Living Wills: A New Way To Approach The Banking Sector

 |  Includes: BAC, C, GS, JPM, MS
by: IncomeHunter

In view of the unstable economy of late, as well as some major mess-ups from some of the larger banks in the country, regulators require that U.S. banks provide living wills, or plans of what they will do to protect as many people as possible, financially speaking, if they find themselves on the verge of collapse. Three main banks that are affected by these policies are Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM), and Bank of America (NYSE:BAC). Some of their competitors, including Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), should also take notice of the effect living wills may have on investor confidence and bottom lines. In the end, living wills highlight the doubts one might have buying into one of these banks, but I will show that there are clear favorites to be had here.

The new law that has been put into place specifically requires banks to "outline the ways to liquidate by breaking up and selling off assets if they are on the verge of collapse". Citigroup is one of the banks that has been named as a party that needs to provide this information to regulators. In my mind, being named as a bank that must provide a living will indicates that there is not a lot of faith in its ability to remain intact in the years to come and could incite some doubt were I an investor in that bank.

Over the last three months, Citigroup's share price has declined by nearly 23% and I feel that this is a result of the negative perceptions generated by the fact that the company has to create a living will. The decline will probably continue over the next weeks, and I suggest that investors in the company reassess their investment soon. Citigroup is down over 30% from its point last mid-July. It still provides a decent 3.57 EPS, but its dividend is down to $0.01, leaving little to like here.

JPMorgan was also named as a bank that needed to provide a living will plan that would account for any losses that it may accrue should it go bankrupt. The company put forward a plan for the "systematic dismantling of its businesses that would eliminate every systematic risk to the financial system". This seems like a good plan, but should banks really be in a position where they have to make plans for their potential future collapse? And what effect does this negative perception have on the stock prices of banks like JPMorgan?

Over the course of the five days before and after the news that JPMorgan would be required to present a plan for liquidity was announced, the company's share prices dropped by more than 3%, though it is trading at around $38 per share. JPMorgan has sort of beat out the general perception, as its actually climbed over 8% in 2012. It offers a decent dividend of $0.30 and a yield of 3.33%. It's still down 10 points from its 52-week high, but I think investors have been generally pleased that the bank has drowned more already. More pleased, perhaps, with a still decent 4.44 EPS and an estimated 3Q revenue of over $24 billion (last year's 3Q profit was $24.37 billion - not too far off).

Bank of America recently announced a comprehensive living will plan to account for any losses that may be incurred should the bank collapse. Specifically, the company will "place its U.S. banking operations into FDIC receivership, unwind its Merrill Lynch unit by putting it under a government-appointed trustee and place its non-bank and non-broker holding companies into Chapter 11 bankruptcy".

The company's stock price has been up and down over the last month or so, but the stock has increased overall by about 2.5% over that time period. In addition, the company is trading around $8 per share and since it started 2012 off at such a low point, it's up over 40% this year, though it's down from the $10 price of last July. It offers an EPS under 1, and with doubt in the future of large banks (summed up by living wills), I can't imagine that these earnings will bring too many investors around.

Besides, the Barclays news has hurt the big banks and I don't see Bank of America climbing too high until international attention on these banks subsides a bit. Plus, the banks are still hurt by extremely low net interest margins, though analysts have pointed out that Bank of America has done a good job of combating this by reducing non-interest expenses (among other things). It has a long way to go, but it's still breathing and capable.

Two other banks recently released their living wills - Goldman Sachs and Morgan Stanley. These two banks and the three others already discussed are five of the nine banks that have been requested to submit their living wills to regulators so far. By the end of 2013, this number will be at more than 100. The news hit Goldman Sachs rather badly, as the company has experienced a decrease of about 19% in stock prices. Morgan Stanley is also down by about 20% over the last three months. It is not yet a definite fact that these declines are a result of the living will situation, but I believe that this does play a part.

Still, Goldman Sachs' second quarter beat expectations in both revenue and earnings per share - a good sign for sure. Unlike Bank of America, Goldman Sachs' EPS of 6.71 should excite potential investors, as there's something to be gained here. With a corresponding P/E ratio of just over 14, there's some decent rewards to be had here if you're willing to buy the pricier Goldman Sachs stock (over $105 per share).

The concept of banks creating living wills indicates just how uncertain we are about our economic future. The nine banks that have been required to provide these plans first can be assumed to be the ones in the most susceptible positions at the moment, so it will definitely correlate with declines. The idea is less tangible of an affecting factor than financials' losses and gains, but it does highlight the fickle aspect of the banking industry. It's never been for the weak of heart. JPMorgan continues to perform well this year and it's even managed to increase its dividend. If you want to stick with a bank, that may be the best way to go, though it could drop soon with so much outrage from LIBOR and the international banking stage.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.