Citigroup: Too Big To Fail?

Although, “it was really a moment of levity in a rough day, rather than a display of humility.” In 2008, Treasury Secretary Hank Paulson dropped on one knee before Nancy Pelosi, the House speaker, imploring her not to blow up the $700 billion bank bailout deal by withdrawing Democratic support.  “I didn’t know you were a Catholic,” replied Ms. Pelosi, herself of impeccable Italian Catholic ancestry.

How soon do we forget!  It is again the rough-and-tumble presidential election year politics trumpling over the usual campaign issues. This time, Democratic presidential candidate Hillary Clinton has picked on big banks, “…. the reason we passed Dodd-Frank was to make it clear no bank is too big to fail, no executive too powerful to jail. And we’ve got to keep face with the American people. I’m sorry that you’ve made bad decisions, but we’re going to have to unwind you and yes, break you up …..”  As expected, all big bank stocks, including Citigroup, plunged amid Mrs. Clinton’s calls to rein in the financial industry.

Although, critic may argue that after Dodd-Frank, all big banks, albeit bigger, are under much tighter scrutiny.  We still have, on average, one bank closed every day just like the last 60 years.  Any surviving banks need to be big enough to get access to public capital market in time of confidence crisis, so taxpayers’ bailout like 2008 won’t happen again.  However, we can only hope that, like any other campaign pivoting, the rhetoric will soon dissipate after the Primary.

Although, banks are in the business of making money from risk premium, the notions of negative interest rates certainly are not something banks want to hear.  Negative interest rates will only squeeze bank’s interest margins and earnings.  Following Sweden (2009 and 2010), Denmark (2012), and European Central Bank’s (2014) negative interest rate moves, Bank of Japan has just spurred the Japan banks by adopting negative interest rates at January 29.  Bank of Israel was expected to follow suit in 3 months.  No wonder that all U.S. banks did not respond well to Federal Reserve Chairwoman Janet Yellen’s comment (2/10) that she would not take negative interest rates off the table should the economy see a downward turn.  While it is widely believed that such a move isn’t likely any time soon, especially since the Fed only recently raised rates, investors were seemingly dumping banking stocks. Citigroup stock was trading at their lowest levels since 2012.

Although, we do not think the above mentioned macro factors will pose a serious risk to the banking industry, we cannot dismiss Citigroup’s indifference to market’s demand for more pivotal information for its high-risk energy holding. Bank of America has reported to put up 2.4% reserve against its $21.2 billion-funded energy portfolio, JP Morgan Chase’s 5.4%, and Wells Fargo’s 7%.  In contrast, Citigroup has repeatedly refused to provide more color about its reserve ratios for the energy portfolio.  Although Citigroup may not be required by law to answer every question in their conference calls, they will have to answer every question to their shareholders eventually.  Today, Citigroup is traded at the lowest valuation among major banks, with a price-to-book ratio of 0.7, JPMorgan Chase at 1.2, Bank of America at 0.8, and Wells Fargo at 1.7.  You can draw your own conclusion from that.

Although, that being said, some may be still tempted to draw a parallel from 2008’s bank exposures in mortgage loans to today’s exposures in energy loans.  As the numbers bear out, today’s banks’ energy loans are just 1/14 of the mortgage loans on bank balance sheets at 2008.  We are also at near-bottom oil price levels per most benchmarks.  While significant energy loan defaults are forthcoming, we estimate the negative impact on banks will not amount to a historic proportion.

In short, Citigroup’s stock may look cheap but do not mean it is a bargain.  After all, Warren Buffett’s $5 billion in Goldman and Saudi Prince Alwaleed bin Tala’s $349 million in Citigroup have not seen the day light yet since 2008.

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