Bank Of America And Citigroup Face Challenges; Not The Time To Buy Big Banks

Includes: BAC, C, FITB, GS, JPM, WFC, XLF
by: Dividend Kings

In my years following Bank of America (NYSE:BAC), now seems to be the worst possible time to invest in this fledgling business. Bank of America earned accounting profits but sustaining earnings per share looks negative: Third quarter earnings last year were reported at $6.2 billion but were mostly gains in accounting and pre-tax benefits from the sale of a Chinese bank.

The current price of BAC is so far above its earnings it makes price to earnings valuation unusable. Based on this alone I would expect BAC to continue losing value. Furthermore, analysts' estimates are hard to take, consensus estimate for next year reported on Yahoo! Finance is 2300% growth. I don't think this outcome is likely.

The new regulations put into place protecting big banks, and our society, against another financial meltdown will affect business. The rules are stemming from the Frank-Dodd Act. It could require banks with assets over $50 billion to keep more cash on hand to soften economic downturns. It will require banks with $500 billion in assets to have even more available cash. Banks with over $500 billion include Bank of America, JP Morgan Chase (NYSE:JPM), Citigroup (NYSE:C) and Goldman Sachs Group (NYSE:GS). Most banks are fighting the new rules, claiming that it will impact their ability to make loans.

Tougher regulations, combined with a decreased loan demand, will prevent the larger banks from aggressively seeking out new business. In an effort to raise cash, Bank of America announced that it will be cutting out lending to small businesses, requiring them to repay loans immediately or face higher interest rates. In another move to raise revenue this year, BAC tried charging a monthly fee of $5 for ATM use. This was not taken well by its customers and the idea was soon shelved. The fee was BAC's attempt to circumvent the Durbin Amendment to the Frank-Dodd Act. The amendment limits the amount of money banks can charge to merchants for ATM and CC services.

Another hurdle for BAC to overcome is the rising popularity of small, local banks. Fifth Third Bancorp (NASDAQ:FITB) is set to be one of the stars of the financial world this year. It outperformed the financial sector in 2011 and is expected to do well into 2012. In 2011 alone FITB loaned $19.5 billion and is planning to loan an additional $20 billion by July of 2012. FITB is currently trading around $13 with a P/E of roughly 11 times earnings. FITB current dividend yield is 2.44% and is rated a moderate buy by an average of 24 analysts. Bank of America pays a dividend, but I think, only as a means of attracting investment. The current yield is .72%, or $0.04/share.

Citigroup also offers a dividend yielding .14%. Citigroup and Bank of America should keep that money; it could help them withstand another crisis. Fifth Third also carries less debt than its larger competitors with a debt to equity ratio of .77 compared to BAC's 1.9, Citigroup's 1.8 and JP Morgan's 1.74. FITB has been trending in line with the Dow Jones Industrial Average, up about 42% since August of this year. Bank of America declined about 50% in the same time.

Bank of America and others are still dealing with fallout from the sub-prime mortgage crisis. Most recently, BAC paid out $335 million in a settlement against its Countrywide unit. Countrywide was accused of unfairly discriminating against qualified minority borrowers. This is on top of billions paid earlier in the year. BAC agreed to pay $8.5 billion to settle suits stemming from the financial crisis, a settlement that is still being fought over. In similar statements BAC has said it will cost upwards of 20 billion to put the crisis behind it. Other large banks such as JP Morgan and Wells Fargo (NYSE:WFC) are also facing such charges. The question I ask now is, what other charges will be brought against these companies?

The entire financial sector, represented by the Financial Sector Spider (NYSEARCA:XLF), is down 20% for 2011. BAC is down 60% and looks like it will continue to lose ground. Momentum is bearish and BAC is still well above its long term support level established in 2009. I think BAC will decline another 40-50% over the next year while the banking sector continues to recover. Bank of America will continue struggling to remain profitable. Lack of faith in large banking, the recession in Europe, slowing growth in China and low interest rates here at home will all come out of the bottom line. Bank of America does have some attraction as a growth stock and will probably rebound, but now is a very risky time to get in. 2012 will see a continuation of restructuring and rebuilding among the financial giants.

Citigroup is facing the same challenges. Citigroup's most recent earnings report did little to impress me. They posted net gains for the Q3 2011 versus the same period last year with a 21% decline in investment banking revenue and basically flat earnings. Citigroup inflated its earnings with a shift of $1.4 billion from its loan reserves, accounting for 85% of its earnings. Further into the statement exposure to Europe and other macro-economic were listed as area of concern. Citigroup is currently trading around $28, near the mid point of its 3 year trading range. The long term indicators support a weak market, and there is a bearish triangle forming. I think Citigroup will decline at least 50% with possible support $10.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.