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Monday, July 31, 2006

The Money Center Bank Problem: Citi and B of A

Stocks: (JPM)(C)(BAC)(WFC)

The environment that has been driving near-record results at the nation’s largest money center banks is running out of steam. Not unlike the year 2000, when the banks hit record high stock prices, problems in consumer lending and investment banking cut some of the stock prices of the big money centers by as much as 50% by 2003.

Because of the success of the stocks at the large banks, investors have been pressuring the management at Citigroup to improve returns, or even break the bank into pieces to improve shareholder value. The bank has been trading at $48, around its 52-week low. By contrast, Bank of America has been trading near its 52-week high at $51.66. Another huge U.S. bank, Wells Fargo, also trades near a one-year high at $72.41. So does JPMorgan, which is just a $1 below its 12-month high at $45.48.

While Citicorp may be viewed as the worst off of the lot, all the banking firms face the same, acute problems.

The consumer-based real estate mortgage business is in retreat. As a matter of fact, mortgage defaults are rising. According to a recent article in the Chicago Tribune: "For many people, buying meant using exotic mortgage products such as adjustable-rate mortgages, with low initial rates that typically jump after a few years, which can raise payments by thousands of dollars a year. As interest rates rise, experts say potential buyers should be cautious before agreeing to one of these loans .A person can lose money on a home — especially if the housing market cools, as many analysts predict. People in over their head with mortgage payments who made a low down payment might have to sell a house for thousands less than they have to pay their lender."

According to RealyTrac, which keeps track of problem real estate loans, delinquencies rose 25% this spring compared to a year ago. The firms said that there were 272, 000 homes facing foreclosure in the second quarter.

Jamie Diamond, the head of JPMorgan and Citi’s CFO have both made statements regarding their concern about the potential problems in their consumer lending businesses. Quoted in the Houston Chronicle, they voiced their worries about consumer credit: Jamie Dimon, JPMorgan Chase's chief executive officer, said credit delinquencies and defaults have been at extremely low levels. This has allowed banks to reduce reserves against possible defaults, adding to their profitability.That's changing, Dimon warned.He said rising interest rates and a likely increase in bankruptcy filings — which were depressed after the bankruptcy law was toughened last fall — could lead to credit card losses at JPMorgan Chase of "several hundred million dollars" in the third quarter, and perhaps as much as $500 million before year's end."In credit cards, we know it's going to happen. ... We're telling people upfront," Dimon said. Sallie Krawcheck, Citigroup's chief financial officer, also expressed concern about credit quality as consumers grapple with the higher minimum payments on credit card bills that went into effect earlier this year. Still, she said, consumers were handling the rule change better than expected.

Consumer credit card and mortgage issues are only a part of the problems facing the banks.

Private equity deals and investment banking income are also facing a slowdown. The record pace of corporate buy-outs cannot continue. At JPMorgan, net income from investment banking rose 37% in the last quarter to $839 million.

A firm that tracks private equity investment says that the pace of such deals is at a record level according to Reuters: “The rise in private equity-backed deals comes as the volume of global mergers and acquisitions has risen to $2.18 trillion in the year to date, topping the $2.13 trillion notched up during the same period in 2000 at the height of the Internet boom, Dealogic data shows” But, as was true in the rush of money that hit the market six years ago, the financing environment cannot defy gravity forever.

After the heady days of 2000, JPMorgan’s stock dropped from over $60 to under $20 in 2003. During the same period, Citi’s stock fell from about $60 to $30. Bank of America’s traded flat.

As the market in private equity cools and consumers struggle with rising rates in adjustable rate mortgages, money center bank stocks could easily hit two or three year lows in 2007.

Douglas A. McIntyre can be reached at He does not own securities in companies that he writes about.

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