Banks' Earnings

Banks have been reporting earnings this quarter and they have been terrible, yet their stocks are rallying.

Today Citi reported a huge $6 billion loss, give or take few billions who is counting at this point, and the stock is up 6% or so last time I checked. J.P. Morgan earnings slumped and the market rallied, yet JP Morgan is quietly raising money, although it is one of the better capitalized banks, so its situation is not as strong as everyone believe.

The view is that the huge writedowns are coming to an end and the biggest losses are behind them. I am fine with that point view, but investors tend to underestimate the unpredictability of the consumer lending business losses that banks have yet to absorb. Loss provisions could continue rising in the coming months as the effects of the US slowdown are felt. In prior recessionary periods, credit problems typically followed as a result of the weakening economy.

Another risk is where the earning going to come from going forward?

With housing market on the rocks, the employment situation is shaky and real earnings are being eroded by high inflation, how banks are going to lend or earn fees from the strapped consumers. More importantly banks like Citi have a weakened franchise that can not go after market share.

I have bought USB and BofA recently and I still like them as a business. My picks are for the heavy presence of BofA and USB in their states and the strong market share that can be leveraged to gain additional business from all their weak competitors. I think BofA and USB will grow earnings as a result of gaining business from others rather than nominal growth.

I will not add to my positions or look for another opprtunity in banks, as I think better returns can be had elsewhere.

Visa IPO

Visa's IPO could be one of the biggest IPOs in history reaping $18.8 Billion. At the midpoint of its proposed price range of $37 to $42 a share, Visa's offering of 406 million Class A shares would raise $16 billion. Visa said it might sell an additional 40.6 million shares to meet demand, which could boost the proceeds to almost $18.8 billion at the top end.

Although Visa's IPO will be the biggest IPO in history, Visa will see very little of the proceeds for its operations. According to its registration statement with the SEC the use of the proceeds will be as follows:

1. $3 Billion to go to an litigation escrow
2. $10.2 Billion to pay out existing shareholders
   
3. $2.346 Billion to be used to redeem other securities from shareholders later in 2008
   
4. The balance of $454 Million will be used for general corporate purposes.
   

There are big differences between Visa and MasterCard's IPOs. MasterCard came with no litigation risk associated with its operation not like Visa which have a huge litigation risk hanging over its head. A large chunk of the IPO proceeds will go for litigation reserve escrow; money that will not be used for operations. The other difference is the net cash inflow to Visa operations from the IPO will be much smaller that MasterCard's. MasterCard took in $650 Million or 26% of its IPO, while Visa is taking in only a mere 2.8%, which will not contribute much to expand its operations.

Still Visa's business is very intriguing as it gives owners a sustainable competitive advantage that is worth the risk. I am still reading their prospectus to understand their exposure and risk, it is not very east to digest.

On another note, BofA along with JP Morgan are the big beneficiary from the IPO from three sources:

1. As shareholders there are poised to make a windfall capital gains on their ownership stake, which will shore up their capital base.
   
2. The two banks are the two lead underwriters of the IPO; their fees and options will provide for nice gain in 2008.
3. With Visa off their books they can limit their exposure for further litigation risk that is plaguing Visa; it will become Visa's public shareholders problem.

Citi subprime ills could spark takeover by JPMorgan: analysts | Reuters

Citi subprime ills could spark takeover by JPMorgan: analysts | Reuters


I just love headlines like these; wild speculation with no hope to materialize. It never going to happen. Although Dimon would love to be back into the driver seat at Citi, a position he coveted before he was forced to leave the bank, I do not think he will take the bait.

Citi would not offer JPM any significant assets in the US, but it will offer them a significant international exposure, which is what is really valuable at Citi. JPM lacks that international exposure and buying it at this time would be opportune investment. But the premium of fixing Citi, I think is too taxing. Citi is too large and disorderly and have morale issue at the moment. Combining two large entities like JPM and Citi will be a huge undertaking that even deal savvy Dimeon will find hard to accomplish. JPM would much better in finding smaller acquisition internationally than buying Citi.

Citi shareholders may not like this as well. Citi has Price Alwaleed, Eddie Lambert, Abu Dabhi Fund and others who invested in a troubled company to realize excess returns. A buyout at this time will short change that prospect.

I will be surprised if an offer is made to Citi.

Photo courtesy of barron's

In the Lead - Barron's Online: JPM

In the Lead - Barron's Online


The publication praised the bank for its management quality, risk management, and growth potential. In my research in Bank of America, see post here, I did realize the value of JP Morgan. The bank have one of the best management team, tech savvy, deal experienced and cost conscious. very important qualities in many management teams, let alone a bank of the caliber of JPM.

However, my problem with JPM is it derives a considerable revenue from investment banking and those revenue stream can be very volatile. The income stream can fluctuate widly and hinges on careful management execution where margin for error is much smaller than retail banking.

Another factor is valuation, JPM is richly valued. Investors are factoring tremendous growth in its future earnings. The bank will have good revenue growth going forward but the price premium it commands relative to other banks is large. Mostly the premium is Mr. Dimon factor. Mr Dimon is considered as the best banker on the street. No doubt Mr. Dimeon has helped built Citi into an empire.

The bank is well run and have solid assets base but it is pricey for a value idea.