Analyzing the U.S.'s Four Largest Banks 27 comments
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The following is an analysis of the four largest banks in the United States. The four banks analyzed represent 5.17% of the S&P 500 Index and play a major role in both the USA and global economies.
BANK | S&P 500 % WEIGHTING |
JPMorgan Chase (JPM) | 1.82% |
Wells Fargo (WFC) | 1.40% |
Bank of America (BAC) | 1.38% |
Citigroup (C) | 0.57% |
TOTAL % OF S&P 500 WEIGHTING | 5.17% |
The following charts will show the combined results for all four banks in order to gauge the health of the banking sector when compared over a 12 year time frame. By taking a long view we can determine how healthy they are as a group over a variety of business cycles.
The first thing I always look for as an analyst is the long term debt picture for any company I analyze. I like to see long term debt coming down over the years as a sign of fiscal responsibility by management. Whether we are talking about an individual or a company, how one manages their credit determines how they are to be judged. By looking at the chart below one can clearly see that the four banks are borrowing money hand over fist and that is not a promising sign.
The group has increased their debt 774% over the last 12 years (including estimates for 2009 and 2010) or at an annualized compounded rate of 19.80%. That is pretty scary when you think about it. If you as an individual had $10,000 in credit card bills in 1999 and increased your borrowing at the same rate you would end up in 2010 with total credit card bills equal to $87,394.04 and would be in trouble.
But then again it is all relative to your income. If in 1999 you were making $50,000 and now you are making $200,000 a year your credit card situation, though still a problem, can be eliminated in just a few years with some fiscal responsibility. But if your salary only went up to $70,000 during that time, then you are in a much worse situation than you were in 1999 by a large margin.
Let’s see the long term picture for the group in reference to their net profits.
As you can see, their long term borrowing went up 774% but their net income went up only 55% during that time, so this is not a good sign. But then again these are banks and they borrow the money for next to nothing from the government and then loan it out to customers for a nice spread. They also loan out customer deposits, which they pay little or no interest on and loan out the money at 5%+. So let’s see how the group is doing on the loan front.
So they borrowed $1.375 trillion and have loaned out $3.165 trillion, so why are they not making the huge profits similar to what they were making in 2004-2006? Well it’s called bad loans and their customers are having problems paying them back. This can clearly be seen in the following chart.
Nothing eats away at a bank’s profits more than loan loss provisions. This is a clear sign that they have a lot of bad loans on their books, which they will probably have to eat. The above chart represents the percent of loan loss provisions to loans but here are the actual dollar figures.
So as you can see it is pretty hard to make money when you have to keep $136 billion on the side to cover your bad loans. This is the key measure to look for when judging banks as when they see little need for loan loss reserves, then all that money will eventually go to the bottom line and that will result in huge profits being made.
This is also a clear sign that the Federal Reserve cannot raise interest rates until these banks get their books in order. The interest payments on $1.375 trillion in debt goes up big time for every quarter point the Fed raises. So the Fed is held hostage and can't move as we will spiral down again if they do.
Now let's see how the shareholders in these banks are doing on an ownership front? The following chart shows that they have not only lost money when their stock market prices tanked, but that their percentage ownership has been cut as the group has increased their shares outstanding (and not because of any stocks split).
This clearly shows that the banks used their shares as currency to buy the Washington Mutuals, Merrill Lynches and Wachovias of the world and also issued new shares to get their hands on some much needed cash to stay afloat. Now the best time to use your stock for currency is when your stock is overvalued and the stock you are buying is undervalued. The worst time to do it is when your stock price is low and you’re buying something that is selling at a premium to its current condition.
The jury is still out on whether these purchases, that these four banks made, were good investments or not. If you look at the combined shareholders equity of the banks you will see that they may have gotten some value out of these purchases.
The numbers above may be real or they may be fiction and we cannot really know as we don’t know what assets are on the companies’ books and what those assets are really worth. Are they full of illiquid REITs, who are full of empty commercial properties and who are quoted at $10 in annual reports, but can only be sold for $4 in the secondary market? How much of this stuff is fluff or the real numbers we will never know and having said that I don’t put much faith in the banks' book values just as I don’t put much faith in intangibles when analyzing tech stocks.
The way I analyze a bank is by its return on invested capital (ROIC). In other words, how much return am I going to get in profits for every $1 of invested capital that is employed? Total capital is just shareholders' equity + long term debt, so since we have both numbers, let’s put up a chart.
As you can see from the chart above, total capital has gone from $297 billion in 1999 to $2.079 trillion estimated for 2010. That’s a lot of money and is very impressive, but then again we need to go back to the rule that I judge all companies by. “How much profit are you going to make me for every dollar of capital that you are going to employ?”
I don’t care if you make buggy whips or ice cream cones, every company can be judged by this parameter on an equal basis. So though the number is impressive, I want to see at least 20% ROIC (return on invested capital) before I even think about investing a dime in any enterprise, whether that be on Main Street or Wall Street. Here is a chart to show that I won’t be investing in this group anytime soon.
As you can see from these dismal numbers, the equity they have on their books is non producing and that they have borrowed way too much money as it is easy to get. If you want to fix the banking industry, limit the amount of money that banks can loan out to their customer deposits.
The customer deposits for all four banks are quite substantial and there is no need for these banks to borrow such excessive amounts.
Customer Deposits per bank as of 6/30/2009
Bank of America = $970,742,000,000
Citigroup = $ 804,736,000,000
Wells Fargo = $813,735,000,000
J.P. Morgan Chase = $866,477,000,000
So as you can see, without borrowing a dime from anyone they could make a nice profit from just loaning out their customer deposits in which they loan out money at 5% and pay .25%-1% in interest.
We need to get back to the old way of banking and require that homebuyers put 20% down and that Fannie Mae and Freddie Mac be put out of business. Banks should hold onto their loans and not sell them as securitized packages. The old way of banking works best and that’s where we need to get back to!
Disclosure: Author has no positions in WFC, BAC, C, JPM
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice.
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
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This article has 27 comments:
This reinforces my position to hang my hat and go long on Citigroup being the cheapest and has a greater potential of price growth (%) over the other 3 large banks.
THey much rather make their money trading with the free discount window money they can access from the Fed by Pretending to be a bank holding company. And I am not just referring to Goldman Sachs.
And vice versa, with lots of leverage to speed the plow.
Fwi hits nail on its head.
Glass Steagal should be reinstated and commercial banks should be separated from investment banks.
To the commenter who is high on Citi, I wonder what gives him that confidence since the Company is being being dismembered and its earnings potential is being reduced with each divestiture. Finally, I don't think our Pols have the will to do what is right, i.e., bring back Glass Steagal and break up the combo banks. I am afraid that we are destined for many decades of pain and agony similar to Japan.
The other issue with Citi is 22 billion shares, with 60 billion authorized. Only penny stocks that cannot earn their way to higher stock prices have these numbers. Citi plans a reverse split, thus harming hareholders further, since they've sold future revenues.
The bottom line is that Citi needs to be broken up and sold off. Anyone who believes in the future of this badly managed firm (think how they lost Wachovia and Goldman) needs to examine his/her stock selection strategies. Citi isn't growing, and they probably never will. Citi founders basically built a Madoff type of Ponzi scheme that still flounders today.
Here are the correct numbers in ($million);
Year Shareholders Equity
1999 139,866
2000 182,660
2001 198,080
2002 209,701
2003 226,617
2004 352,455
2005 361,941
2006 416,721
2007 431,250
2008 584,650
2009 671,750
2010 704,700
Analysis Skills = Good
Computer Technical skills = Not so good
Thanks for catching that I will try to get SA to correct it with the correct chart.
Regards,
Mycroft
On Nov 08 12:53 PM thannagan wrote:
> Unless I'm looking at the numbers incorrectly, the Total Capital
> chart seems wrong if TC is Equity plus LTD. I can't tell what this
> means for the ROIC ratio shown. ??
seekingalpha.com/insta...
I have informed SA and they should correct the chart soon.
Thanks again for catching it.
On Nov 08 01:08 PM thannagan wrote:
> I think you show the same $$ charts for Total Loans and Equity. Probablly
> not the case.
Depending on the rates (at the time ) these mortgages are reset, many of the current homeowners with such ARMs might be in deep do do - especially those who will become retired and therefore "no longer qualified" to take out any conventional or jumbo loan based on the Current Debt to Current Income ratio requirement which generally do NOT ??? take into consideration the potentially significant income producing assets of homeowner's investment portfolios and or especially the income generated and available from their IRA 401K or other retirement plan's annual minimum required distributions.
On Nov 08 09:24 AM fwi wrote:
> It is interesting that I read this well written article and drew
> the completely opposite conclusion. I believe that the banks will
> not straighten their course. They have already forgotten the lessons
> of just one year ago. They do not want to be in the lending/deposit
> business anymore because of the dreaded loan loss provisions.
>
> THey much rather make their money trading with the free discount
> window money they can access from the Fed by Pretending to be a bank
> holding company. And I am not just referring to Goldman Sachs.
It will be good for 2-3 of these banks in a few years, but you are betting on that income stream...against todays ficticous books.
Banking is aggregating the depositors money and using it as capital to allow them to back loans to businesses, homes, and commercial property. Nowadays they won't write a home loan unless they can dump it to the Mac and Maes and they certainly don't need the capital to back the already bloated commercial property market. And every businessman knows that they won't lend businesses a dime these days unless you don't need it like always.
So what are they doing with the money? Well keeping a lot in reserve to cover their still hidden derivatives (That's understandable. You can't fix an egg that's already broken.) Goldman has learned to corner the market on the market (Ingenious little Goldman.) The rest are piling into the Goldman equity trap buying equities or driving up non-core inflation by speculating in commodities (Little do they know that they are cutting their own throats because their actions inevitably cause inflation that they can't afford), and many are buying US bonds and junk bonds (They are essentially the same these days and will only exacerbate their losses when interest rates rise). So the author is right to say the last things these banks should be doing is borrowing more money.
However, on that note maybe they should be doing what they are doing. In a sense they have nothing to lose given the taxpayer always pays. Greed is great when risk is subsidized.
Mycroft
On Nov 08 12:53 PM thannagan wrote:
> Unless I'm looking at the numbers incorrectly, the Total Capital
> chart seems wrong if TC is Equity plus LTD. I can't tell what this
> means for the ROIC ratio shown. ??
The thing that scare me is the value of their derivatives. Two of these banks are in the 80-90 trillion dollar range... yes, I said trillion.
Now in reality they are hedged, and probably have say 40.59 on one side of trades, and 41.023 on the other side, but when you talking about trillions...
The clearest logical problem is the impact on the "analysis" of grouping these companies together. This only makes sense if one is considering buying the group as a basket. Strikes me that very few would consider this, and so it makes no sense to group them for any analysis; comparing them would be more useful.
JPM and WFC, by most accounts, are very well-run, and have done a much better job managing risk than most banks. BAC's purchases put very much it in a category of its own.
And as for C - does it make any sense whatsoever to group C with ANY other company? What happens to your numbers if you pull C from the discussion?
Assuming the economy continues to improve, at some point it will become apparent that the companies are over-reserved, and when that happens, reserve reversals will have a far greater impact on earnings than other invested capital. This is because when reserves are released, the capital, itself, passes back through the income statement in addition to being freed up for other more risk-based investments.
So, the reserves, themselves, represent potential pure profit, and not just an increase in available capital.
On Nov 09 10:20 AM Tack wrote:
> The $136B in reserves is a huge wildcard in the equation. Contrary
> to making it difficult to make profits, the reserves, themselves,
> represent the greatest source of potential future earnings.
>
> Assuming the economy continues to improve, at some point it will
> become apparent that the companies are over-reserved, and when that
> happens, reserve reversals will have a far greater impact on earnings
> than other invested capital. This is because when reserves are released,
> the capital, itself, passes back through the income statement in
> addition to being freed up for other more risk-based investments.
>
>
> So, the reserves, themselves, represent potential pure profit, and
> not just an increase in available capital.
Now if you go to Value Lines 2010 estimates for the four banks and take out Citigroup from the picture you get a ROIC for the remaining 3 of 2.4% compared to 2.1% for the four, so the other three still do not inspire.
Here are the 2010 estimates for Reserves/Loans outstanding.
JPM = 4.18%
WFC = 2.47%
BAC = 3.69%
C = 2.99%
So it seems from that data point that JPM might have a lot more bad loans on the books then the others and that C's situation may not be as bad as people think.
Hope that addresses your concerns.
On Nov 09 09:03 AM Vox Rationalis wrote:
> Sorry, but there are big problems here. First off, source your data.
>
>
> The clearest logical problem is the impact on the "analysis" of grouping
> these companies together. This only makes sense if one is considering
> buying the group as a basket. Strikes me that very few would consider
> this, and so it makes no sense to group them for any analysis; comparing
> them would be more useful.
> JPM and WFC, by most accounts, are very well-run, and have done a
> much better job managing risk than most banks. BAC's purchases put
> very much it in a category of its own.
>
> And as for C - does it make any sense whatsoever to group C with
> ANY other company? What happens to your numbers if you pull C from
> the discussion?
On Nov 08 09:24 AM fwi wrote:
> It is interesting that I read this well written article and drew
> the completely opposite conclusion. I believe that the banks will
> not straighten their course. They have already forgotten the lessons
> of just one year ago. They do not want to be in the lending/deposit
> business anymore because of the dreaded loan loss provisions.
>
> THey much rather make their money trading with the free discount
> window money they can access from the Fed by Pretending to be a bank
> holding company. And I am not just referring to Goldman Sachs.
<img class="authors_reply" src="static.seekingalp...
<img class="authors_reply" src="static.seekingalp...
Actually if we use the poster boy for the perfect bank Goldman Sachs, on two occasions you could have bought it when their ROE was 20% and you would have made a killing. In 1999 you could have bought the stock for $55.20 and then watch it go to $133.6 the following year (Now this could have been because of the dot.com bubble) but then again in 2005 you could have gotten in at $94 and ridden it all the way to $250.70 by 2007.
There are no banks that I can find that are selling for a ROE of 20% currently, so that is why I am not buying the sector. I am very concerned with the excessive borrowing that is being done by the banking industry across the board. Goldman Sachs for example in 2010 is expected to have $192.5 billion in long term debt but only has a market cap of $91 Billion. So 192/91 = 2.10 Long Term Debt to Market Cap. Add in another $36 billion in short term borrowing and you have a serious problem. Instead of the press concentrating their attention on the bonuses paid out, they should concentrate on their debt picture. This is supposed to be the premier bank in the world and they are just a ship of debt. In 2007 when they got in trouble at their peak they were at 2.36 Long Term Debt to Market Cap. If this is the worlds best bank then I am not investing in the sector at all. Did they not learn anything in the 2007-2008 crash? Let's hope history doesn't repeat itself.
Disclosure : No Position in GS
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice.
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
On Nov 09 01:38 PM James Allen wrote:
> seems to me if you are waiting for a return on equity of 20% before
> making an investment, you are pursuing a strategy that will most
> likely find you buying at the top. Wouldn't the anticipated change
> in the delta be more important? If we assume the current share price
> factors in all of this publicly available data, then shouldn't we
> also assume that improvements in the data would result in higher
> stock prices? Just how exactly in a zero interest rate environment
> does any banking institution generate an ROE of 20%?
If this was the reason you grouped these, why did you instead mention only the S&P 500 in your article? No mention whatsoever of why these should be grouped. But let's break this down a little further - current holdings of XLF:
1 JPMorgan Chase & Co. 12.61%
2 Bank of America Corp. 9.57%
3 Wells Fargo & Co. 9.32%
4 Goldman Sachs Group Inc. 6.48%
5 Citigroup Inc. 3.87%
6 U.S. Bancorp 3.35%
So why no GS, which makes up a much higher portion of the XLF? Or more importantly, why C at all, since its losses dramatically pull down all of your numbers while accounting for over 10% of the group's market cap?
"Now if you go to Value Lines 2010 estimates for the four banks and take out Citigroup from the picture you get a ROIC for the remaining 3 of 2.4% compared to 2.1% for the four, so the other three still do not inspire."
Wow. I hadn't even read to the end of your article: "I want to see at least 20% ROIC (return on invested capital) before I even think about investing a dime in any enterprise." You really have a complete lack of understanding about how banks work, and should have known better than to provide any advice without more study.
A banker is an intermediary who directs capital to where it can be put to good use. Take this function away, as you suggest by limiting banks to their deposits only (which, by the way, are borrowed funds with a different name), and capital no longer moves as efficiently, the cost of doing business increases, and economic activity and growth decline.
And so, since banks operate on the margin, that their returns are lower than other businesses is not just intuitively obvious to the casual observer, but NECESSARILY so. Dramatically simplifying, banks MUST be low-return businesses or other businesses couldn't afford to borrow money.
As an example, consider Hudson City Bankcorp, which Forbes named the Best-Managed Bank of the Year for both 2007 and 2008. Here are the ROIC figures, according to their annual report:
2007: 1.03%
2008: 1.27%
The big three banks have ROIC of 2.4%, much higher than the Best-Managed Bank in America, and you think they're dramatically too low? If your 20% were really a good yardstick for banks, do you think HCBK would be thought of so highly? I ran a screen just for giggles. Of the 38 large-cap banks (<$8B), only one -- Banco Bradesco -- had a ROIC higher than 10%, coming in at 11.4%. Most of the Canadian banks - which have been sailing through the trouble unscathed - run between 5% and 10% ROIC.
Banking is all about leverage and risk; if there were no risk, there would be no reason to limit the amount of money a bank borrows and then lends -- no need to limit leverage. Of course, risk is inherent in any borrowing, and the recent industry failure to manage risk is a big part of what we're all dealing with now. Do I want a banker who takes no risk? Of course not, because my returns as an investor or depositor would be surely reflect this risk intolerance. I want a banker who properly assesses risk. We pay for the banker's ability to assess and manage risk in a leveraged environment - not ROIC.
"So it seems from [2010 loan loss reserve estimates] that JPM might have a lot more bad loans on the books then the others and that C's situation may not be as bad as people think."
Man, this is just ignorance - you should follow the banks for a while before spouting advice on them. WFC has taken HUGE amounts of heat among analysts for not increasing its loan reserves more (WFC insists it is generating sufficient cash to cover its losses without adding to reserves). Citi really hasn't had to increase reserves as much as it should, because it's mostly government-owned anyway and needs every productive dollar it can get. Taking JPM's higher number as an indicator that it has more losses is just plain stupid - it could just as easily, and in fact far more likely, indicate that JPM is a more conservative operator.
Apologize to the nice people for wasting their time. DISCLOSURE: long WFC, BAC.
You might be interested in seeing your method in use:
seekingalpha.com/insta...
You did a great job, congratulations on your purchase and thanks for informing me of your blog,
Mycroft
On Nov 09 08:49 PM Chimin Sang wrote:
> A side note:
>
> You might be interested in seeing your method in use:
> seekingalpha.com/insta...
That's a huge hint that the industry is NOT doing the right thing or that the major players are taking exorbitant risks to make money. In the banking industry, we can see it's definitely BOTH of these cases, hence this huge mess we're in.
I thought I read an article in SA somewhere that the financial industry accounted for more than 1/4 of GDP in the US. Now, shouldn't that set off alarms when more than a quarter of all your 'production' is to get the rest of your production more efficient?
To put it in analogy, let's say I have a million bucks. Now I want to spend that million the best way possible. In GDP terms, I have just spend a quarter of million dollars to make sure that I used my three quarters of a million well. And then I continue to do that year in and year out. That sounds pretty stupid to me... The financial services/banking industry should be 10 or maybe 15% of our economic output, MAX.