A Tale of Two Banks: Citigroup and Wells Fargo

rcwhalen's picture

Your humble scribe is scheduled to be on CNBC Squawk Box on Tuesday, January 17th ~ 8:00 ET to talk about the large bank earnings parade, especially Wells Fargo (WFC) and Citigroup (C).   As with the earlier missive about JPMorgan’s (JPM) earnings, the operative paring of factors for C and WFC is better earnings on down revenue and business volumes.  Send any comments to Ben Bernanke at the Federal Reserve Board in Washington.  But why is C trading at half the multiple of WFC? 

If you refer to the last 10-Q for WFC, for example, < http://www.sec.gov/Archives/edgar/data/72971/000119312511301024/d239752d... > total interest income was down a billion dollars to $12.1 billion YOY.  Interest expense fell $400 million in the same period, but overall net interest income (NII) fell YOY.  While for several years the Fed has been able to support the cash margin on reduced revenue flows through the big banks, cash NIM is finally starting to compress with a vengeance thanks to Fed zero rate policy.   

The key change for WFC that is taking results up YOY is reduced costs for credit loss provisions, only $1.8 billion in the first nine months of 2011 vs. $3.4 billion in 2010.  So NII after provisions at WFC was up $1 billion at the end of Q3 2011.  You with me?   

A $400 billion loss from trading activities pulled total noninterest income down but somehow WFC cut $500 million in non-interest operating expenses.  That’s what allowed WFC to hit a $600 million increase in net income for Q3 and up more than $2.5 billion for the nine months through September 2011 vs. the year before to $11.1 billion.  So we have down net interest income, but up NII after provisions for loan losses.   

At $30 on Friday close, WFC is trading 1.25 times book or about a 9 forward PE with a beta of 2, above the large bank average beta of 1.8.  Of note, the subsidiary banks of WFC were rated “A” by IRA at the end of Q3 2011 and the enterprise had a risk adjusted return on capital of 2.6%.  You can look up the ratings for your bank or any US bank at www.irabankratings.com.

By comparison with WFC, the bank subsidiaries of C were rated just “C” by The IRA Bank Monitor in Q3 2011, mostly due to the default rate 2x the industry average and more aggressive posture on Exposure at Default.  Citigroup is trading on a 9 forward PE, but at just 0.5 times book and all this with a nosebleed market beta of 3. < http://www.sec.gov/Archives/edgar/data/831001/000104746911009017/a220610...

C like WFC saw a sharp, 8% drop in NII in Q3 2011 as the effect of Fed low interest rate policy forced a downward re-pricing of assets.  For the first nine months of 2011, C’s NII was down 12% to just $36 billion.  Non-interest revenue was up more than $1 billion, offsetting the shrinkage in income from earning assets. 

Unlike WFC, operating expenses at C rose almost $1 billion in Q3 2011 vs. Q3 2010, but sharply lower credit loss provisions at $3.3 billion vs. almost $6 billion the year before let C turn in a 74% or $1.7 billion YOY increase in net income in Q3 2011.  For the first nine months C was up 9% to $10.1 billion, including $1.8 billion in favorable adjustments due to the wonders of fair value accounting.      

My friend Dick Dove thinks that a revitalized C could explode on the upside, as we discussed on Bloomberg TV last week with Tom Keene < http://www.bloomberg.com/video/84060982/>.   Bove likes the piles of cash at C, but of course C, being a bank, most of this cash belongs to somebody else. 

But the fact remains that the markets today value a $1 of C revenue and earnings at half the equity multiple of WFC and trade the C equity like an option with a market beta of 3.  Only when C starts to tells us why this new, slimmer business model makes sense compared with its asset peers is the comparative valuation gap likely to shift IMHO. 

I continue to believe that the difference between the valuation of WFC and C is actually about right and is a function of the high-risk business model at C.  Say what you want about the piles of cash, Dick Bove, C has a gross yield on lending assets that is more than 350bp above the industry average, a function of a subprime internal default target for the average customer.  This is a deliberate business model choice and one that, frankly, makes it hard for me to justify buying C. 

The risk-reward equation at C is a tad light on remuneration for buy and hold investors and always has been, but as a high beta trading vehicle for hedge funds, C is the perfect date.   One reason why WFC has been so much more stable than its similarly sized peer C is that the bank continues to have a very loyal and stable shareholder base, even though WFC has some considerable legacy issues in real estate.   But frankly the visibility on 2012 revenue at WFC is not a lot better than at C. 



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arg's picture

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falak pema's picture

Carry trade for HFs with a beta of 3... Citi is, was, will stay, an imperial bank, whose historical legacy is international. Its their corporate lifeblood since 1970 days. WF is a local bank that has grown immensely in the wake of international banking (BofA, Citi, JPM-Chase etc.) meltdowns in the golden period 2001-2011. Now its sitting on a national asset pile which is potentially, under the carpet,  stinking to hi-heaven. So the whole sector is a pile of unknown toxics, both on national and international fronts. 

Bottom line : stay away from banks. Until there is meltdown or there is an entrenched, inexpungable, central bank 'print press to infinity' world wide. We are there, somewhere in between, and 2012/2013 period will be the end of time line for world capitalism to decide which way the cookie crumbles : mega inflation spiral or mega deflation pancake. Of course, if you believe in miracles...there is the third route of planned, programmed monetary inflation and resolution of debt mountain with effacement of asymmetric divide built on international labour arbitrage's global model.

A return over time to safe, prudential financial havens and reindustrialisation in first world based on new global paradigm model, not dependent on ME oil monopoly dictat  and MIC military perpetual war games. WITHOUT HEARTBREAKING, WAR CREATING, TURBULENT FINANCIAL RESET. Hail Mary, thou who art in heaven...

lamont cranston's picture

Spot on; however, I really don't feel we have a true "World Capitialism" model operating right now. World Crony Capitalist/Fascist works for me.

US/Euro banks have abandoned the traditional business model for the casino, and until they flush all the crap down the toilet nothing will change. The sad part is that when the Big Flush comes, we're dead meat, unless you have 10 acres near Big Timber Montana, a hoard of lead, and enogh stored food to feed an extended Mormon family for a year or two.

IMO, CHS hits the nail on the head with his blog today at oftwominds.com.

twotraps's picture

Good morning Lamont, have to agree with you.  Even with Falak's global reset...and assuming everyone is in agreement....the big banks game it, start the double top secret triple rehypothecation programs again and we are right back to where we were.  A little like Europe, go ahead, pay the tab for Greece....see you in five years whenn they can't pay.  Without structural change, forget it.   France and Germany knew that Greece-Ireland-Italy were not in good order in the run-up to the Euro......everyone knew since there numerous articles in the papers everywhere about the total disconnect economically, yet they went ahead and rammed through their political agenda.  We want desperately for there to be an economic outcome  given the current situation but in reality the political component is overlooked.  Please find lectures from  Finest Economics Institute in the land from 2006 and look up TARP, not there huh?  

dracos_ghost's picture

The big banks are already 'gaming it'. The headlines that are being discussed are based on retail deposits and books -- crisis, crisis, crisis. These same banks have client front-running Cayman Operations making sure that the pain is at the highest level to keep Zirpes going. We forget that these banks are now hedge funds(thanks Graham-Leach-Blilely) that have access to the discount window at 0% rate. Why would any of these banks want the global economy to recover when they have that golden goose crapping out golden eggs that only they have access to. Hell, even a simpleton can borrow at 0% and then buy 'dividend paying' large caps. When the stocks become too overvalued they dump them to the retail investor. Rinse. Repeat.

disabledvet's picture

Of course on just a "bottom feeding" technical level ALL of Wall Street is a buy...especially Citi since foreign loan growth/yield curve is always upward sloping. Problem is EUROPE IS KILLING ALL OF US. As we all know they're lender número uno to the world...and we all can watch pretty much all global equities stagnate right along with their Sugar Daddy. WF does better in my view cuz they have no Euro in them...and the West has both energy and tech...and has had that for decades now. Throw in the possibility that US still grows and at least you can conceive of loan growth without tanks in the Street. To me if the tanks role into Athens...and I have seen ZERO out of Europe that has said FOR TWO YEARS NOW that Europe will move heaven and earth to stop this outcome...then this nodus operandi will spread like wildfire throughout the world of Citi. "keep your friends close...your enemies closer"...and so it should be with your money...keep the friends of your money close (asset advisors) but keep your money's enemy (the critic of said advisor) closer. It's just a question of minimizing uncertainty: are those really "my people"...or is that asshole I really want to kill telling me EXACTLY what I need to know to keep those closest to me from taking me for all I am worth? I say remove your own heart when it comes to money and trust. The one you hate speaks the truth...which is always bitter.

onlooker's picture

There is no trust here with such bogus banks. The Big Lie is not an easy sell and I don’t buy it. Or their stock, Or their services, Or their loans. to hell with um.

Zone1's picture

What happened to all those "Pick-a-payment" mortgages that WFC inherited from Wachovia?

FMR Bankster's picture

They wrote them down 50% at the time of the Wachovia merger. (excluding the ones that were made prior to 2003 which were written down by a smaller amount) And so far that's working out about right as they charge off large losses against this massive reserve. WFC did the Wachovia deal pretty well. That's not to say they don't have problems of their own making, say home equity lines of credit on california and nevada real estate. And of course they still have further exposure from robo signing, securitizations, ect. I'd own none of the large US banks but if someone insisted on owning some WFC and USB look best.

msorense's picture

Yeah Chris - what happened to that "bloodbath" of bank earnings that was supposed to happen a year or so ago?  You are just a tool of the banks sending shorts to the death!  No wonder you get along with Dick Bove and his ilk.

Georgesblog's picture

When we last checked in on the boys, it was a little tense. You can’t blame them. Anyone would be stressed by the inconsistencies and contradictions in the economy. Not to worry ! Today, our little lunch group is graced with the presence of the Silver Tongued Devil, himself. Yes, Fed Chairman Ben Bernanke doles out a little of his regal and condescending insight for the benefit of ……. well, we’ll see who it benefits.


twotraps's picture

Enjoyed the article and loved the 'considerable legacy issues in real estate'..... to continue in the spirit of your understatement....I am skeptical about properly pricing banks at this time.  This time or any time in the past several years, for that matter.   The pathetic tangle of truly hidden problems,  problems the govt is allowing them to hide, and unusual involvement of the Fed,  there is little hope in properly pricing them.   With solvency issues in sight, I highly doubt shareholder issues are keeping them up at night either.   When a big producer at a big bank contact of mine went digging through the company statements with some higher-ups....he was told 'not to go there'.   That was about all I needed to hear.