Have Banks Turned or Burned? - Barron's

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Includes: BAC, C, CMA, COF, JPM, KEY, STI, USB, WFC
by: Judy Weil

For the stout-hearted, Barron’s’ Andrew Bary wonders whether a bottom for financials may be at hand.

On Friday, financial shares tanked after the U.S. government and large private investors offered to convert their preferred shares in Citigroup (NYSE:C) to common shares. The conversion will raise Citigroup’s tangible capital ratio [TCR], the measure of a bank’s common equity divided by its tangible assets, to around 4% from 1.5% currently. Fearing massive dilution however, investors dumped financials; Citi shares fell 39%.

With 4% likely to become a requirement, Bank of America (NYSE:BAC) and Wells Fargo’s (NYSE:WFC) 2.6% and 2.8% TCR respectively, look worrisome. However, both banks maintain they’ve already written down most of the bad stuff, which lends credence to claims that they don’t need to raise any more money for TCR.

JP Morgan (NYSE:JPM) is the only mega-bank with close to a 4% TCR. Because of that, investors may double JPM share prices this year-- despite still-high leverage of 25-1. Others like healthy regionals such as Comerica (NYSE:CMA) and U.S. Bancorp (NYSE:USB). BofA, Capital One (NYSE:COF), KeyCorp (NYSE:KEY), SunTrust Banks (NYSE:STI) and Comerica are all trading below book value, making them attractive.

There's concern that of Citi’s projected $81 billion equity, $44B in deferred tax assets will only materialize if Citi returns to profitability. And public holders of Citi’s preferred want the same terms as the government, while congress should frown on the initial 55% haircut it will have to take on its converted TARP preferreds. But Citi’s preferreds rallied on Friday. Perhaps investors think Citi has dealt with its balance sheet once and for all?

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Curious Investor says markets have inefficiently priced in catastrophic scenarios. Savvy buyers face unprecedented opportunities, even in financials. East Coast Economics warns markets are still concerned that the stress test is too lenient, an expression of TCR concerns.

The NY Times details the destruction of Saudi Prince Walid bin Talal’s longtime investment in Citigroup. He has agreed to convert his preferred shares into common shares; the Abu Dhabi sovereign wealth fund will not. The Wall St. Journal reports that options traders are betting Citi will rise from here.