Disclosure: I am long C
The dispiriting price action for Citigroup was accompanied by price declines in JP Morgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC). The percentage decline at (C) was greater than at these other large banks.
It seems clear that in the current environment market participants will always be able to find something disturbing with bank financials that will outweigh any improvements cited by management. In the case of Citi the decline in net interest margin (NIM) to 2.82% in the second quarter of 2011 from 2.88% the previous quarter was particulary unwelcome news. During the second quarter of 2010 Citi had reported a NIM of 3.15%; therefore, NIM declined by 33 basis points or 10.5% in one year. Wall Street hates declines in margins and has a long history of punishing companies and/or industries that experience such declines.
An examination of the decline in net interest margin at Citi reveals it was largely attributable to a very pronounced decline in the yield on its investment portfolio. The yield on that portfolio was 2.79% during the quarter just ended, while it was 3.17% during the first quarter of 2011 and 3.89% during the second quarter of 2010. This is a remarkable and worrisome decline in yield on an investment portfolio that averaged $318 billion during the second quarter of 2011, $320 billion in the prior quarter and $311 billion during the second quarter of 2010.
Adding further selling pressure to (C) was the fact that Citigroup increased its staff by 2% or 3,000 people during the second quarter. The fact that it increased staff while margins were under pressure is a source of concern even though its total staff is the same as it was the year before. Investors generally expect payroll reductions, not additions, when margins are under pressure.
On a positive note it should be mentioned that loans outstanding rose slightly in the second quarter versus the prior quarter and the average loan yield rose 13 basis points to 7.93%. Loans outstanding still remain well below the level of the prior year.
The positive impact that would result from redeploying funds from investments yielding 2.79% and deposits with other banks yielding 1.06% into quality loans yielding 7.93% is obvious. Citi needs to accelerate its lending if it expects to meaningfully increase its income by reversing the decline in its net interest margin, and it must do so without compromising credit quality. If its lending staff cannot generate quality loans then Citi will have to start acquiring fixed and floating rate corporate obligations with the ample funds it currently has available.
Disclosure: I am long C
Wednesday, May 4, 2011
CitiFinancial Sale Weighs on Citigroup
For several months, Citigroup has been seeking a buyer for CitiFinancial, which is the largest consumer finance company in the US. CitiFinancial is reported to have a book value of about $2 billion and some $13 billion in assets. The delay in getting this transaction done is weighing on Citigroup’s stock.
This unit of Citigroup is one of the many trophies Sandy Weill acquired as CEO when he paid $31 billion in Citi stock for Associates First Capital, CitiFinancial’s predecessor. In 2010 Citigroup closed more than 300 CitiFinancial branches, stopped making loans at another 184 and rebranded the remaining 1,500 outlets OneMain Financial.
Four groups had been rumored to be among the interested bidders. One group was comprised of private equity firms Warburg Pincus LLC WP.UL and KKR & Co LP. It was supposedly aligned with Spain's Banco Santander and BlackRock Inc.
A second group of rumored bidders included Brysam Global Partners, Blackstone Group LP, Carlyle Group CYL.UL, Thomas H. Lee Partners THL.UL and Wilbur Ross' WL Ross & Co. Brysam is run by former Citigroup executives, including former COO Robert Willumstad and former Global Consumer Group CEO Marjorie Magner, who know CitiFinancial well.
Other rumored bidding groups had included Apollo Management APOLO.UL and J.C. Flowers; and Clayton Dubilier & Rice and Onex Corp.
Disposition of this troubled consumer-lending unit has dragged on to the point where it appears to be getting shop worn. Terms keep changing as Citigroup attempts to avoid a significant loss on any sale, while at the same time it unloads troubled loans.
On May 4 the New York Post, citing people close to the transaction, reported that the Brysam Group and the Apollo Group have both dropped out of the bidding.
This unit of Citigroup is one of the many trophies Sandy Weill acquired as CEO when he paid $31 billion in Citi stock for Associates First Capital, CitiFinancial’s predecessor. In 2010 Citigroup closed more than 300 CitiFinancial branches, stopped making loans at another 184 and rebranded the remaining 1,500 outlets OneMain Financial.
Four groups had been rumored to be among the interested bidders. One group was comprised of private equity firms Warburg Pincus LLC WP.UL and KKR & Co LP. It was supposedly aligned with Spain's Banco Santander and BlackRock Inc.
A second group of rumored bidders included Brysam Global Partners, Blackstone Group LP, Carlyle Group CYL.UL, Thomas H. Lee Partners THL.UL and Wilbur Ross' WL Ross & Co. Brysam is run by former Citigroup executives, including former COO Robert Willumstad and former Global Consumer Group CEO Marjorie Magner, who know CitiFinancial well.
Other rumored bidding groups had included Apollo Management APOLO.UL and J.C. Flowers; and Clayton Dubilier & Rice and Onex Corp.
Disposition of this troubled consumer-lending unit has dragged on to the point where it appears to be getting shop worn. Terms keep changing as Citigroup attempts to avoid a significant loss on any sale, while at the same time it unloads troubled loans.
On May 4 the New York Post, citing people close to the transaction, reported that the Brysam Group and the Apollo Group have both dropped out of the bidding.
Monday, April 18, 2011
The Revenue Growth Fixation
Financial analysts have been focusing their attention on revenue growth because of a general belief that companies need such growth to fuel earnings at this stage of the business cycle. While this focus certainly has merit for most businesses, it is far less applicable to financial firms.
Revenue at the major commercial banks is a mixture of interest income and noninterest income and is not identical to sales figures reported by nonfinancial firms. The former is determined by the level of interest rates and the volume of earning assets. Increases in rates and volume of earning assets will be accompanied by revenue growth.
Analysts were quick to point out that gross revenue at Citigroup was down 22% in the first quarter of 2011 versus the first quarter of 2010. Few, however, mentioned that the decline in assets at Citi Holdings was a prime contributing factor.
Citi Holdings is effectively the “bad bank” Citigroup created to house its worst assets during its near death experience. The assets in Citi Holdings fell by $166 billion or 33% from the end of the first quarter of 2010 to the end on the first quarter in 2011. Concurrently, revenue declined 50% to $3.3 billion and that accounted for 57.9% of the decline in Citigroup’s total revenues.
As of March 31, 2011 Citi Holdings had total assets of $337 billion, which is down from a peak of $827 billion reached during the first quarter of 2008. Citigroup management has clearly stated it considers the businesses and assets contained in Citi Holdings to be nonessential to its core business going forward. The remaining assets are to be liquidated through business divestitures, portfolio run-offs and asset sales.
A continued reduction in Citi Holdings assets will weigh on Citigroup’s gross revenues; however, it should continue to lower Citigroup’s risk profile. Citi Holdings reported losses of $36.5 billion in fiscal 2008, $8.8 billion in 2009, $4.0 billion in 2010 and $0.6 billion during the first quarter of 2011.
Disclosure: I am long Citigroup (C)
Friday, April 8, 2011
Tough Comparison For Citigroup (C)
Citigroup (C) is scheduled to release its first quarter earnings on April 18. It is important to note that the first quarter of 2010 was, by far, the most profitable quarter last year for Citi. In that quarter it earned $4.428 billion.
The first quarter of 2010 was followed by progressively worse quarters as it earned $2.697 billion in the second quarter, $2.168 billion in the third quarter and $1.309 billion in the fourth quarter. This trend of declining quarterly earnings is unacceptable, weighs of the stock price and must end in 2011. Bank earnings should be relatively consistent throughout a year.
Recent appearances and comments by Chairman Richard Parsons and CEO Vikram Pandit suggest that Citi has turned the corner. The forthcoming April 18 report will either reinforce that view and be well accepted by shareholders, or Parsons and Pandit will be confronted by a hostile crowd at Citi’s annual stockholders’ meeting on April 21.
The fact is that it will be difficult for Citi to report earnings above last year’s first quarter and that is why Citi call options are so quiet. Things could change quickly if Citi reports an increase in reported earnings and they then forecast even better results for the rest of 2011. Today, few market participants seem willing to bet on such a favorable scenario unfolding in the next few weeks.
Disclosure: I am long Citigroup (C)
Sunday, February 6, 2011
What is Citigroup (C) Worth?
Belief that credit quality at the largest lending institutions is improving continues to gather adherents. As bank balance sheets heal from their near mortal wounds it is time to look ahead and ask how much these banks can earn so investors can determine how much a share of stock is worth. In this regard it seems appropriate to focus on Citigroup (C) since it came so close to financial death, has a unique worldwide franchise, and did not acquire other troubled institutions during the financial meltdown.
Credit quality is clearly improving at Citigroup (C) as evidenced by the fact that non-accrual assets at the end of 2010 were 37% ($12.2 billion) lower than they had been at year-end 2009. This improvement helped Citigroup report net income of $10.6 billion for 2010 versus a loss of $1.6 billion in 2009.
Citigroup's board recently approved a base salary of $1.75 million for CEO Vikram Pandit. Pandit had vowed in 2009 to receive an annual salary of $1 until Citigroup returned to sustained profitability. This recent board action is therefore particulary interesting.
Credit quality is clearly improving at Citigroup (C) as evidenced by the fact that non-accrual assets at the end of 2010 were 37% ($12.2 billion) lower than they had been at year-end 2009. This improvement helped Citigroup report net income of $10.6 billion for 2010 versus a loss of $1.6 billion in 2009.
Citigroup's board recently approved a base salary of $1.75 million for CEO Vikram Pandit. Pandit had vowed in 2009 to receive an annual salary of $1 until Citigroup returned to sustained profitability. This recent board action is therefore particulary interesting.
Given the implied belief that sustained profitability has returned at Citigroup, investors now need to ask how much Citigroup can be expected to earn going forward and how much of a dividend will it pay to shareholders. Future earnings and dividends will largely dictate price movements in C.
An appropriate way to determine future earnings is to focus on a bank’s return on total assets (ROA). This measure has always been a generally accepted, standard metric used to compare the relative profitability of banks. For example, high-earning banks typically earn more than 2% on their assets, while low-earning banks earn less than 1%.
The SEC filings of Citigroup during the relatively halcyon period from 1997 through 2006 revealed that its ROA ranged from a low of 0.79% in 1998 to a high of 1.66% in 2005. Its average ROA for that decade was 1.33%. Its dividend payout during this same time period ranged from a low of 13.98% of net income in 1997 to a high of 48.19% in 2004. Its average dividend payout from 1997 through 2006 was 27.95%.
At the end of 2010 Citigroup reported total assets of $1.915 trillion, more than 12% below its 2008 asset peak of $2.187 trillion, but up slightly from the end of 2009. It is likely that Citigroup is in the early stages of expanding its asset base; however, its rate of asset growth should not be expected to equal or exceed the 8.09% annual average achieved from 1997 through 2006 when its total assets grew from $680 billion to $1.484 trillion.
In a book I wrote for the American Bankers Association titled Asset/Liability Management I noted that high-earning banks had higher earning power ratios, which I defined as the ratio of interest earning assets divided by interest paying liabilities (EA/PL). Other things being equal, the bank with the highest earning power will be more profitable as measured by ROA.
A particularly healthy sign at Citigroup is the fact that its earning power is once again rising. From 1997 through 2010 Citigroup’s earning power (EA/PL) ranged from a high of 125.18% in 1999 to a low of 107.88% in 2008. Importantly, Citigroup’s earning power reached 113.59% in the fourth quarter of 2010, which is the highest reading since 2000. The recent increase in this important predictor of bank income reflects improving credit quality at Citigroup as loans return to accrual and the continued jettisoning of non-earning assets.
A conservative forecast using the above data suggests that Citigroup’s total assets can be expected to grow by 6% per year. Its ROA in 2010 was about 0.50%. Accordingly, it is reasonable to expect that Citigroup’s ROA should return to the 1% area in the near future and that it could comfortably payout 20% of net income in common stock dividends.
The application of these assumptions yields earnings per share for Citigroup of about $0.66 per share for 2011 and a dividend of about $0.12. By 2015 earnings per share should reach $0.85 and dividends $0.17.
At a current price of $4.82, Citigroup shares are valued at 7.3 times expected 2011 earnings and 5.7 times 2015 earnings. By comparison the S & P 500 and KBW bank indexes are both trading around 15 times earnings.
This brief analysis suggests that a significant increase in Citigroup’s stock price is possible as the turnaround at Citigroup gathers momentum and it returns to financial health. A doubling in the current price of C would put its price earnings multiple on par with other large corporations in its peer group and should not be ruled out.
An appropriate way to determine future earnings is to focus on a bank’s return on total assets (ROA). This measure has always been a generally accepted, standard metric used to compare the relative profitability of banks. For example, high-earning banks typically earn more than 2% on their assets, while low-earning banks earn less than 1%.
The SEC filings of Citigroup during the relatively halcyon period from 1997 through 2006 revealed that its ROA ranged from a low of 0.79% in 1998 to a high of 1.66% in 2005. Its average ROA for that decade was 1.33%. Its dividend payout during this same time period ranged from a low of 13.98% of net income in 1997 to a high of 48.19% in 2004. Its average dividend payout from 1997 through 2006 was 27.95%.
At the end of 2010 Citigroup reported total assets of $1.915 trillion, more than 12% below its 2008 asset peak of $2.187 trillion, but up slightly from the end of 2009. It is likely that Citigroup is in the early stages of expanding its asset base; however, its rate of asset growth should not be expected to equal or exceed the 8.09% annual average achieved from 1997 through 2006 when its total assets grew from $680 billion to $1.484 trillion.
In a book I wrote for the American Bankers Association titled Asset/Liability Management I noted that high-earning banks had higher earning power ratios, which I defined as the ratio of interest earning assets divided by interest paying liabilities (EA/PL). Other things being equal, the bank with the highest earning power will be more profitable as measured by ROA.
A particularly healthy sign at Citigroup is the fact that its earning power is once again rising. From 1997 through 2010 Citigroup’s earning power (EA/PL) ranged from a high of 125.18% in 1999 to a low of 107.88% in 2008. Importantly, Citigroup’s earning power reached 113.59% in the fourth quarter of 2010, which is the highest reading since 2000. The recent increase in this important predictor of bank income reflects improving credit quality at Citigroup as loans return to accrual and the continued jettisoning of non-earning assets.
A conservative forecast using the above data suggests that Citigroup’s total assets can be expected to grow by 6% per year. Its ROA in 2010 was about 0.50%. Accordingly, it is reasonable to expect that Citigroup’s ROA should return to the 1% area in the near future and that it could comfortably payout 20% of net income in common stock dividends.
The application of these assumptions yields earnings per share for Citigroup of about $0.66 per share for 2011 and a dividend of about $0.12. By 2015 earnings per share should reach $0.85 and dividends $0.17.
At a current price of $4.82, Citigroup shares are valued at 7.3 times expected 2011 earnings and 5.7 times 2015 earnings. By comparison the S & P 500 and KBW bank indexes are both trading around 15 times earnings.
This brief analysis suggests that a significant increase in Citigroup’s stock price is possible as the turnaround at Citigroup gathers momentum and it returns to financial health. A doubling in the current price of C would put its price earnings multiple on par with other large corporations in its peer group and should not be ruled out.
Sunday, January 23, 2011
Citigroup Undervalued
Valuation of common shares in bank holding companies has become a challenge as the amount of data released in SEC filings has increased. Analysts have responded by narrowing their focus to selected metrics such as the current share price divided by tangible common equity per share and net interest margin. An examination of these measures for six (6) of the largest bank holding companies shows significant variation and suggests that at the present time some are undervalued relative to others.
The bank holding company trading at the greatest premium above its tangible book value as of the close on January 21, 2011 was U.S Bancorp (USB) at 2.89 times. At the other extreme, Bank of America (BAC) and Citigroup (C)trade at the smallest premium to their tangible equity, 1.10 times. The second largest premium observed was for Wells Fargo (WFC), which trades at 2.34 times its tangible equity. It was followed by PNC at 1.65 times and JP Morgan (JPM) at 1.49 times.
Net interest margin (NIM) is the difference between interest income and interest expense expressed as a percentage of interest earning assets. It is normally presented on a taxable equivalent basis and is a measure of relative profitability of a banking franchise. An examination of the fourth quarter net interest margins reported last week in the SEC 8-K filings for the above six companies showed WFC had the highest at 4.16%, followed by PNC at 3.93%, USB at 3.83%, C at 2.97%, JPM at 2.87%, and BAC at 2.66%.
This brief analysis suggests that at the present time BAC and C are undervalued relative to JPM, while WFC and USB are overvalued relative to all the other bank holding companies examined.
The bank holding company trading at the greatest premium above its tangible book value as of the close on January 21, 2011 was U.S Bancorp (USB) at 2.89 times. At the other extreme, Bank of America (BAC) and Citigroup (C)
Net interest margin (NIM) is the difference between interest income and interest expense expressed as a percentage of interest earning assets. It is normally presented on a taxable equivalent basis and is a measure of relative profitability of a banking franchise. An examination of the fourth quarter net interest margins reported last week in the SEC 8-K filings for the above six companies showed WFC had the highest at 4.16%, followed by PNC at 3.93%, USB at 3.83%, C at 2.97%, JPM at 2.87%, and BAC at 2.66%.
This brief analysis suggests that at the present time BAC and C are undervalued relative to JPM, while WFC and USB are overvalued relative to all the other bank holding companies examined.
Tuesday, January 18, 2011
Back From The Brink
The financial media is awash with speculation about major bank holding companies increasing dividends and/or buying back shares. While regulatory authorities have acknowledged that bank balance sheets are healing, those same regulators need to remember how difficult it was to raise bank capital within the past few years. Similarly, bank holding company board members need to carefully balance the care and feeding of shareholders with the need to re-establish sound dividend policies that will not have to be reversed.
An overly aggressive dividend policy runs a serious risk of financial embarrassment in the event that a dividend has to be cut in the future. A better option would be for a bank holding company to pay modest quarterly dividends and then augment them with a year-end extra dividend based on the full year results.
A review of the financials for Bank of America, JP Morgan, Citigroup, Wells Fargo, and U.S. Bancorp for the period from 2005 through the third quarter of 2010 suggests that none of them are strong enough to buy back shares. They all remain highly levered financial institutions that have benefited from a period of artificially low interest rates.
These five bank holding companies have significant amounts of goodwill on their balance sheets as a result of acquisitions and accounting treatments accorded by U.S. GAAP. Goodwill is represents the excess of the purchase price of an acquired entity over the fair value amounts assigned to assets acquired and liabilities assumed. Even though goodwill must be tested for impairment every year, its true value is very questionable and excluded from tangible common equity and Tier 1 capital calculations.
As of September 30, 2010 goodwill accounted for 35.60% of Bank of America’s common equity, 32.21% of U.S. Bancorp’s, 29.35% of JP Morgan’s, 21.35% of Wells Fargo’s, and 15.65% of Citigroup’s. Given the significant amounts of goodwill, the degree of financial leverage among the five aforementioned bank holding companies was gauged by reducing their common equity by goodwill and then expressing that more tangible amount as a percentage of total assets. This methodological approach revealed that Wells Fargo had the lowest degree of financial leverage at 7.49%, while JP Morgan had the highest at 5.48%. In between were Citigroup at 7.01%, U.S. Bancorp at 6.53% and Bank of America at 5.85%.
This brief analysis strongly suggests that it would be folly for the major bank holding companies to buy back shares of their common stock and/or establish large dividend payouts so soon after perching on the financial abyss. The general public, as well as shareholders, would be better served by these companies using their earnings to support loan growth. This generation of bankers needs to understand that the public’s appetite for bailing out banks has been satiated for the foreseeable future. Banks must therefore be operated with more common equity and less financial leverage.
An overly aggressive dividend policy runs a serious risk of financial embarrassment in the event that a dividend has to be cut in the future. A better option would be for a bank holding company to pay modest quarterly dividends and then augment them with a year-end extra dividend based on the full year results.
A review of the financials for Bank of America, JP Morgan, Citigroup, Wells Fargo, and U.S. Bancorp for the period from 2005 through the third quarter of 2010 suggests that none of them are strong enough to buy back shares. They all remain highly levered financial institutions that have benefited from a period of artificially low interest rates.
These five bank holding companies have significant amounts of goodwill on their balance sheets as a result of acquisitions and accounting treatments accorded by U.S. GAAP. Goodwill is represents the excess of the purchase price of an acquired entity over the fair value amounts assigned to assets acquired and liabilities assumed. Even though goodwill must be tested for impairment every year, its true value is very questionable and excluded from tangible common equity and Tier 1 capital calculations.
As of September 30, 2010 goodwill accounted for 35.60% of Bank of America’s common equity, 32.21% of U.S. Bancorp’s, 29.35% of JP Morgan’s, 21.35% of Wells Fargo’s, and 15.65% of Citigroup’s. Given the significant amounts of goodwill, the degree of financial leverage among the five aforementioned bank holding companies was gauged by reducing their common equity by goodwill and then expressing that more tangible amount as a percentage of total assets. This methodological approach revealed that Wells Fargo had the lowest degree of financial leverage at 7.49%, while JP Morgan had the highest at 5.48%. In between were Citigroup at 7.01%, U.S. Bancorp at 6.53% and Bank of America at 5.85%.
This brief analysis strongly suggests that it would be folly for the major bank holding companies to buy back shares of their common stock and/or establish large dividend payouts so soon after perching on the financial abyss. The general public, as well as shareholders, would be better served by these companies using their earnings to support loan growth. This generation of bankers needs to understand that the public’s appetite for bailing out banks has been satiated for the foreseeable future. Banks must therefore be operated with more common equity and less financial leverage.
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