Citigroup Earnings, NIM and the FDIC TAG Program


Your humble scribe is scheduled to be on CNBC this Monday ~ 8:00 ET to talk bank earnings for Citigroup (C) and then Goldman Sachs (GS) the following day.  With all of the attention being paid to JPMorgan and its hapless CEO Jamie Dimon, I’ve been less attentive to the zombie dance queen than usual.   Let us repair this deficiency.


Like most of the TBTF banks, C has been showing steadily improving numbers in its public disclosure to the SEC and federal regulators.  Indeed, even with the high loss rate, C managed to climb up to a “B” in The IRA Bank Monitor as of Q1 2012 vs. “F” where the bank languished for more than two years.   Citi did about $3 billion in net income in Q1 2012 on $18 billion in revenue, and likely will come in around that level again, assuming no “surprises.”


Because C’s natural credit loss rate is 2x the industry average, it is very difficult for C and other high loss rate peers such as Capital One Financial (COF) to ever achieve an “A” in IRA’s tough quarterly stress survey of the US banking industry.  Recall that C management has previously made some noises about changing the bank’s business model to include a lower internal target loss rate, but the latest disclosure does not show this nor should we expect to see any meaningful change in the Q2 2012 earnings release. 


For example, the average Bank Stress Index score for the US banking was 1.3 in Q1 2012 (1995=1), but C had a stress score of 1.7.  In terms of charge-offs, C reported a score of 4.4 vs. 2.3 for the banking industry as a whole.  Remember that the Bank Stress Index industry average includes C, which is more than 10% of the whole industry.  So the ex-Citigroup population’s score for charge-offs is even lower than the industry average suggests when compared to C alone.  Of note, C common has fallen to a beta of less than 2 vs 3 for much of last year, but it remains among the most volatile stocks in the group.


To give you another perspective on C’s risk/return profile, in Q1 2012 IRA calculated a risk adjusted return on capital or RAROC of 0.543%, a pathetic level of real return typical for the TBTF banks.  By and large the zombie banks are value destroyers, on net taking resources from the economy and equity holders as well.  When people tell you that we need to have large banks to make the US economy competitive, ask them: Just how exactly does that work? 


Question:  If banks like C are perennial losers, both in nominal and real terms, why do we tolerate their continued existence?  Because people like former Treasury Secretary Robert Rubin and his minion, Timothy Geithner, find it useful to have this wounded bank around as a political “blood doll,” to use a popular metaphor.  If you understand that former C chairman Rubin is Melkor to Geithner’s Sauron in the J.R.R Tolkien “Lord of the Rings” pantheon, then all becomes clear.  Seen from that angle, Geithner is the de facto chairman of Citigroup.   It’s all so Latin, isn’t it?  But we digress.      


The Street has C down mid-single digits for revenue in 2012, but miraculously up revenue for 2013 even as the Fed continues ZIRP.  It is hard to square the Street view of 2013 earnings with continued Fed manipulation of short-term interest rates through 2014.  One of the more bizarre parts of the JPM analyst meeting came when Dimon and his team stated emphatically that there would be no further erosion in net interest margin (NIM) through the latest interest rate cycle.  You should expect to hear similar prattle from C, this even as the zombie bank pushes in Washington for continuation of one of the largest and most odious subsidies of all, namely the FDIC’s Transaction Account Guarantee program.   


Despite the incipient optimism about a recovery in housing, these are still dark days for the zombie banks -- even with the continuing flow of tens of billion in annual subsidies from Washington.  You may have noticed during my questions to JPM CEO Jamie Dimon at last week’s analyst conference a query about extension of the Transaction Account Guarantee program, known in the corridors of power as “TAG.”  Dimon pretended to be clueless, but I am not buying it -- any more than I buy the idea that Dimon did not know about the CIO’s UK exposures in 2010.  See ZH, “A few more questions on JP Morgan and the London Whale.”


Would it surprise you that C and other large banks are supporting extension of the “temporary” TAG program, a federal subsidy that was meant to help small community banks through the crisis?  Indeed, contrary to what most members of Congress think they understand, TAG is helping to reinforce the large bank cartel in many markets at the expense of smaller banks and the public.  I wrote about this in American Banker (“More Evidence TAG Helps Only the Big Banks.”)


First put in place during the dark days of 2008, TAG provides unlimited deposit insurance coverage to non-interest bearing transaction accounts -- including Treasury deposits, payroll, tax and loan payments in process.  The TAG program was extended by Congress for two more years in 2010, but now C and most of the largest banks are trying to permanently extend TAG and thereby entrench themselves as government sponsored entities like Fannie Mae and Freddie Mac. 

Conceived as a program to help small banks, instead behemoths like C and JPM are the main beneficiaries of TAG.   Your typical community bank has a couple of percent of liabilities in non-interest bearing transaction balances.  Large banks, on the other hand, can have balances covered by TAG 3-4 times that percentage.  FDIC Chairman Sheila Bair said in 2010:


"It's necessary to extend the TAG program because the lingering effects of the financial crisis that emerged in 2008 in large systemically important banks have now spread to institutions of all sizes, particularly in regions suffering from ongoing economic weakness. Allowing the TAG program to expire in this environment could cause a number of community banks—already under stress—to experience deposit withdrawals from their large transaction accounts and would risk needless liquidity failures. This reflects the continuing legacy of too big to fail and the different liquidity pressures our community banks experience as a result."


Bair is right about the legacy of too-big-to-fail; TAG reinforces it beautifully from the perspective of C and other large banks.  For C, the TAG program covers non-interest bearing deposits of over $100 billion or about one eighth of the bank’s total deposit footprint.  Indeed, by extending FDIC insurance to all of C’s deposit liabilities, the FDIC is reinforcing the TBTF cartel in markets such as residential and commercial mortgages.  TAG, for example, allows banks such as Wells Fargo (WFC) to underprice residential and commercial loans, supporting a nearly 1/3 market share for WFC nationally.  Hello? 


It may – or may not -- surprise you to learn that many small banks are also supporting making TAG permanent, this even though overall the program clearly hurts smaller lenders.  Trade groups such as the Independent Community Bankers Association have publicly called for an extension of TAG.  I hear that the American Bankers Association is prepared to do the same.  But other industry groups are opposing any extension of TAG and rightly so.  Thomas Lemke. General Counsel and Executive Vice President of Legg Mason & Co testified on Dodd-Frank on behalf of the Investment Company Institute on July 10.  He flatly opposed extension of TAG:


“We understand that some are calling for Congress to extend this unlimited insurance program beyond its statutory expiration date.22 ICI strongly opposes any such extension. We view the program as having the potential to dislocate markets and increase systemic risk in times of market stress by creating an unlimited taxpayer-supported backstop for these transaction accounts… Historically, the risks posed by deposit insurance programs have been mitigated by capping the amount of a depositor’s account that is insured (currently $250,000).  In the case of the insurance authorized by Section 343 of the Dodd-Frank Act, the statutory limits on the types of accounts covered and the December 31, 2012 termination date should serve to reduce the possible negative effects of the program. With the stability of the U.S. financial system at stake, the importance of these limits cannot be overemphasized.  Congress therefore should resist any efforts to vitiate them.”


By giving C an additional $100 billion plus in cost-free deposits, the FDIC is helping C and the other TBTF banks prey upon smaller lenders, increasing the degree of concentration in the US banking system.  But the key point regarding C earnings is that absent the TAG program, how would a bank such as C look?  My guess is that TAG is reducing interest expense for C and the top four banks by 10-15% annually.  For Citi this is something on the order of $2.5-$3 billion annually added to revenue or one quarter of annual earnings in 2011.  As I’ve noted in the past, a bank should not be able to count TAG balances as deposits at all.   


As and when the Fed does allow rates to rise, much of the incremental funding that has fled to the TBTF banks will run right back out.  But the prospect of SEC regulation of money market funds may push even more funds into the banks, begging the question as to why we really need TAG at all.  In any event, the rosy predictions regarding the stability of NIM may turn out to be as false as the promise of stable revenue and earnings has always been for the TBTF banks.  The subsidy provided to C, JPM and other TBTF banks by the FDIC TAG program is bad enough, but you could argue that virtually all of the earnings of C result from one federal subsidy or another. 


So remember, ask not how the TBTF banks can help the US economy, but rather how much economic value these financial vampires will drain from America’s economic patrimony in 2012 due to their choke hold on Washington.  Programs such as TAG illustrate how the TBTF banks can hijack a program that was passed by Congress to help small banks, but instead has turned into a rich subsidy for the largest, most risky banks in the nation.   So when you see Citi’s Q2 2012 earnings, remember that about ¼ of the number will come from non-interest bearing deposits covered by TAG.