Chris Whalen Comments On Citigroup, Bank of America, Wells Fargo, and J.P. Morgan
We spoke with Whalen on February 24, 2009.
Which banks, specifically, are in the most trouble? How long before they will be forced to raise more capital or before some other event forces the government to deal with their stability?
My ranking of the top four banks, in order of most to least worrisome, is Citigroup (C), the Bank of America (BAC), Wells Fargo(WFC), and J.P. Morgan (JPM).
J.P. Morgan’s relatively stronger position is attributable to a critical decision [CEO] Jamie Dimon made four years ago, shortly after he came there from Bank One. He sold their residential mortgage backed (RMBS) portfolio to GMAC, GE Capital and a bunch of other players. This allowed them to dodge the bullet as the CDO markets collapsed and to avoid the structured finance exposure that essentially dooms the other big banks, including Citigroup, UBS and Merrill Lynch, which the Bank of America was forced to absorb to save the primary dealer. Even though J.P. Morgan has bought itself some time, they still may not outrun the macro economy tsunami.
Citigroup, on the other hand, was already an outlier in terms of its credit loss rate before the onset of the crisis. Now its structured exposure sits on top of the thinnest tangible capital in the industry, even if they convert the preferred as widely expected. As the credit crisis deepen, the loss rates out of Citigroup will be so high that its off-balance sheet losses may be greater than those on its balance sheet. This is the legacy that Sandy Weill and Robert Rubin have left for the Citigroup shareholders.
Turning to Bank of America, as I said, Ken Lewis seemingly was bullied into saving Merrill Lynch, and that acquisition now may cripple the bank. Bank of America started 2008 as the most stable large bank holding company, and it is now just behind Citigroup as the second weakest bank, in my view.
Well Fargo’s status is less clear. The wisdom in the lending origination channel is that slamming Wells and Wachovia together was a marriage of two weak players. If this is true, then Wells faces serious problems, especially if the economy remains weaker than official projections. One observer told me that success in terms of Wells absorbing Wachovia requires a Q3 09 economic bounce, but this seems unlikely.
When Jamie Dimon bought Washington Mutual, he bought the bank after it had been restructured and paid only a few cents on the dollar for its assets, allowing him to aggressively clean up its balance sheet. J.P. Morgan is now in the middle of its peer group, with an efficiency rating of 50%, versus 65% for Citigroup. [Ed. Note: The efficiency rating measures the cost of acquiring a new dollar of revenue. An efficiency rating of 50% implies a cost of 50 cents to generate a dollar of new business.
Interestingly, Dimon, in addition to selling the RMBS business, made an earlier move that illustrates his management approach to cost cutting and business model choices. Immediately after taking charge at Banc One, he closed Wingspan Bank, the loss-leading Internet banking effort. He has demonstrated a different operating mentality from his peers, and that has kept his firm out of the worst troubles in the industry — at least so far.
In terms of the industry as a whole, much of the cancer is at the top. Of the $1 trillion in banking industry write-offs we forecast for this year, two-thirds will occur in these top four banks.
For financial advisors, the important implication is that the bottom two-thirds of the industry may be boring, but it is safe and stable.
At the end of the third quarter of last year, two-thirds of U.S. banks were rated A or A-plus. By the end of this year, that percentage will drop to about half of all banks. The industry will continue to see losses, but the major parts of the banking system are okay.
Click here to read on Chris Whalen's comments on nationalization of banks and how to invest in bank stocks.