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Published: January 18, 2010
Next week the market will be focused on the
nation's banks, as the top U.S. financial institutions report
their quarterly earnings. Their earnings parade actually started
today, with a quarterly report from JPMorgan Chase & Co.
(NYSE: JPM), and it will continue next week with word from
Bank of America Corp. (NYSE: BAC), Wells Fargo & Co.
(NYSE: WFC), Goldman Sachs Group Inc. (NYSE: GS) and
a half dozen smaller institutions before Wall Street changes
focus on Friday with earnings announcements from General
Electric Co. (NYSE: GE), McDonald's Corp. (NYSE: MCD)
and Schlumberger LTD (NYSE: SLB).
J.P. Morgan's profit was up but revenue fell short of Wall
Street's expectations, which pushed stocks lower Friday, though
the Dow is still in positive territory for the year. The
pullback in banking shares may present an opportunity.
I'll be buying Citigroup (NYSE: C) shares in anticipation
of its Tuesday earnings release, to which I think the market
will react favorably.
Wall Street expects a -$0.30 per share loss, the bank's ninth
consecutive quarter in the red. But analysts' forecasts for this
company tend to miss the mark, and I want to make sure I'm
positioned for the possibility of an upside surprise. (An
earnings surprise is just one of several "profit catalysts" that
could boost a company's share price quickly.) Much of the risk
of this position is mitigated by today's pullback: Morgan's
revenue shortfall milked the rattlesnake and brought Citi shares
within pennies of their low for the year.
There's another reason I like Citi: I think its worst losses are
behind it. The bank is entering a new, post-crisis era: Its
largest investor, Prince Alwaleed bin Talal of Saudi Arabia, has
told Citi CEO Vikram Pandit in no uncertain terms that his
honeymoon is over and he expects results, a clear signal that
the worst has passed. Wall Street also has signaled it expects
the bank to return to profitability in 2010, with a consensus
estimate of $0.09 a share, though forecasts range as high as
$0.23 a share.
The latest numbers from the Federal Deposit Insurance
Corporation (FDIC) show that Citi had interest income of $35.1
billion and total interest expense of $10.6 billion, leaving it
with $24.5 billion in net interest income. Of that, more than
80%, or $19.9 billion, was set aside to cover bad loans. In
other words, without those bad loans, Citi would have had a $20
billion quarter instead of posting a loss. But here's the thing:
Citi now has $493.8 billion in loans. Of those $35.3 billion are
past due, and most but not all of which will have to be eaten
and charged off. Of that $35 billion, however, half are wholly
or partially guaranteed by the government, which means Uncle Sam
will get the bill, not Citi. Here is the data from the FDIC.
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Citi currently has $23.3 billion in its
loan-loss reserve. Adding another $20 billion to it would imply
that nearly 9% of its entire loan portfolio – nearly one in ten
loans -- is worthless. That’s high: The net chargeoff rate for
commercial banks is 2.8%, which Citi has covered by a factor of
two. I think it’s unlikely Citi will be obligated to use such a
great percentage of its net interest earnings to replenish its
reserves. If it doesn’t, then those dollars go straight to the
bottom line.
Shedding its bad loans has been a long and difficult process for
Citi, to say nothing of the exorbitant expense. On Dec. 31,
2007, the bank held a portfolio of $677.1 billion in loans with
a mere $10.7 billion in loss reserves. In the ensuing quarters,
Citi has winnowed its portfolio to just under $500 billion in
loans, with a reserve provision of $23.3 billion. The most
difficult losses have been charged off. The bank is ready to
come out from hiding, the shareholders are ready for profits and
the regulators, alas, could do with a little vacation after
these past 18 months.
Citi has long-term upside. It also is likely to see a pop with
its earnings, which, at this point, have nothing but upside.
-- Andy Obermueller
Chief Investment Strategist
Government-Driven Investing |
