Citi and Bank of America Miss on Litigation Costs

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Despite headlines (and some data) to the contrary, mortgage difficulties and increasing litigation costs plagued both Citigroup (NYSE: C) and Bank of America (NYSE: BAC) fourth quarter results. Both of them have been looking to focus on even more cost cutting measures.  While the housing market may be improving somewhat, there is still not only a ton of shadow inventory weighing on prices but also the continued hollowing out of the real economy in the U.S. at the expense of keeping the banks afloat.  Any credit bubble the Fed manages to reflate will only result in another round of liquidations later with Citi and BofA at ground zero of the bust again.

Although Citigroup’s quarterly net income increased by 25% to $1.16 (EPS of $0.38), it seriously fell short of analysts’ estimated EPS of $0.96. Top line revenue increased by 6% to $18.2 billion, also a full $500 million below consensus. Citigroup only pulled $142 million from loan loss reserves as opposed to $1.47 billion in the final quarter of 2011.  And, frankly, since this type of charge can be molded to fit whatever narrative the bank wants to tell the street, this tells me that Citi is looking to both attenuate expectations while it prepares for a possible next wave of problems.  Even by excluding one-off items such as the restructuring costs, Citi’s earnings only net out at $0.69 per share, still short of expectations. According to the bank, the rise in litigation costs was the main contributor to the bank missing its target.  

On the other hand, Bank of America, the nation’s second largest bank in terms of assets, posted a massive drop in profits of 63% to $732 million which translated into earnings of $0.03 per share, beating the street by a penny – a classic “goal-seeking” number to manage the headlines.  Revenues fell by 26% to 19.6 billion. The bank took a $2.7 pre-tax charge in relation to the $3.6 billion it has agreed to pay GSES Fannie Mae as part of the settlement. Bank of America will make a total payment of $11.6 billion. A total of 14,601 jobs were eliminated in the last year and more can be expected in the future.

The decline in Citi’s profit is mainly attributed to the massive litigation charges of $1.3 billion, which includes the $305 million related to mortgage foreclosures, which were accounted for in this quarter.

Citi’s once hailed chief executive Vikram Pandit, who was responsible for steering the bank out of the global financial crisis, has now become the new scapegoat after Citi’s board of directors unanimously agreed that Mr. Pandit was responsible for mismanaging the bank’s operations.  This is simply blame deflection while the bank continues to deal with a spiral of debt and credit deflation.

Citigroup’s new CEO Michael Corbat is trying to cut expenses through massive restructuring. Corbat announced in December that the bank will be laying off another 11,000 employees, along with branch closures in developing markets such as Paraguay, Romania and Turkey. Corbat will be undoing most of Vikram Pandit’s expansion drive. All this in an attempt to cut costs, as the revenues for the bank shrank in some international markets. Although quarterly income from Asia and Latin America increased by 16% from last year the Europe, Middle East and Africa region reported a 6% decline. Overall, annual profits for the bank went down from $11.1 billion in 2011 to $7.5 billion in 2012.

Mr. Corbat has outlined that Citigroup plans to close 84 branches worldwide, and the bank will be scaling back its consumer banking operations. These steps reduce costs by $900 million this year and $1.1 billion in the next.

The quarterly dividends for the company are fixed at 1 cent per share owing to the company’s effort to build capital as it continues with the sale of riskier assets to meet regulatory requirements.

The major U.S. banks stories are all the same at a fundamental level.  What goes up on hot air must come down.  And, like a lot of the U.S. credit-based expansion of the past 20 years, a great deal of it is returning home.   We’re seeing this in a number of industries – the U.S. pulling back in international influence.  The companies hitting on all cylinders are the ones that can provide a unique value proposition to emerging markets.  With the capital base in the U.S. tied up in deflating assets where are the advantages overseas for the big banks like Citigroup compared to local banks?

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Citigroup</p> </td> <td> <p>Bank of America</p> </td> </tr> <tr> <td> <p>Stock 6M</p> </td> <td> <p>44.32%</p> </td> <td> <p>41.92%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>16.76</p> </td> <td> <p>45</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>2.44</p> </td> <td> <p>0.25</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>0.10%</p> </td> <td> <p>0.40%</p> </td> </tr> <tr> <td> <p>Beta</p> </td> <td> <p>1.88</p> </td> <td> <p>1.78</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>0.42%</p> </td> <td> <p>0.19%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>4.27%</p> </td> <td> <p>1.79%</p> </td> </tr> </tbody> </table>

2012 was a good year for bank stocks.  The worst of the news put behind them and the programs put in place by the major central banks in October 2011 created enough cross-border liquidity to keep the monetary and lending system limping along.  The SPDR Financial Select Sector ETF (NYSEMKT: XLF) put in a stunning performance off that October 2011 low and has returned 28.4% year-to-date, on stronger sector earnings. The problems at banks like BofA and Citi, however, will continue to reassert themselves, especially as we approach the long-term top in the S&P 500 and the markets approach a valuation inflection point.  Continued credit growth will swell bank earnings and blow another credit bubble while extending the bond bull market that much longer, but that will create an even bigger problem down the line. 

So, while the banks may be great short-term trades, fundamentally they are still zombies that will eventually run out of food.

PeterPham8 has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America and Citigroup Inc . 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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