The financial fundamentals of big banks are returning to the news as the next round of Fed stress tests are soon expected to come out with new rules and guidelines that will sharply impact how banks can go forward. Some banks that still retain government investment are restrained in the amounts of dividends, share buyback plans and other forms of management and investor compensation.
Meanwhile these upcoming rules regulating bank reserves of those corporations "too big to fail" can sharply impact the real liquidity situation of a company. I looked at the biggest US banks with an eye to see how strong their balance sheets are:
- Bank of America Corporation (BAC)
- Citigroup, Inc. (C)
- Goldman Sachs Group, Inc. (GS)
- JPMorgan Chase & Co. (JPM)
- Wells Fargo & Company (WFC)
My first check was a look at the enterprise value (EV) to free cash flow (FCF) over the trailing twelve months (TTM). This measure provides an excellent measure of the financial strength and liquidity of a company. As defined in Stockopedia:
The lower the ratio of enterprise value to the free cash flow figures, the faster a company can pay back the cost of its acquisition or generate cash to reinvest in its business. Enterprise Value is arguably a more accurate measure of the value of a firm, as it includes the debt, value of preferred shares and minority interest, but minus cash and cash equivalents.
With this measure Goldman Sachs is the head and shoulders leader of the group at a solid 7.533 ratio. Many people will be astonished to see Bank of America (16.93) is just trailing JP Morgan (12.61) and Wells Fargo (13.39) while there is little surprise that Citigroup badly lags the field with its uncomfortably high 31.33 standing.
I also looked at the quick ratio - measuring the ability of a company to pay its short term debts with its most liquid assets. Here, the higher the number the better:
Here Goldman Sachs is the clear leader (0.721), while Citigroup (0.5909), JP Morgan (0.4926) and Bank of America (0.357) string out below, while surprisingly Wells Fargo (0.136) shows by far the worst position of this screen.
An important point, the Fed also takes into consideration a number of factors when judging a bank's strength, including its size, the amount of risk inherent in its business model as well as other factors. Here is a brief look at the banks themselves:
Bank of America Corporation
Financials: Bank of America's recent closing price was $9.39, within a 52-week trading range of $4.92 - $10.10. The company currently trades at a price to earnings ratio of 25.38 with earnings per share of $0.37. It has profit margin of 6.75% and operating margin of 17.99%. The company declared a quarterly cash dividend of $0.01 per share, payable on December 28, 2012 to shareholders of record as of December 7, 2012. The annual yield on the dividend is a thin 0.40%, with a conservative payout ratio of 11%.
Profile & Recent News: Bank of America earned $340 million, on revenue of $22.5 billion by cashing in consumer demand for new mortgages and refinancing old ones. Meanwhile its tarnished portfolio of pre-financial crisis mortgage loans continued to cut into profits. Bank of America employees could face civil fraud charges as part of a federal lawsuit accusing the bank of causing taxpayers more than $1 billion in losses by selling toxic mortgage loans to Fannie Mae and Freddie Mac.
Bank of America is also planning to cut 16,000 jobs by year end 2012 as it speeds up a company-wide cost-cutting initiative amid declining revenues. CEO Bryan Moynihan has trumpeted such measures, recently stating that BofA's campaign to strengthen their balance sheet included divesting itself of $60 billion in underperforming assets, which generating over $12B in Tier 1 common capital while sacrificing less than $2B of earnings.
While Bank of America is not yet exactly healthy, especially compared to banking stalwarts Goldman Sachs and JP Morgan, it is much better than the disastrous situation of 2011. However it is still dragged down by lingering legacy of its post financial meltdown purchases of Merrill Lynch and Countrywide Mortgage. Overall this is a mixed bag, but definitively on the way up.
Financials: Citigroup's recent closing price was $36, within a 52-week trading range of $23.30 - $38.72. The company currently trades at a price to earnings ratio of 15.18 with earnings per share of $2.37. It has profit margin of 12.46% and operating margin of 13.52%. The company declared a quarterly dividend on the company's common stock of $0.01 per share, payable on November 21, 2012 to stockholders of record on November 5, 2012, annual yield on the dividend is 0.10%, with a microscopic payout ratio of 2%.
Profile & Recent News: Citigroup, Inc, operates through two segments, Citicorp and Citi Holdings. Management has been in some turmoil after CEO Vikram Pandit was forced to resign following a clash with the board over strategy and performance.
Citigroup already failed the last Fed Stress Test, unlike its peers, after regulators ruled the bank did not have enough liquid reserves. I would expect it to pass this time around, based on a positive 3Q earnings report, but the process for the stress tests are very opaque, with a lot of guessing going on by analysts and pundits over whether Citigroup will pass this time around.
The Goldman Sachs Group, Inc.
Financials: Goldman Sachs recent closing price was $115.27, within a 52-week trading range of $86.90 - $128.72. The company currently trades at a price to earnings ratio of 11.07 with earnings per share of $10.42. It has a profit margin of 18.07% and an operating margin of 27.56%. The company declared a quarterly dividend on the company's common stock of $0.50 per share, payable on December 28, 2012 to common shareholders of record on November 30, 2012, with the annual yield on the dividend at 1.70%, the payout ratio is a conservative 15%.
Profile & Recent News: The Goldman Sachs Group, Inc. is more investment banker rather than retail banker like the others in this group, giving it a somewhat riskier dynamic for its operations. The company is in settlement talks with US regulators after a company trader concealed an $8.3bn position from the investment bank five years ago. This riskier business model is causing market watchers to expect Fed reserve requirements to skyrocket 67% to $728 billion. So while Goldman Sachs is generally stronger, it will have to be in order to soak up the higher reserve requirements it is expected to shoulder.
Goldman's third quarter net income for common shareholders was $1.5 billion, or $2.85 per share, while revenues more than doubled to $8.4 billion, from $3.6 billion a year ago. The bank shed about 1,600 jobs, or 5 percent of its work force, compared with a year ago, and cut spending on communications, occupancy and market development.
JPMorgan Chase & Co. (JPM)
Financials: JPMorgan's recent closing price was $40.40, within a 52-week trading range of $28.28 - $46.49. The company currently trades at a price to earnings ratio of 8.57 with earnings per share of $4.71. It has profit margin of 21.97% and operating margin of 34%. The company pays a quarterly dividend on the company's common stock of $0.30 per share with an annual yield of 3%, under a payout ratio of 23%.
Profile & Recent News: JPMorgan Chase & Co., is arguably the most diverse bank of this group, dealing in retail and investment banking and practically anything in between. JPMorgan like Bank of America and Goldman Sachs is working hard to settle an investigation. The problems come from how its Bear Stearns unit handled mortgage securities it packaged and sold to investors. However the potential liability of these problems are less defined as those of its peers, at least at the moment.
The bank cut 3,000 jobs 3Q 2012, but headcount overall is up 1% in the past year to 47,412. JPMorgan third quarter profit beat expectations with $1.40 per share, while revenue increased to $25.9 billion. The company should be safe with the coming round of stress tests.
Wells Fargo & Company
Financials: Wells Fargo's recent closing price was $32.35, within a 52-week trading range of $23.19 - $36.60. The company currently trades at a price to earnings ratio of 10.17 with earnings per share of $3.18. It has profit margin of 23.18% and operating margin of 39.32%. The company declared a quarterly common stock dividend of $0.22 per share, December 1, 2012, to stockholders of record on November 9, 2012. The annual yield on the dividend is 2.70%, with a payout ratio of 25%.
Profile & Recent News: Wells Fargo & Company is the most specifically retail company of this group. The banking giant is expanding in Canada to capitalize as demand for borrowing jump among companies, particularly those with cross-border and overseas businesses.
The home lender agreed to refinance mortgages after a probe of the industry's practices, and may forgo as much as $2 billion in interest, $300 million more than previously estimated. The bank's third quarter net income rose to $4.72 billion from $3.84 billion in the same period last year. Mortgage financing, in part juiced by the Fed's QE3 stimulus is reportedly surging.
While cash flow is tight at the moment, I expect that to clear up as the mortgage pipeline broadens in coming quarters under pressure from QE3. I expect Wells Fargo to come through the stress tests in fine form.
Disclosure: I am long BAC.