Tuesday, September 11, 2007

Money Center Banks as Investments

Last Thursday, the Wall Street Journal ran an article entitled, "Do-It-All Banks' Big Test."

In it, Robin Sidel focused on how the nation's largest three commercial banks- Citi, Chase, and BofA- will be able to whether the current turmoil in the credit markets.

Her emphasis was on profitability, losses from exotics and mortgage lending.

She quoted one Robert Maneri, a portfolio manager at an also-ran bank, KeyCorp, of Cleveland, as saying,

"These banks rarely hit on all eight cylinders at the same time, but they can make a pretty good profit hitting on six out of the eight."

True. My old boss, Gerry Weiss, one-time SVP of Corporate Planning and Development at Chase Manhattan Bank, used to note,

'Despite our ineptitude, we still make a lot of money. Can you imagine how well we'd do if we really tried?'

Sadly, they never actually try. I conducted extensive research into the performance of a wide variety of financial service firms, while Director of Research at Oliver, Wyman & Co., now the financial services unit of Mercer Consulting.

What I discovered is that universal banks and diversified brokers/investment banks almost never attain consistently superior total return performance, relative to their industry index. Later, I found the same to be true for them regarding the S&P500, as well.

The Yahoo-sourced price charts for Citi, Chase, BofA, and the S&P500, for periods of 1, 5, and longer numbers of years, appear in this post.

All three banks have drastically underperformed the index over the last year, as shown in the one-year chart.

The five-year chart, which appears nearby, finds only Chase outperforming the index over the past five years. But most of the outperformance can be traced back to early 2003- well before the current conglomeration. Otherwise, Chase has more or less mirrored the index, and the other banks.

Only looking back much further, to the mid-1970s, do we see Citi significantly outperforming the S&P. In this case, we see BofA and Citi even with the index in 1996.

It is essentially the next five years that account for Citi's current return lead over the index during this 30-year timeframe. Even then, it experienced a severe dip during those five years, in 1998- the Asian crisis and LTCM debacle.

Hardly 'consistently superior total return' performance, is it? More like a lucky five years over a period of 30+ years. The other two banks, ending up below the S&P over the same period, couldn't even manage that and hang on.

Avoiding risk and loss is not the point of super-money center banks. Consistently superior total returns is. And none of them have demonstrated the ability to do it. Ever.

It's extremely unlikely that these companies will ever achieve such performance going forward, either.


Basically, because they are too diversified. Last December, I wrote this post, in which I quoted Kirk Kerkorian said,

"Diversification is for people who aren't sure about what they are doing."

Just so. Money center banks are in so many businesses that one is always blowing up. Same thing with large investment banks. This is what I learned in my research at Oliver, Wyman.

The only types of financial service firms which showed themselves capable of consistently outperforming their sector index were mono-line firms: credit card companies, asset managers, and mortgage bankers. They would have streaks of several years of outperformance, then fall back to earth. It's just the way Schumpterian dynamics works.

However, by being focused on one or just a few businesses, these companies were able to actually grow fast and profitably. Money center banks just can't do this. They're too big, complicated, and costly to run.

Even back over a decade ago, when I was a senior strategist at Chase, my SVP, Gerry Weiss, noted how complicated a money center bank was to manage. That it was probably beyond most of the best CEOs in the country- and we didn't get them. We got loan officers who had been promoted too far.

So I think Ms. Sidel is focused on the wrong measure of success. Money center banks may well avoid disaster in the near future. But they won't be worthy of investing, beyond some lucky timing plays.

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