Citigroup Still Has its Leash and Collar
George is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Citigroup (NYSE: C) recently announced improved numbers and long-suffering investors (some may say "speculators") were encouraged. Most financials such as Wells Fargo (NYSE: WFC) and JPMorgan (NYSE: JPM) as well as Citi seem to have shared the same mantra. Credit an improving economy, reducing loan loss provisions and even, pray tell, some reversals where yesterday's red ink turns miraculously black. You have to love bank accounting. But in Citigroup's case a good understanding of bank accounting or how to analyze a bank from an investor's point of view are not necessary at the present time.
The key difference for Citigroup was recognized by the CEO Vikram Pandit very early in his prepared remarks in the last conference call. As it turns out, the Federal Reserve still decides the major issues. It sounds like the Fed will decide what are the major issues before they tip their hand. So as an investor you have to say thanks for the honesty when Vikram Pandit describes at length something he calls the CR Process. He continues to describe that Citi has to resubmit a capital plan to the Fed. Basically this means the board is not ultimately responsible. Only a few paragraphs preceding in the conference call's prepared remarks, Vikram Pandit laid out where Citi was in line with the Basel ratios and everything seems lovely.
Basically he is trying to soft shoe the very embarrassing fact that Citigroup still is subject to abnormally high levels of regulatory oversight. If you are re-submitting plans to the Fed things are not lovely. In fact you have been kept in after school so that the teacher can pay special attention to your particular circumstances. in many ways you should say thank you, but clearly the other banks running around the financial school yard are having way more fun and so are their shareholders. While we can only speculate about the Feds response, Vikram Pandit is telling one and all that the Fed will respond just shortly before the end of their Q3.
So investors wishing to maximize wealth need to be aware of the real back room power that the Fed has. Layered over this realization is the puny dividend yield which the Fed is probably restraining for now. In coming quarters Citigroup will need to address the classic problem all banks and financial institutions have when interest rates start to rise and that is managing interest rate margins as your cost of funds increases and borrowers attempt to go long and lock in the cheap rates.
Wells Fargo, long a Warren Buffett favourite pick is experiencing growing loan and mortgage demand. Management views loans made early in the recovery cycle as less risky than loans generated late in the cycle. They also are effective at cross selling more products to customers which increases loyalty and improves profitability. As previously posted they will also be challenged by a rising interest rate environment with the risk of margin compression. JPMorgan has already experienced increasing interest rate cost on their long term debt so their battle against margin compression has already begun.
Citigroup may be in for a tough ride, so buckle up.
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