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.

GE to Buy Most of Citis Commercial Lending Unit - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

GE to Buy Most of Citis Commercial Lending Unit - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times


Citi has been selling its assets left and right. Lets recap some of the sales:

• Sale of commercial and leasing unit to GE,
• Sale of leveraged loans to private equity,
• Sale to Wells Fargo & Co. (WFC) of consumer and business deposit accounts and loans, totaling $500 million in deposits and $60 million in loans,
• The closing of several branches around the country this year -- eight in Texas, six in Florida, three in New Jersey, one in California and one in Maryland,
• Halt plans to open two branches in Florida, two in California, and two in Maryland,
• Sale and lease back of real estate: it has conducted several sale and lease back transaction on some of its buildings,
• Selling or closing some retail branches and consumer-finance operations in Europe, Asia and Latin America.

Most of Citi moves have one thing in common: protect the international franchise, while shedding all US retail operation to a minimum. Citi is in a tight bind and they rather sacrifice the US operations for the growing international units. I think Citi will emerge from this realignment as an international investment and commercial bank mainly rather than a mega super store financial institution, which is fine as long as they have a solid and clear vision of themselves.

Additional moves made by Citi, from Forbes magazine:

- MORTGAGES: Earlier in March, Citi said it would reduce the residential mortgage assets of its U.S. mortgage business by about $45 billion over the next 12 months.

-- WEALTH MANAGEMENT: Citi said earlier in March that it would reorganize its wealth management business.

-- LAYOFFS: Citigroup, having eliminated 17,000 jobs last spring before the credit crisis even began, announced in January it was reducing its staff of about 320,000 by another 4,200, and that more layoffs were likely to come. The bulk of these job losses are in the company's investment banking group. -- OPERATIONS ABROAD: On Monday, Pandit gave more autonomy to Citi's operations around the world by naming executives to head the Asia Pacific region; the Western Europe, Middle East and Africa region; the Central and Eastern Europe region; and the Mexico and Latin America region. Meanwhile, Citigroup said earlier this year it would be merging its Japanese businesses with the ones it now runs after acquiring Japanese brokerage Nikko Cordial Corp.

FT.com / Companies / Financial services - Citi struggles to reduce EMI loan exposure

FT.com / Companies / Financial services - Citi struggles to reduce EMI loan exposure

Citi deal to sell leveraged buyout loans to a group of private equity shows the desperation of Citi for two reasons:

1. Citi financed $9 Billion of that purchase, and
2. It took out all the questionable loans that it could write down in the future like EMI loan in the story. In other words the loans that Citi got rid off are good loans.

Next week will be interesting with JPMorgan Chase, Merrill Lynch, Citigroup and other large banks and financial services companies reporting their first quarter earnings. With their reporting could answer some questions about :

1. Have the financial losses begun to decline?
2. Is guidance going to show that we are starting to see the light at the end of the tunnel?

If the answers to these questions are worse than the negative sentiment or expectations of investors, then financial stocks probably are going to get knocked down again.

Citigroup near sale of $12 bln loans: sources | Reuters

Citigroup near sale of $12 bln loans: sources Reuters
That is a positive move for the banking sector in general. However the devil is in the details. The discount is a mundane 90 cent on the dollar, that is not enough for the private equity group to make enough return to satisfy their hurdle rates. So the deal has to be leveraged. Maybe it is to the tune of 10 to 1 to generate satisfactory returns for private equity investors.

The $12 billion question is who is going to provide the leverage? May be Citi will provide financing? That will be fine deal making by Citi management. It would be very interesting to see the details of this deal. May be credit problems for Citi are over or it is just the begining!

Citi Prunes Its Branch Expansion - WSJ.com

Citi Prunes Its Branch Expansion - WSJ.com

The News: Citigroup will end a push to open more branches, concluding that the strategy has done little to increase the company's stature amid entrenched competition.

I think this is a sound strategy by Citi: focus on your strength rather than weakness as the cost to improve your strengths is very marginal compared to the cost to improve or neutralize your weaknesses. Coincidentally this action bodes well to the likes of BofA and USB as they will face less competition for market share.

Citi has one of the smallest number of retail branches in the US with just 1100 compared to over 6000 for BofA. Clearly fighting BofA or JP Morgan is a losing battle for Citi and its shareholders. Citi holds no competitive advantage or economies of scale to leverage in its fight for market share. The most logical conclusion is an orderly retreat and redeployment of cash to an area where Citi is much more competitive.

So far Citi has been doing all the right strategic moves: reshape of losing strategy, cut dividends, lay offs and cost cutting and new capital infusion. Citi is looking more attractive as a turn around story.

Citi's Earnings better than Expected!

If you call a $9.83 loss and $18.1 Billion in write downs better that expected, then sure!

So far Citi's write downs total $24.1 billion or 20% of its book value. But that is not newsworthy, it was expected, actually some analyst called the write downs better than expected as they were expecting figures in the neighborhood of $25 billion for this quarter alone.

The bank also will raise another round of capital of $14.5 billion that will bring total capital raised to $22 billion. This will represent 15% ownership dilution to the bank shareholders. However, you can argue that the dilution is already priced in the stock as it declined by 46% in one year, while the banking index declined 25% for the same period.

Citi also made the right move by cutting its dividend by 41% to $.32 from $.54. That represent a boost to its capital of another $4.5 billion annually. This was a tough call but much needed. I would have rather the bank cut the dividend altogether than raise outside dilutive capital. With a dividend cut you would take a temporary decline in the stock price, but it can recover with a well implemented turnaround plan. However with equity dilution it is permanent.

However the more disappointing news is there was no announcement to their future plans regarding job cuts, assets sales and turnaround plans.

The bank has one of best international assets around but it is big, poorly managed and lacks a vision. If the new CEO can pull a vision to unite banking units and stream operations, the business will be a huge success and shareholders will be rewarded tremendously. So lets wait and see if a turnaround plan will be articulated before investing in Citi.

I hope that Citi has thrown the kitchen sink in this quarter. I am sure that a lot of investors do not want to hear any more write downs or mortgage losses in the future, as it will be very disheartening.

Citi to sell assets

Heard on the Street - WSJ.com
The article in the Wall Street Journal reports that Citi is planning to sell assets to shore up capital. It is a very logical approach for the struggling bank. But the question is which assets? And at what price?

Any financial institution in this current environment will find it hard to locate buyers. So in order to generate funds it will be forced to sell quality assets at a steep discount. Citi has tried to unload non strategic bank branches earlier with no success. Now with the cedit crises at full swing citi has to offer two things: 1. great assets, and 2. steep discounts to find buyers.

Selling assets is a welcome move but it will take place at the wrong time. I think Citi is better holding those assets for the time being and selling them later when it can get better value for them. For Citi to shore up capital, it needs to do the following:

1. cut costs by streamlining the "empire"
2. cut jobs
3. cut dividends

Once I see some of the above happen in Citi, it can be a turnaround investment candidate.

Citi consolidate SIVs onto Balance Sheet

Citi is doing the right thing by bailing out those SIVs. It may be painful for their operations in the short term but it will be good for the credit market and bank in the long term. The board of directors have said in the past that there would be no bailout for SIVs, but it looks that the new CEO is stamping his authority and reversing that course. Good news for Citi.

This action could be another prelude to another reversal of the board stance. The board maintained that the dividends would stay put. I do not see how they can maintain it. The new CEO will have to propose to cut the dividend. It is the only logical thing to do to maintain its operations The cut is more necessary now that they have consolidate some $45 billion onto the balance sheet.

This move all but sure killed the super fund plan, which was not effective plan in any case. The plan was mainly designed to rescue Citi. The plan would not have solved any issue and would have prolonged the credit situation.

What is in Store for Citi with new CEO and Chairman

Citi has selected Pandit as its new CEO and appointed Bischoff as its new Chairman. The move to break up the two positions speaks to the difficulty of one person to handle both positions at Citi. The other explanation is that may be none of the two newly appointed leaders are capable of handling the two position combined and the breakup is a compromise.

Dividends to stay

The new CEO did not comment on the issue when it came up, and Rubin skated around it, so there is not confirmation of the status of the dividends. That means that they may consider a cut at the board level. That is good for Citi and its shareholders. It is a very cheap way to boost capital and in the long run it will yield benefits.

It does not make sense to keep the dividends where it is; it actually hurts shareholders when the company borrows at 11% and dilute their ownership just to plow it back. And I also do not get shareholders that want their dividends to stay the same, while the company struggles to borrow money and be in a situation where it is under capitalized to earn income.

The breakup of Citi:

Many are calling for the breakup of Citi to unlock shareholder value. Well, a move like that will not be a good one at this time. Typically a breakup of a corporation into two publicly traded corporations is done to unlock value that investors are not seeing or not appreciating. It is done in well run companies with different divisions at varying growth rates. Usually management spins off the highly growing company to shareholders to be free to expand more aggressively and break free from the weight of the more mature divisions. For example, Altria will spin off its International Tobacco division due to its high growth potential from the more mature domestic division. but both companies are being run well and cost efficient and that is the key for successful breakup.

Citi is not well run and it is not cost efficient at all divisions. Newly appointed CEO has set running the business more efficiently as a top priority. All Citi's divisions are run somewhat poorly, so any breakup would result in divisions of need of a fix up, not what you call unlocking value.

Citi needs to address its internal mess before thinking about any breakup. As I said before Citi has a great international exposure that it can leverage to spur growth, however it needs to lean a bit, integrate the great empire well and get a handle on risk management and it will realize value to shareholders.


Photo courtesy of Wall Street Journal

U.S. Bancorp Raises Dividend, Selects CEO as New Chairman - WSJ.com

U.S. Bancorp Raises Dividend, Selects CEO as New Chairman - WSJ.com
That came from left field. A bank raising dividends.

US Bancorp raised dividends to $1.7 per share annually. the bank's current divided yield at close of today awesome 2.5% drop is 5.17%. The divided increase is such a confidence booster to USB shareholders to the quality of the assets that the bank hold.

WM Cuts dividends

Bloomberg.com: U.S.: Washington Mutual to Take Write down, Slash Dividend

It was expected that some of the banks will have to cut their dividends. The dividend cut will contribute $1.4 Billion in cash saving to the WM. In addition the bank is planning to raise capital and cut costs.

The tally for the crises so far is an awesome $65 billion in write downs and in the next year I am expecting to be busy updating my spreadsheet with additional figures, you can find it here. So far the write downs amounted to 10.25% of reporting banks market cap.

I expect that Citi will follow suit after the new CEO takes the helm, and cut its dividends, although Citi chairman said the dividends will not be touched. Citi has been seeking costly capital, the 11% convertible sale, and selling real estate assets and leasing them back to raise funds.

A dividend cut is more than likely as Citi problems keep mounting. Moody's downgrade of SIV papers will no doubt hurt the SIV business model of investing in long term assets and financing the purchase by short term borrowings. These borrowings will have to be financed with higher rates, and that is if there is any takers. Citi will have to bail out these SIVs meaning it will need cash to do so.

How much is the dividend cut is going to be, I am not sure. Citi pays $11 Billion a year in dividends to shareholders and so far it has raised $9 Billion from capital raising and real estate sales to offset the reported $5 billion write down in the 3 rd quarter. Citi is expected to have an additional write down of $5-10 Billion, so a $5-7 billion dividend cut will not be that surprising.

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

'Super Fund' for SIVs may not be so Super after all

'Super Fund' for SIVs, Hoped for $100 Billion, May Be Half the Size - WSJ.com


The super fund is being reduced in size due to "lack of interest from other banks". Well, lets call it like it is, banks saw little benefit in joining the fund. The super fund is akin to collecting trash from the neighbourhood houses and then pile it together in the middle of the street. Instead of smaller ones spread across, it is just one big load of stinky garbage piled together.

Banks ought to do what HSBC done by taking these obligations onto their balance sheet. Off course Citi can't do that without crippling its operations. Citi has mush more exposure than HSBC to SIVs, Citi has $83billion compared to HSBC's $45 billion, and a much weaker capital position. In addition many of Citi's SIVs has been put on negative credit watch by the rating agencies and taking them back onto Cits' books mean a higher borrowing costs to the bank.

Citi has been trying to shore up its capital by: 1. selling its real estate assets, and 2. raising capital from equity sale.

Complicating things at Citi is the lack of leadership. So far the bank has not found a successor to the former CEO Chuck prince, and it does not look like there is any one on the horizon.

Citi can be a value idea similar to Wells Fargo in the 1990s when housing prices tumbled and made the bank in need of capital. But to properly evaluate this more one need more information about the bank and its liquidity, which is hard to ascertain with all of this off balance sheet entities

Corporate as "Sub prime Borrowers"

The Big Picture Citibank Receives Emergency Cash Injection:

In his blog, see link above, the Big Picture, Citi bank was called "sub-prime borrower". A fitting description given the cost it has to pay for the $7.5 billion investment from Abu Dhabi investment fund (ADIA), 11% interest. The 11% yield is akin to junk bond status.

If Citi is given the label of "sub-prime borrower", what can be said about all junk bond issuers. It got me thinking about other junk issuers and borrowers that borrowed heavily and depend on credit for their operations.

The economy was buoyant since 2002 and in good economic times junk bond issuance usually spikes. These bonds were issued for a low risk premium as investors assumed more risk in search for yield. Junk bond issuers took advantage of that and issued more than $800 billion in 2007 with little spread to treasuries. Now the market repriced all these issues and spreads have shot up. Moreover, Private equity funds were on a tear for the last few years. Their funding and deals are predicated on covenant lite borrowing and highly leveraged capital structure. So the market is littered with "sub-prime borrowers" with very leveraged balance sheets that leave little margin for error.

The situation can be a repeat story of the implosion in the housing market. Companies leveraged their balance sheets, bought more assets on credit and issued debt similar to consumers who bought larger houses on cheap credit, which they could not afford once rate started to move upwards. Junk bonds is named "Junk" for a reason. Default in junk issuers in recessions shoot up to 47% for issuers within 4-5 years of issue. If the economy softens coupled with tighter lending and ceased credit markets, it could mean defaults in corporate "sub prime" or junk issuers will increase. And this will lead to another implosion similar to the housing sub prime.

If this defaults in Junk Bonds occur, then banks, again, will have more write downs in all sort of places. One of these areas is the credit default swaps. Credit default swaps are used by purchasers of debt to hedge their purchases of junk bonds as the counter party in the swap will pay if the issuer defaults on their payments. Normally the counter party will receive a premium to assume the risk, similar to insurance companies, which pay insurance claims and receive premiums from insurers. Banks have been a counter party in this $45 trillion market for about less than half of that market. If defaults increase claims against banks will rise to pay investor for their insurance.

We hope banks will be hedged against this risk.

The dwongrades of CITI keep coming

Wall Street Market blog has compared a Goldman Sachs analyst and CIBC analyst take on Citi (C). Both reports arrive at a similar conclusion, surprise ...surprise.

The recent analyst recommendation on C (Source:Market Watch) is 6 buys and , well, 11 sells (8 hold, 3 outright Sell).

Many called for the breakup of C as it has gotten too big. The problem is not being too big, it is being too big for the sake of being big. C has been put together by a series of acquisitions by Sandy Weill with the vision of creating a huge organization that will allow for cross selling and back office synergies.

The problem with C is the lack of vision and lack of a strong competitive advantage. The bank has great assets, particularly its global network. Its international assets will harvest great returns due to emerging market solid economic activity and growth. What C ought to do is leverage its US assets and financing to enhance returns oversees primarily.

What C needs is strong leadership from the top that needs to refocus the organization and rally it around a vision for the next 5 years. The last 5 years the bank went floundering in every direction and now it is paying the price.

The bank can be an excellent value idea but it depends on its strategy and leadership. It has solid asset base to leverage and maximize returns. It will be interesting to see who will take the helm at C and what he/ she will do.