Analysts united: Citi deal bad for bank stocks

With Citigroup Inc. closing in on a deal that could see the U.S. government take a bigger stake in the struggling bank, many analysts and money managers wondered what impact nationalization would have on other bank stocks.
Of course, many fear such a move at New York-based Citi would negatively impact its banking peers. Earlier this week, Chicago-based Fox-Pitt Kelton Cochran Caronia Walker analyst David Trone wrote in a note to clients that if Citi is nationalized, “all bank stocks are likely to get crushed in fear.”
But while fund managers find it difficult to be bullish on bank stocks, the outlook may not be entirely negative.
“The market is being unfair to take down every name in the sector as if they all have the same balance sheets,” said Kevin Conn, a U.S. financial services analyst at MFS Investment Management Inc. of Boston, which has $134 billion in assets. “They are throwing out the baby with the bath water, as if these firms are all bankrupt and all going away. That is not the case.”
The federal government’s “stress tests” to gauge the health of U.S.’s largest banks should differentiate among the firms, Mr. Conn said. “It’s probably a handful of banks that have very weak balance sheets,” he said.
That said, for the next two or three years, it’s going to be hard to be bullish about banks, Mr. Conn said.
“Of the 82 [financial] names in the S&P 500, I could easily see that being only 40 names in two years,” he said. “With the re-regulation of the financial sector, which will take three years to unfold, the system will be … safer. Returns on equities will be lower. In some ways they’ll operate like utilities.”
When more details of the Citigroup talks are released by the government, the outlook may improve for bank stocks, said John Fox, director of research at Fenimore Asset Management Inc. of Cobleskill, N.Y., which manages the FAM Funds with $1.2 billion in assets.
“If the government takes 40% to 50% control of a large company like Citigroup, there is not much left for the rest of the shareholders,” he said. “What is the impact on the shareholders? That would cause investors to be fearful of bank stocks in general.”
But the outlook for the financial sector may improve with the Term Asset-Backed Securities Loan Facility program, Mr. Fox said. “The government will provide support for asset-backed securities on the balance sheet,” he said. “That could be very positive for financials, including banks.”
Of course, the market has already sent a message.
“The [bank stock] asset class itself is almost un-investible right now,” said Patrick Becker Jr., chief investment officer at Becker Capital Management of Portland, Ore., which has $1.6 billion in assets under management. “The rules can change almost overnight. I think the market has already discounted things.”
Mr. Becker said that if the government takes a bigger stake in the banks, it would be negative for the sector.
It will dampen those multiples and the valuation on those earnings will be less going forward,” Mr. Becker said. “With nationalization, equity will be wiped out. That will keep investors on the sidelines and keep a lid on valuations in general.”
Robert Morrison, president of AFBA 5Star Fund Inc., the $200 million asset-management arm of the Armed Forces Benefits Association based in Alexandria, Va., said a temporary move would be a better strategy.
“We think long term it will help the sector,” he said. “But we would look at banks stocks very cautiously.”
The core problem for banks, Mr. Morrison said, is the mark-to-market system, which requires companies to record the value of an investment on their balance sheet at the current market price.
That’s the issue that needs more focus, he said. “It’s not the core business of the bank that’s the issue,” he said.
Mr. Becker agreed. “The government suspended mark-to-market in 1937,” he said. “What the banks need is time to fix these problems. We need to focus on suspending mark-to-market.”

Related Topics: Banking, Citigroup Inc.