Bank Cyber Security Issues Dog Financial Stocks

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I used to regard banks and other financial companies as black boxes, mostly because it is hard to account for the value of their assets. However, I have found that the more fundamental problem with huge financial companies is that they are too complex to understand or predict. I literally could not make up some of the issues that erupt for these firms. The problems that surface for these firms cannot be quantified or even guessed.

Wells Fargo’s (NYSE: WFC) service interruptions and HSBC’s (NYSE: HBC) money laundering investigation and settlement are the latest examples of wild, unpredictable risks.

Bank Cyber Security Issues

The Wells Fargo website has consistently been inaccessible to customers amidst fears of cyber attacks targeting major banks. The company that boasts of the fourth largest asset base amongst U.S. banks is said to have about 21 million online banking customers. Though the high number of customers accessing the website at a time may effect accessibility of online services, the hacking threat by Izz ad-Din al-Qassam Cyber Fighters cannot be ignored. Wells Fargo apologized to customers on Twitter while spokesperson Bridget Braxton continued to reassure them that the problem was being looked into.  According to Braxton, "Our technical teams have been working around the clock to ensure our Web site is accessible to our customers."

The hacker group has made several posts on the internet and it is said to target major banks that have denied the existence of cyber attacks. Banks may not openly admit to such problems, as it may cause panic amongst customers and consequently effect the banking sector negatively.

Major banks like U.S Bancorp and PNC Financial Services Group experienced some interruptions, but the respective spokespersons either declined to comment or refuted the claims. As part of its regulation duties, the Office of the Comptroller of the Currency (OCC) advised banks to take precaution. According to the OCC, "Banks need to have a heightened sense of awareness regarding these attacks and employ appropriate resources to identify and mitigate the associated risks.”

HSBC Settlement

HSBC agreed to settle with the U.S. Department of Justice over money laundering investigations. HSBC will pay about $1.92 billion, which includes $665 million in civil penalties and a $1.25 billion forfeiture, in exchange for a deferred prosecution agreement. This is the largest such settlement payment ever made by a bank, and beats the $619 million paid by Netherland’s ING Groep for similar penalties last June.

As part of the agreement, HSBC will create a board to implement anti-money laundering controls and create a special office to report on group money laundering detection and prevention, aside from spending $700 million over five years on “know your customer” procedures.   Robert Werner—U.S. Treasury’s Office of Foreign Assets Control and Financial Crimes Enforcement Network former head—was tapped by HSBC to head the compliance board and to be the money laundering reporting officer.

Senate investigations and the U.S. Justice Department found numerous violations, which include HSBC’s failure to comply with anti-money laundering review, which resulted in hundreds of millions of dollars and trillions of dollars in wire transfers in Mexican illegal drug money passing through U.S. bank accounts. U.S. Treasury Undersecretary David S. Cohen said, “Despite the well-known illicit finance risks associated with Mexican drug trafficking organizations, HSBC inexplicably placed Mexico in its lowest possible risk category.  As a result, it allowed billions in wire transactions and bulk cash to pass through its gates with minimal if any monitoring.” HSBC’s U.S. and Mexican business units failed to monitor around $9.4 billion in dollar purchases and about $670 billion in wire transfers.

The bank’s failure to implement adequate and anti-money laundering procedures left dangerous gaps that criminals could readily exploit. HSBC was also used as a conduit to circumvent economic sanctions. Thanks to HSBC, about $660 million in Office of Foreign Assets Control’s prohibited transactions moved through U.S. financial institutions from countries with economic sanctions such as Iran and Cuba. In addition, investigators identified $430 million from 2,300 transactions that transpired between March 2004 to June 2010, which violated economic sanctions imposed against Cuba, Libya, Iran, Sudan and Burma.

Senate investigation revealed that HSBC also handled ‘U-turn transactions’ through U.S. financial institutions involving money from Iran to non-U.S. banks, editing transaction records to hide information about its real clients.  An audit by Deloitte likewise revealed that about 25,000 transactions with sanctioned Iran worth around $19.4 billion were processed, and 90% of these passed through the U.S.

HSBC management apologized, and CEO Stuart Gulliver said, “We accept responsibility for our past mistakes.  We have said we are profoundly sorry for them, and we do so again. The HSBC of today is a fundamentally different organization from the one that made those mistakes.”

I respectfully disagree. The root cause of these problems is that complex financial companies like HSBC are very, very hard to manage. Mistakes will probably be made in the future. Heightened compliance may help in the short run, but it will likely focus on what happened in the past rather than anticipate unpredictable future scandals.

To be fair, HSBC is not evil. It is just complicated, and its complexity allowed room for such nefarious actions to take place.

Searching for Cheap Bets

Prudent investors should keep away from financials they don't understand. Some investors refuse to swear them off. For these risk-seekers, the question is whether HSBC is now cheaper than its peers. Consider these price multiples:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> </tr> <tr> <td> <p><span>BAC</span></p> </td> <td> <p><span>Bank of America</span></p> </td> <td> <p><span>31.75</span></p> </td> <td> <p><span>2.09</span></p> </td> <td> <p><span>0.52</span></p> </td> <td> <p><span>3.54</span></p> </td> </tr> <tr> <td> <p><span>RBS</span></p> </td> <td> <p><span>The Royal Bank of Scotland</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.92</span></p> </td> <td> <p><span>0.54</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>BCS</span></p> </td> <td> <p><span>Barclays</span></p> </td> <td> <p><span>1872</span></p> </td> <td> <p><span>1.56</span></p> </td> <td> <p><span>0.64</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>C</span></p> </td> <td> <p><span>Citigroup</span></p> </td> <td> <p><span>17.66</span></p> </td> <td> <p><span>1.78</span></p> </td> <td> <p><span>0.66</span></p> </td> <td> <p><span>6.68</span></p> </td> </tr> <tr> <td> <p><span>STI</span></p> </td> <td> <p><span>SunTrust Banks</span></p> </td> <td> <p><span>9.35</span></p> </td> <td> <p><span>2.57</span></p> </td> <td> <p><span>0.76</span></p> </td> <td> <p><span>10.34</span></p> </td> </tr> <tr> <td> <p><span>MTU</span></p> </td> <td> <p><span>Mitsubishi UFJ Financial</span></p> </td> <td> <p><span>178.67</span></p> </td> <td> <p><span>2.55</span></p> </td> <td> <p><span>0.78</span></p> </td> <td> <p><span>1.82</span></p> </td> </tr> <tr> <td> <p><span>LYG</span></p> </td> <td> <p><span>Lloyds Banking</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.57</span></p> </td> <td> <p><span>0.81</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>PNC</span></p> </td> <td> <p><span>PNC</span><span> Financial</span></p> </td> <td> <p><span>12.2</span></p> </td> <td> <p><span>3</span></p> </td> <td> <p><span>0.82</span></p> </td> <td> <p><span>5.19</span></p> </td> </tr> <tr> <td> <p><span>JPM</span></p> </td> <td> <p><span>JPMorgan Chase</span></p> </td> <td> <p><span>9.65</span></p> </td> <td> <p><span>3.01</span></p> </td> <td> <p><span>0.87</span></p> </td> <td> <p><span>3.2</span></p> </td> </tr> <tr> <td> <p><span>CS</span></p> </td> <td> <p><span>Credit </span><span>Suisse</span></p> </td> <td> <p><span>334.88</span></p> </td> <td> <p><span>1.46</span></p> </td> <td> <p><span>0.89</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>UBS</span></p> </td> <td> <p><span>UBS</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>3.56</span></p> </td> <td> <p><span>1.1</span></p> </td> <td> <p><span>1.7</span></p> </td> </tr> <tr> <td> <p><span>HBC</span></p> </td> <td> <p><span>HSBC Holdings</span></p> </td> <td> <p><span>15.21</span></p> </td> <td> <p><span>3.29</span></p> </td> <td> <p><span>1.15</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>WFC</span></p> </td> <td> <p><span>Wells Fargo </span></p> </td> <td> <p><span>10.88</span></p> </td> <td> <p><span>3.74</span></p> </td> <td> <p><span>1.19</span></p> </td> <td> <p><span>8.68</span></p> </td> </tr> <tr> <td> <p><span>BMO</span></p> </td> <td> <p><span>Bank of Montreal</span></p> </td> <td> <p><span>10.11</span></p> </td> <td> <p><span>2.97</span></p> </td> <td> <p><span>1.43</span></p> </td> <td> <p><span>5.01</span></p> </td> </tr> <tr> <td> <p><span>TD</span></p> </td> <td> <p><span>The Toronto-Dominion Bank</span></p> </td> <td> <p><span>12.15</span></p> </td> <td> <p><span>3.4</span></p> </td> <td> <p><span>1.6</span></p> </td> <td> <p><span>6.46</span></p> </td> </tr> <tr> <td> <p><span>BNS</span></p> </td> <td> <p><span>The Bank Of Nova Scotia</span></p> </td> <td> <p><span>11.03</span></p> </td> <td> <p><span>3.98</span></p> </td> <td> <p><span>1.72</span></p> </td> <td> <p><span>12.75</span></p> </td> </tr> <tr> <td> <p><span>WBK</span></p> </td> <td> <p><span>Westpac Banking</span></p> </td> <td> <p><span>14</span></p> </td> <td> <p><span>2.24</span></p> </td> <td> <p><span>1.84</span></p> </td> <td> <p><span>6.08</span></p> </td> </tr> <tr> <td> <p><span>CM</span></p> </td> <td> <p><span>Canadian Imperial Bank of Commerce</span></p> </td> <td> <p><span>10.39</span></p> </td> <td> <p><span>2.73</span></p> </td> <td> <p><span>1.96</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> </tbody> </table>

HSBC’ stock is not cheap based on price-to-book, price-to-sales, or price-to earnings multiples when compared to its peers. Sun Trust Banks, PNC Financial, and JPMorgan Chase (NYSE: JPM) are all cheaper than HSBC based on cash flow, earnings, sales, and book multiples. HSBC stock is not a good deal at current price levels, even for speculators.

Wells Fargo is a better speculative bet, though SunTrust and JPMorgan Chase are cheaper with respect to all the listed price multiples, too.

Conclusion

Bank scandals are a fact of life. At best, these companies are speculative bets. Neither HSBC nor Wells Fargo are cheap enough given their bad news. SunTrust and JPMorgan Chase are better bets.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase & Co. and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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