Citigroup Downgrades Several Large Regional Banks
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So, analysts at beleaguered Citigroup's (NYSE: C) investment banking unit have downgraded many of the large regional banks, citing revenue struggles stemming from the low interest rate environment. I have highlighted numerous times how banks have struggled on the revenue side due to sustained low rates, which show no real sign of rising any time before 2014. But there is another side of this; not only have banks been forced to accept declining interest revenue, they have been aided by declining credit costs. Now that short term interest rates are near zero, there is only so much lower those credit costs can go. But as mortgages, auto loans, and other term loans expire or are refinanced, they are being replaced by today's ultra-low longer term rates. Successful banks today even have a remedy for that; it is called “loan growth.” Let's take a look at some of the banks that the Citigroup analyst downgraded.
SunTrust (NYSE: STI) was one of the regionals that Citigroup named. Ironically enough, on the same day as the Citigroup announcement, Argus Research joined what in recent weeks has been a number of analysts who have upgraded their opinions on SunTrust. Argus' reasoning is the same reason I have for consistently endorsing SunTrust for the last year. The economy of Florida, especially, but also Georgia, will grow faster than the nation as a whole, and allow SunTrust to grow its loan portfolio enough to more than counter any losses in the net interest margin. SunTrust ended 2011 as Florida's third largest bank in terms of market share, and its share ticked up 30 basis points in 2011 from 2010 to 10.61% in 2011.
In the first quarter of 2012, SunTrust had average loans outstanding of $122.5 billion, up $7 billion, or 6%, from the year earlier quarter. Total revenue was $2.218 billion, up about $60 million, or three percent from the year earlier. Credit costs in the first quarter were $317 million, or $130 million less than a year earlier. The bank has been actively managing its balance sheet so as to comply with new Federal Reserve capital requirements. You may recall that in the first quarter of 2012, SunTrust's then current capital was sufficient, but its plan to raise dividends or repurchase shares left it short of capital in the Fed's “stress test.” The bank will be resubmitting a new capital plan in the second quarter, which the Federal Reserve should rule upon in the third quarter. But no matter what, I see SunTrust accelerating its loan growth going forward, and I think it will outperform the banking sector as a whole over the next 2 to 3 years.
Wells Fargo (NYSE: WFC), hardly a regional bank, is another large bank on Citigroup's list. In the first quarter of 2012, its average loan portfolio of $768.5 billion was a $14 billion increase from the first quarter of 2011. Interest income actually fell about 2%, or $220 million, in the quarter versus 2011. But credit costs fell by 25%, or $450 million. Combining these factors, and Wells Fargo's net margin of 3.91% actually was two basis points higher than the fourth quarter of 2011.
Wells Fargo is acquiring nearly $4 billion in loans from its acquisition of BNP Paribas’ (BNP.PA) energy division. Wells Fargo is also the nation's leading consumer bank, and it is shoring up that position with mortgage, auto and credit card loan increases. Combine that with the bank's commitment to reduce costs by about $600 million in the second quarter of this year, I think now is a great time to buy shares in our country's premier $1 trillion plus bank.
Another large bank to suffer Citigroup's analysis is PNC Financial (NYSE: PNC). This big Midwest bank got a shot in the arm by acquiring Royal Bank of Canada's domestic retail branches, which closed toward the end of the first quarter of 2012. This $3.5 billion, all cash deal gives PNC a foothold in high growth Southern states including Florida, Georgia, and the Carolinas. Largely on the strength of that acquisition, PNC's loans in the first quarter of 2012 ended at $176 billion, up from $149 billion one year earlier. But because those increased loans only accrued to PNC's balance sheet with about three weeks left in the first quarter, its net interest income only grew 5%, or $115 million, in the first quarter of 2012 over the first quarter of 2011.
PNC's costs will come down after spiking in the first quarter of 2012, due to the upfront costs of the RBC purchase. The RBC purchase price was for about 5% less than its tangible book value, meaning those one-time costs aside, the purchase was immediately accretive to earnings. And since it was all cash, it was non-dilutive to shareholders. Not only that, but PNC is also selling about 14% below where it was a month ago. I believe PNC has a bright future for shareholders ahead of it, and should be considered by those interested in a bank stock.
I am not saying all of Citigroup's logic is out of order. The state of the interest rate environment is not ideal for any bank. And that includes the holding company that authorized this report. But Citigroup was the only bank in the bunch that had to do a 20 for one reverse stock split. It pays a paltry one penny per quarter dividend, and knows its capital is so weak that it won't even request of the Federal Reserve any further distributions of capital to shareholders for the foreseeable future. Citigroup's net interest margin in the first quarter of 2012 was 2.90%, a full percentage point below Wells Fargo's net interest margin. The fact is, management at Citigroup sees pickings to be so slim in the United States that Citigroup will focus its attention in developing markets overseas. Its credit ratings are also likely to be lowered again this week. I would rather invest in any of the above downgraded banks, than invest in Citigroup, that is for sure.
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