Large US Bank Performance In The Wake of Concerns Over Increased Capital Requirements

Tom Brown's announcement in early June that he had bought BofA shares for his sector fund. That post was on June 3rd, so Brown bought no later than that- perhaps in late May, perhaps earlier that week.

On June 9th, I wrote this post discussing the subsequent call by various regulators for large "too big to fail" banks to hold from 3% to perhaps 7% additional capital.

As of yesterday, the major US banks included in the nearby price chart, have all declined since late May. The S&P500 Index is about flat.

We don't know precisely when Tom Brown bought his fund's BofA shares, but all of the banks shown- Citigroup, Chase, BofA and Wells Fargo- have declined absolutely and relative to the S&P for the past three months.

No wonder Brown was cheering on Jamie Dimon's objections to the sensible call for these banks to be capitalized as, well, banks, rather than unsecured loan providers.

Could it be that between the divestitures and closures of now disallowed businesses, and the specter of higher capital requirements, these banks are in for a long term correction down to price levels more consistent with giant, slow-growing, government-insured deposit-taking financial utilities?

Flashes In The Pan: Inconsistent Total Returns

Lest you be overly-impressed by the recent year's returns of some equities, take a longer term perspective.

For example, here is a price chart of the remaining four large 'real' US commercial banks (excludes Goldman and Morgan Stanley), and the S&P500 Index, for the past 12 months.

Looks impressive, doesn't it? BankAmerica up nearly 100%, Wells up over 50%, and Chase even with the index. Even Citi is positive.

Trouble is, my proprietary equity performance research found that one- or two-year outperformances of the S&P are actually pretty common.

Given that the index hit bottom last March, then rocketed upward over the next 8 months, the past 12 months are going to look good for a number of firms.

Looking back five years, those same four banks, and the S&P, look quite different, don't they?

The index has been flat. Only one bank, Chase, has been positive. The other three banks were not, two having appalling losses in shareholder wealth.

Chase, of course, looks better simply because, as usual, it was late to the CDO and mortgage party, and, though anemic in absolute terms, managed to avoid the crippling losses of its more agile competitors.

I chose a handful of large commercial banks, but you can probably construct similar charts in other sectors right now.

Being fooled by 1-year performances can lead to unpleasant surprises for the longer term. Much of the current hoopla over the recent gains in the equities of many firms amounts to little more than backward-looking timing plays. Buying into a firm's equity now, on the strength of just the last year, is the epitome of rather naive momentum investing.

Whether all of these firms can actually maintain fundamental performances and total return outperformance for the next few years is an entirely different matter. Last year's March low in equities provides a handy comparison for so many equities this quarter.

Investor beware.

Buffett, CNBC, Wells Fargo & Manipulating Investors

I had lunch with a colleague yesterday, during which we discussed Warren Buffett's appearance on CNBC that morning.

As I related Buffett's comments about his displeasure with the Kraft purchase of Cadbury, my friend and I agreed that Buffett couldn't very well announce his intention to dump the former's stock. But, on reflection, I'm surprised he went as far as he did to castigate Kraft's management. When Buffett begins to sell out of Kraft, his activities, as a 9.8% owner, are sure to draw attention among brokers. It won't be long before those in the business of moving largish blocks of equities know who is selling.

On the other hand, Buffett shrewdly used the appearance to 'talk his book' about Wells Fargo. The nearby chart of Wells' and the S&P500 Index's prices over the past five years illustrate that Wells has underperformed over the period.

Perhaps, with a dividend, Wells has managed to pull even with the index.

For the risks entailed in holding individual equities, especially large banks for the past few years, this hardly covers the risks Buffett took.

How astute, then, for him to spend precious minutes of an appearance on a major business cable television channel, on the day of Wells' earnings announcement, touting the stock?

Everyone knows Buffett's Berkshire Hathaway owns a lot of Wells. Buffett, in a style reminiscent of Lee Cooperman's attempt to tout Home Depot a few years ago, smacks of something close to a violation of SEC regulations. His comments were hardly analysis, and he spoke generally about the management, in contrast to, say, this morning's piece in the Wall Street Journal that was quite critical of Wells.

I continue to be amazed at what this guy gets away with in public. He may as well begin his remarks with,

'Hi, I'm Warren Buffett- and you're not. I want to take few minutes here on CNBC to publicly identify our institutional equity and fixed income holdings, in hopes that my reputation will cause investors to stampede into positions in my holdings, thus driving up their value today, and in months to come.'

Buffett is careful to criticize derivatives, which are trickier to manipulate, and tend to have smaller markets, making entry and exit tougher for investors of Berkshire's size. To my knowledge, Buffett doesn't engage in short-selling, either.

Instead, he continually wraps himself in seemingly patriotic investing. You know, basic equities for the long term. But look at Berkshire's recent 2- and 5-year performances relative to the S&P500 Index. The firm trails the S&P in the shorter term, and leads, but not by much, and only over the past year, for the longer period.

CNBC's willingness to give people like Buffett free air time to talk their books is one reason I rarely pay attention to topics that aren't strictly news or debates on economics or the equity markets between reputable pundits.

Appearances like yesterday's by Buffett, to me, cheapen the network and give it the image of simply being a camera for rent to favored asset managers. And not necessarily outstanding asset managers, either.

The Folly of TARP & Government-Mandated Capital Raising

I had to laugh when I read yesterday's Wall Street Journal article concerning the federal government punishing Citigroup and Wells Fargo with heavy capital requirements before they can repay the TARP money they were forced to take.

If anything points to the veracity of Anna Schwartz' comments about the financial sector crisis of last year, this episode would be it.

Why are we letting some middle-level bureaucrats dictate what sort of capital levels these two banks require, when the obvious, better solution is to let the capital markets signal that. Under-capitalized banks will see their equity prices fall. If they are in a jam, where dilution to raise capital further depresses equity values, then, eventually, some other bank management will take over those assets at the depressed price.

That's how the market votes on managerial (in)competence.

Government mandates for capital are just stupid. Just as the Fed can set a funds rate, but can't actually control market appetites for Treasuries, or force banks to lend, arbitrary capital requirements set by mediocre regulators won't actually have much meaning to investors.

This latest dustup over banks trying to repay government funds shows clearly what a travesty Hank Paulson's and Ben Bernanke's TARP plan always was.

Now, as of this morning, Treasury Secretary Geithner sent a letter to Congress notifying it that he will extend the TARP slush funds and dubious authority until next October.

To add comedy to this act of governmental overreach, Geithner claimed both that the financial sector is still in need of help, but, magically, the government assistance will now actually aid "main street."

Good luck with that, Tim. It hasn't worked yet.

Wells Fargo's Mortgage Woes

My friend B predicted this at lunch late this summer.

As we discussed the expected continuing bank loan losses, he mused that Wells had bought a truckload of trouble via Wachovia's purchase of Golden West Financial some years ago.

You may recall that the Golden West acquisition was a material cause of Wachovia's slide into insolvency, leading to Ken Thompson's ouster.

When Wells swooped in to take Wachovia out of the arms of failing Citigroup last year, many thought it to be a clever purchase.

However, Wells' own California-focused mortgage business, coupled with the Golden West loans, is now stressing Well's loan loss reserves. California was certainly among the most over-priced areas in the US during the mortgage finance excesses of the past few yeas, and Well's mortgage portfolio's delinquencies are now reflecting that.

As the unemployment rate continues to remain high and probably go higher, expectations for these delinquencies to not become defaults are low.

And just this morning, the Boston Fed's president expressed his view, on CNBC, that the economy is still very fragile, and interest rates will have to remain low for some time.

This doesn't look like economic recovery to me.

Have US Commercial Banks "Failed?"

Wells Fargo @ $8.12. Chase @ $16.60. BofA @ $3.17. Citigroup trading @ $1.02.

Yes, you can't even buy McDonalds snackwrap with a share of Citi stock.

Have our largest commercial banks really "failed?" Failed, in the Depression-era sense?

Clearly, they have not. Commercial banks are no longer the same as they were in FDR's era.

In fact, many people mistakenly identify our commercial banks as our total financial system, but nothing could be further from the truth.

First, all of these institutions have, for all practical purposes, had totally-insured deposits for decades. For several months, even their money-market funds have been federally insured, too.

The nation's financial plumbing system- clearing, settlement, electronic cash movement, etc., are separable, if necessary. Loans are made by several sorts of financial service firms, and more could enter at any time.

"Wealth management," a/k/a brokerage and money management, is a sector unto itself, even with the collapse of Merrill Lynch.

Truly, there is little, if any real economic damage from simply letting badly-run commercial banks fail.

From the nearby chart, it's easy to see that, among the surviving large US commercial banks, Vik Pandit, Ken Lewis and the management of BofA and Citigroup should be fired.

Citigroup is, for all intents and purposes, currently a government bank. How can any administration leave Pandit & Co. in charge, when, by comparison, Chase and Wells did so much better, if not so great in absolute terms?

BofA is a wreck, too, now. Lewis has to go.

But there's no actual risk to the economy's health in closing Citigroup and BofA. If anything, as Anna Schwartz noted, that would leave fewer, healthier banks, and opportunities for capital to move into the sector, should it require more lending capacity.

But with two of the largest US commercial banks trading nearly as penny stocks, reflecting investor doubts about the true, intrinsic values of their assets, it's ridiculous to keep them open.

Let's get the thing done, close or nationalize Citi and BofA, bring in new management, and get on with modifying mark-to-market rules to allow for economic valuation.

The Problem Facing Chase & Wells Fargo

There's an interesting problem now facing Chase and Wells Fargo banks.

How do they price and take risks when their two largest competitors, BofA and Citigroup, are effectively nationalized banks?

Citigroup's net market value is now less than Federal infusions.

So if BofA's, if my arithmetic is correct. The bank's current market value is roughly $31B, but it has been given two $20B TARP infusions, plus an open-ended $115B loan loss line for the Merrill purchase.

And we've seen that Vik Pandit sold off his brokerage unit to a joint venture with Morgan Stanley under pressure from the Feds. Ken Lewis was forced to consummate a bad merger with Merrill Lynch because of Federal coercion.

How do John Stumpf and Jamie Dimon compete against a force even larger and prospectively more coercive than the organized crime?

Specifically, while Citi and BofA might actually take fewer new market risks now, they alsom might be coerced into accepting losses on consumer loans or mortgages as part of a Congressionally-mandated 'forgiveness.'

Further, as Bill Siedeman noted on CNBC a few weeks ago, as soon as a bank is seen as being backed fully by the Federal government, its capital costs decrease, its need for capital disappears, and, thus, a key cost component is subsidized.

When competing for loan business, will Chase and Wells Fargo use higher internal capital costs, thus making them less competitive?

Chase and Well Fargo, though performing better over the past six months than Citigroup and BofA, per the nearby price chart, have each still lost roughly 40% of their equity price.

How long before investors abandon the latter two banks, fearing pre-emption by the Federal government, to which Ken Lewis acquiesced at BofA?

It's a very interesting and unusual situation never before seen in US financial services. One can't help but think that heavy governmental intervention, to the point of essentially owning two of the nation's largest banks, by assets, will have to have a damaging impact on competition in the sector going forward.

Wachovia Goes To Wells Fargo- Citigroup Considers Lawsuit

Things are moving at lightning speed in the banking sector, Congressional rescue package or not.

Since I wrote this post on Monday of this week, Wells Fargo has stepped in to buy Wachovia at an actual market price. This is so recent that it didn't even make the print edition of today's Wall Street Journal.

Meanwhile, Citigroup is left standing at the altar, FDIC-brokered deal in tatters.

For the FDIC and, of course, the public, the Wells Fargo deal is much better. No government-shouldered losses. No qualifications. Just a straight combination at an offered price to Wachovia shareholders.

It's likely better for the US commercial banking sector in the longer term, too. It's doubtful Vikram Pandit & Co. over at Citigroup could have actually prospered with the Wachovia acquisition. It's closer to the mark to say that mere survival of the resulting mess would have been heroic, and probably almost too much to hope for.

Now, at least a healthier bank with adult management, meaning the CEO of Wells Fargo, will take over the wreck of Ken Thompson's- excuse me, Bob Steel's- Wachovia.

As the nearby, Yahoo-sourced chart of price performance for the S&P500 Index and Chase, Wells Fargo, Citigroup, BofA and Wachovia for the past five years indicates, Wachovia will be in better hands with Wells.

Citigroup and Wachovia have been the two worst-performing of the bunch. Chase and Wells are nearly equal, just managing a positive return. Not exactly glowing, but it beats the huge losses of the other banks.

If you're going to continue life as a boring, huge, regulated financial utility, at least you can be average. And Wells Fargo appears to be.

What's hanging over the deal, of course, is Citigroup's noises about being jilted. And possibly suing.

Just what we need, eh? At this point in the history of the US financial sector, a limping, near-failing Citigroup would sue for the right to combine with the other worst wreck of a major commercial bank, Wachovia.

You cannot make this stuff up.