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Don't be afraid of the big bad banks
With rates rising and their stocks looking rich, many predict a bad run for Citigroup, JP Morgan and Bank of America. Here's why those predictions are wrong.
By Michael Brush
For most of this year its been popular to kick around our countrys three largest banks. At various points since the summer, Citigroup (C, news, msgs), JP Morgan Chase (JPM, news, msgs) and Bank of America (BAC, news, msgs) were all down about 15% from their recent highs.
But the banking giants clawed their way back to trade near their highs for the year.
That wasnt supposed to happen.
After all, these banks had plenty going against them. The banks are breaking in new management, dealing with regulatory scrutiny or digesting acquisitions. And they are operating in an interest-rate environment that has robbed them of their easy money.
But I think the stock market is right and these stocks were right to climb. They should go higher. Sure, stocks like these are bound to give up some of their recent gains as traders take profits. But there are still plenty of reasons for the businesses, and their stocks, to thrive.
Here's a closer look at what the bears say about the big banks, and why those bears are wrong.
Bear claim # 1: Transition is a distraction
Stability hasn't been in great supply at any of the banks. For example, Citigroup, bothered by nagging regulatory issues, in October 2003 put a lawyer in charge who could hardly be more different from his predecessor.
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Former Citigroup CEO Sandy Weil made his name on the back of bold and risky mergers and acquisitions, the biggest being the marriage of Citibank and Travelers. Under new boss Chuck Prince, who used to head the banks legal department, Citigroup is more focused on reforming the banks culture.
And for good reason. In recent years, Citi has drawn the wrath of regulators, who shuttered the bank's private banking group in Japan and forced the bank to pay $25.3 million in fines and disgorgement related to trades made by one of its London units.
Even the Federal Reserve -- when it approved Citigroups acquisition of a Texas bank -- suggested that Citigroup ought to spend more time on its 5-point plan to improve internal controls. Investors took this to mean U.S. regulators were putting the kibosh on more acquisitions, at least for now.
The bank is still focused on internal controls and cleaning up some of the risk management controls that got a little too much short shrift under Weil, says Morningstar analyst Craig Woker. The upshot: Managers have pulled back and become more conservative, while figuring out what all the changes mean, says Sandler O'Neill & Partners analyst Jeff Harte.
But that wont last forever, and this is where the bears have it wrong. Prince recently said the internal reform should be completed by the end of this year. We believe Citigroup is doing the right things to graduate from the Fed's acquisition penalty box, and that progress on the regulatory front will likely clear the way for acquisitions in 2006, says Harte.
As Citigroup tries to get back in the acquisition game, investors are cautious of JP Morgan Chase and Bank of America because of recent acquisitions. JP Morgan Chase purchased Bank One in 2004. Bank of America is still digesting its 2004 purchase of FleetBoston, and has yet to close on its purchase of credit-card company MBNA.
But the fears here are overdone. Mark Giambrone, portfolio manager of the USAA Value Fund (UVALX), which owns Bank of America and Citigroup, thinks JP Morgan's integration costs will wind down in the coming year, and then the bank will start to see lower expenses thanks to all the work.
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