Will These Banks Go Under?
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
JPMorgan (NYSE: JPM) trades at a paltry book value of .8. Translation: for every $1 that JPMorgan is worth – including its business values, real estate, cash and other holdings, and not including sale costs – the market says that it is worth $.80. Interesting.
Take a deeper look and you will notice the company trading at just 9 times earnings and 7.5 times next year’s forecast earnings. For the $149 billion company that many believe is the top on Wall Street, these numbers seem off.
Now realize that the company’s profit margin is 20.5%, and the firm even pays out a 3.1% dividend. Why is the stock trading at such a discount? Because banks need cash right now – and investors do not want the equity risk.
Turning to Bonds
In order to raise cash, firms have been issuing bonds. This year Goldman Sachs (NYSE: GS) raised more than $12 billion in unsecured debt. According to a Goldman spokesperson: “Engaging our debt investors is part of a broad effort to reach a wider group of stakeholders.”
Goldman’s goal is to raise enough cash to cushion the firm and to conduct share buybacks to help the stock price. In the second quarter, for example, Goldman received Federal Reserve approval and conducted purchases totaling roughly $1.5 billion of its shares. The firm has struggled to create value for shareholders, and the company – like other banks – has struggled to return above its cost of capital.
Finally, Goldman does have some security in the form of deposits. At the end of the second quarter the bank held $175 billion of cash and securities that can be used for liquidity.
Like Goldman, Morgan Stanley (NYSE: MS) also needs liquidity. The company faces headwinds with lower revenues and is in the midst of acquiring Morgan Stanley Smith Barney, a joint venture with Citigroup (NYSE: C).
Morgan Stanley valued the joint venture at $9.5 billion, but Citigroup valued the deal at over $22 billion. The issue is that Morgan Stanley plans to exercise its option to acquire 65% of the firm soon, and hopefully the entire company by 2014. Citigroup and Morgan Stanley joined ranks in order to build a brokerage powerhouse, but the company has underperformed.
In order to revitalize the brokerage arm, the firms have been updating information technology and funding speed, among other improvements.
Thus, Morgan Stanley must raise cash to purchase the asset from Citigroup, assuming the two can reach a deal. Morgan Stanley has grown its cash on hand by 45% since 2007, and its deposit base is expected to jump 80% as well. Finally, the bank has $173 billion in cash and securities at the end of the second quarter. The asset increases have solidified the company’s balance sheet.
“We want to ensure that fixed income investors understand the tremendous amount of work we have done over the past few years to improve the quality of our balance sheet,” said a Morgan Stanley spokesperson.
In all, the banks are doing the right thing – raising capital. In 2007 and 2008 the banks were hit mercilessly by the recession, and cash became king. The downside was that few had the liquidity they desperately needed.
Today the banks are trading at depressed values, but they will not make the mistakes that caused Lehman Brothers and Bear Stearns to go under. Instead, they are stocking up on cash when the times are good so that cash is there when times go bad.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. 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.If you have questions about this post or the Fool’s blog network, click here for information.
