The Healing Process Is On-Going
For Citigroup earnings were just below consensus (EPS was $1.02 versus $1.04 that analysts' expected). The main reason for under-performance, which was related to trading revenues (down by 18% year over year), does not worry me at all.
Investors should keep their eyes on the big prize, which is that the stock is trading at only 90% of its tangible book value while the company is getting healthier and stronger with every quarter. Besides, Citi Holdings, which is where the bank has accumulated all its troubled non-core assets, shrank by 7% quarter over quarter and now represents just 6.4% of the total loan portfolio. Moreover, Citi's Tier 1 common ratio increased by 0.4% to 10.4%.
Since I expect Citi to continue ameliorating its balance sheet fast, my recommendation would be to stay long. Great investors such as Leon Cooperman and James Barrow already own the name.
Litigation Costs Are the Cloud on the Horizon
Bank of America's third quarter results were largely as expected. Overall operational trends are in line with industry trends with revenues slightly below forecasts on lower fee income. On most business lines the bank behaved similarly to its peers. For example trading was down 8% versus 2% at JPMorgan (JPM) and 18% at Citi while mortgage banking was down 60% versus 65% at JPMorgan and 43% at Wells Fargo (WFC).
The primary reason for concern is what the final cost of litigation will be. Even when Bank of America has systematically been settling significant portions of the claims, I need to agree with most analysts on the fact that Countrywide and Merrill acquisitions (during the midst of the financial crisis) surely leave the bank more exposed to negative surprises than most of its peers. As a matter of fact, reported expenses came in higher than expected driven by litigation costs. Reported expenses increased by 2% quarter over quarter thanks to an expense of $1.1 billion related to litigation. If this cost hadn't existed, expenses had declined $200 million quarter over quarter from cost initiatives such as the (still) declining headcount (full time employees are down by 9% year over year).
Clearly, third quarter results also came with some good [size=11.0pt;line-height:115%; font-family:"Calibri","sans-serif";mso-ascii-theme-font:minor-latin;mso-fareast-font-family: Calibri;mso-fareast-theme-font:minor-latin;mso-hansi-theme-font:minor-latin; mso-bidi-font-family:"Times New Roman";mso-bidi-theme-font:minor-bidi; mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA">— — Charles Brandes,[/b] trades at 104% its current tangible book value.
Both Bank of America and Citi should benefit from America's (still timid) economic recovery and both institutions have made huge efforts to lower expenses while improving their balance sheet. Given current market prices and the litigation risks that Bank of America is facing, I would rather own Citi. Once again, “Price is what you give and value is what you get.”
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