by Carl Delfeld, Global Markets Strategists, The Oxford Club
Thursday, August 9, 2012: Issue #1833
We never forget our first real job.
For me it was the First National Bank of Boston, the second oldest in the country, founded in 1784. Hired by the Asia-Pacific Group, I first went through a six-month executive training program that was basically a crash course on corporate banking basics.
Drilled by crusty veterans on how to read a balance sheet, crunch cash flows and evaluate loan collateral, the overriding goal was to determine the creditworthiness of the borrower and have a wide margin for error. The message was clear – get the money back or else.
I’ll bet the big banks don’t have these training programs anymore. Corporate lending is a much smaller piece of their “financial supermarket model” that’s reached levels of baffling complexity.
This management nightmare has also led to landmines exploding on a regular basis, such as JPMorgan Chase’s (NYSE: JPM) ongoing $9-billion trading loss. And just last week, one of the largest banks in the world, HSBC (NYSE: HBC), announced a $700-million charge to earnings from failure to prevent money laundering in Mexico and set aside $1.3 billion to compensate customers for selling misleading products.
These blunders have hit shareholders right between the eyes. They’ve also fueled the movement to slim down or break up banks. This pressure is picking up steam.
And you won’t guess who just jumped on this bandwagon to break up big banks – the 79-year-old former dealmaker that orchestrated the building of Citigroup (NYSE: C), Sandy Weill. Weill has seemingly had a change of heart across the board, moving to sunny California, cashing out of his spacious Manhattan penthouse for a cool $88 million and putting his 200-foot yacht on the market for $60 million.
HSBC’s poor stock performance over the last couple of years is no surprise to me.
Last May, I warned readers to steer clear of the giants like HSBC and offered a Hong Kong-based bank that has increased revenue at an average annual rate of 18% over the last 10 years as a better alternative. Its share price is up over the past five years while HSBC’s stock is down 51% and Citigroup’s is down 94% over the same period.
What about the future?
This movement for slimmer, more focused and transparent banks is a good one for investors. And the spate of bad news has driven share prices down to attractive levels. The unwinding of the financial supermarket model is very likely to show that the value of the parts is bigger than current stock price.
Citigroup’s stock is trading at just 42% of its tangible break-up value and about six times consensus 2013 earnings estimates. For comparison purposes, the stock traded in 2006 at 260% of book value.
The value of Citi’s international network alone with 4,600 branches in 40 countries seems quite high to me. While the bank’s U.S. revenue was down during the first half of 2012, revenue and profits grew in Latin America and Asia. Above all, Citigroup needs top line growth, but continues to cut expenses, with the investment banking group alone shedding $332 million in the second quarter of this year.
I also see some signs of progress and value with HSBC.
Since the beginning of 2011, the bank has completed 36 deals to get rid of non-core businesses, shed 27,000 employees and cut annual expenses by $2.7 billion.
HSBC, formerly known as the Hong Kong and Shanghai Banking Corporation, is finally getting back to its roots in Asia. Hong Kong profits in the first half were up 23% while the rest of Asia was up 17%.
HSBC’s great unwinding has a way to go but it has a balance sheet to stay the course with more than $150 billion on deposit with central banks.
Both of these complex behemoth banks have a long way to go to become more manageable and transparent, but are turning a corner and represent good value.