The Banks' Real Story

What happened at Citigroup (C) last week was very interesting. They sold their Phibro commodities unit to Occidental Petroleum (OXY) for $250m. That is a pittance. Phibro had average earnings of $371m in the past five years. The sale price is actually below Phibro’s net asset value. So why would Citi give its assets away at such bargain basement level?

They had to do this deal so they could mollify the public’s anger with the $100m contractual bonus Phibro had to pay star trader Andrew Hall. This is the result of government involvement in business, because it is too embarrassing to pay someone a bonus he will be paid anyway (similarly, pay restrictions at AIG led to massive departure of senior staff, and that couldn’t have been beneficial to the value of tax payers investment in AIG).

This is indicative of the feeble management at so many of the nation’s banks and financial companies. There are other examples, chief of which is the perplexing manner in which they construct their balance sheets.

Gerald Ford is an authority on banks, given that he made over $1 billion investing in banks and financial companies during several market cycles (he bought his first bank in 1975). The well respected Ford recently told Forbes magazine (for its Forbes 400 issue) that even now too many banks haven't put enough money in reserves to cushion losses. If they took the appropriate marks on their loan books they would be insolvent, says Ford.

So instead banks are stalling, in the hope that an economic recovery, coupled with a steep yield curve, would boost their margins and save them. This is not new, as banks have pulled similar tricks in almost every previous credit cycle. But now, regulators are also complicit in that they are dragging their feet on seizing weak banks. So far, 416 banks were put on the Federal Deposit Insurance Corp.'s troubled list. But many more should be added.

At the end of June, Citigroup was levered 12:1. Other banks have similar debt ratios. If it turns out that consumers are too extended and the recovery proves tepid, or the economy stalls again, many more struggling banks will fail. A new wave of losses from commercial real estate loans could also get more banks in trouble, not to mention all these mortgages where the borrower isn’t required to pay down the principal, and often can’t even keep up with the interest accruing. Recall that as of the end of the first quarter of 2009, about 14% of all mortgages had negative equity, and that number may double before the housing market stabilizes.

Poorly managed and over exposed, banks are not a very safe place for investors to be.

Comments

[Stockmajor:]

...So instead banks are stalling, in the hope that an economic recovery, coupled with a steep yield curve, would boost their margins and save them. This is not new, as banks have pulled similar tricks in almost every previous credit cycle....

Yes, it is a trick. Yes, these banks are insolvent. However, we had all better hope that the trick works and that most of the banks return to solvency, especially the big ones. I'm betting they will.

Oct 14 03:40 AM

[Fairness:]

Alan, you sound like one of those hired guns for the benefit of individuals at the top who caused this all financial mess, and I doubt you have investors in mind. Investors like me will benefit immensely from the departure of such huge risk takers for their own benefit as Andrew Hall and grossly overpaid executives who ruined thousands of solid companies, banks among them.
A general ban on outlandish salaries and CEO compensation would completely stop any exodus, and end the conspiracy at the top directed against the shareholders.
Government needs to curtail CEO power, that's the only way out. Then we'll have a balanced economy, solid companies working for the benefit of all of us: America, and not just to enrich those on the top to the detriment of shareholders.

Oct 14 07:21 AM

[Tejus Trivedi:]

Talking about 'outlandish salaries', Oxy should have no qualms about paying Andrew Hall's humungous compensation. Look at what its own CEO makes. A record breaking top compensated CEO for 2008, Dr Irani ironically was paid $ 65 million for 'cost cutting initiatives' that he undertook for 2008. Talk about irony!
For more on Oxy's governance, look up

www.invesguard.com/com....

Oct 15 01:42 PM

[Tejus Trivedi:]

Ditto your thoughts.....Check out my comment below.


On Oct 14 07:21 AM Fairness wrote:

> Alan, you sound like one of those hired guns for the benefit of individuals
> at the top who caused this all financial mess, and I doubt you have
> investors in mind. Investors like me will benefit immensely from
> the departure of such huge risk takers for their own benefit as Andrew
> Hall and grossly overpaid executives who ruined thousands of solid
> companies, banks among them.
> A general ban on outlandish salaries and CEO compensation would completely
> stop any exodus, and end the conspiracy at the top directed against
> the shareholders.
> Government needs to curtail CEO power, that's the only way out. Then
> we'll have a balanced economy, solid companies working for the benefit
> of all of us: America, and not just to enrich those on the top to
> the detriment of shareholders.

Oct 15 01:43 PM