Bank_Failures_2011-06-29_1214-300x200There was the best of bank stocks  — JPMorgan Chase (JPM) and the worst of banks — Citigroup (C) — and investors had nary a clue as to what to do with these or any other bank stocks.

When in doubt – punt. Keep your money in your pocket or do something else with it. Banks can legally manipulate their profits any way they want to and banks can hide good or bad assets on their balance sheet easier than my dog hides slippers.

What do we know about the banks? Let’s look at JPMorgan and Citigroup.

JPMorgan announced earnings last week that reinforce a.) it is a well-managed bank, b.) it is too big to understand, and c.) Wall Street agrees with both of those statements.

Clues from JPMorgan Chase

JPM is generally regarded as the best big bank in the country — investment bank and local bank put together — with Jamie Dimon as the savviest CEO. No argument here. Here is what its earnings told us:

  • JPM’s revenue fell 17%, the lowest since well before the crash. This fall was driven by large revenue drops in the investment banking and trading parts of the business. The commercial lending side of JPM — business loans, consumer loans — did very well and showed the largest amount of activity in almost four years. Middle-market lending — the core of US business — is up 17%, credit cards 10%.
  • Net charge-offs — writing off bad debt — dropped across the board, noticeably on its consumer group.
  • Dimon said he saw a bottom in housing — not any meaningful rise, just a bottom — and that growth prospects were mixed.
  • The bank has a bit less than a $16 billion dollar exposure to European sovereign debt that is in the headlines every day.
JPM-Chart
Bank stocks: Citigroup is still a mess

Now let’s look at the bank I dislike (as in investment) the most — and this, too, is a pretty common attitude among the geniuses on Wall Street.

Citigroup is and has been a mess for a long time and this last earnings announcement reinforces this opinion. Wall Street agrees — but keeps looking at charts that say the “stock should go up, the stock should go up” and the conflict between investors and traders makes the stock a bumpy ride.

Here is what Citigroup told us:

  • Revenue fell more than 7% due to falloffs in investment banking and trading, especially fixed income trading.
  • New loans grew 14% year over year.
  • The bank continues to shed assets to shrink its balance sheet, reducing the ability to generate profits. Banks acquire assets — buy loans, make loans — to generate profits. The fewer assets you have, the fewer opportunities to lose money — or to make it.
  • On-performing loans dropped 7% — the lowest drop in more than two years — and to me that indicates the company still has a bunch of junk on its books and the stagnation in the economy is not helping things.
Citigroup-Chart
How the banking sector is faring

What do these two banks tell us about the entire sector?

  • Lending into the economy is picking up, providing an impetus for growth.
  • Old, bad assets continue to inhibit profit growth at banks that led the crisis such as Citigroup, retarding profit growth due to the need to set aside more reserves than forecast for 2012.
  • Investment banking is deader than a doornail.
  • Trading income is very weak and will stay that way in 2012 due to the volatility in markets.
What investors must know about bank stocks

Conclusions for investors?

Mixed business model banks — investment banking and lending to Mom and Pop — are not a place to be. The volatility in markets, the dearth of traditional investment banking activity, the crisis in Europe make gauging earnings and therefore stock performance too difficult. Stay away and in one of my services I have recommended buying puts on Citigroup for a while now. If you disagree, think again – JPM is the best of these mixed business model banks and its stock got hit on earnings that will prove to be the most solid in the sector.

Pure business model banks are where you should look. As I write this, Goldman Sachs (GS) is announcing earnings — and the smart guys on the block beat estimates handily despite being at the mercy of investment banking and trading. Very weak – but in line with everyone’s expectations. The stock is trading below book value; these are the smartest guys on the block, untouched by the subprime crisis other than fallout from other banks. When the investment banking and trading sectors turn up, they are the play. The other play is the pure lender – a little regional that never heard of European sovereign debt and is in a part of the county that cannot get worse. One to look at is Associated Banc-Corp (ASBC) despite its customers dealing with football grief – the bank is located in Green Bay Wisconsin. Another is Hanmi Financial (HAFCD), a Los Angeles bank catering to the Korean community – and within ethnic lending communities, people always pay back their loans.

Bottom line: Now is not the time to get into the “sector” – think names only, be contrarian, look to pure business models. And with Goldman, if Europe melts down, it will figure out how to make a fortune on the short side as it does.

 

Share This