By Pam Martens: January 15, 2019 ~
If you’ve ever mucked horse stalls full of smelly manure, you’re better prepared for this week.
Yesterday, the inscrutable Citigroup ushered in the week of mind-numbing fourth-quarter earnings reports from the financial supermarkets/commercial banks/insurance companies/brokerage firms/investment banks/derivative warehouses that have combined under one highly combustible roof, using the simple moniker Wall Street bank. There is so much going on under one roof that you’d need your own team of 100 accountants to have any clue as to whether the bank is doing well or not.
JPMorgan Chase, a component of the Dow Jones Industrial Average, was out with its disappointing earnings this morning. Goldman Sachs and Bank of America report on Wednesday, followed by Morgan Stanley on Thursday.
Citigroup’s big reveal was that it had missed analysts’ revenue expectations by half a billion dollars – not exactly small change. The bank reported $17.1 billion in revenue in the fourth quarter versus average analyst expectations for $17.6 billion. That was mostly owing to a 21 percent decline in fixed income trading.
Its net profits were clearly helped by its report that it had used a big chunk of its capital not to make loans to worthy businesses but to repurchase 74 million shares of its own stock in the fourth quarter and a whopping 212 million shares for all of 2018. Fourth quarter net earnings came in at $4.3 billion or $1.64 per share. Excluding the impact of President Trump’s generous tax cut gift to corporations, net income was $4.2 billion or $1.61 per share.
For the full year of 2018, Citigroup reported net income of $18.0 billion on revenues of $72.9 billion, compared to a net loss of $6.8 billion on revenues of $72.4 billion for the full year of 2017.
But here’s where things really get interesting. According to Citigroup, its “allowance for loan losses was $12.3 billion at quarter end, or 1.81% of total loans, compared to $12.4 billion, or 1.86% of total loans, at the end of the prior-year period.” In other words, despite the Federal Reserve hiking interest rates four times in 2018, which should have led to an increase in troubled loans, Citigroup was able to reduce the money it had set aside for loan loss provisions. And that’s not because its loans were reduced. Citigroup reported $684 billion in loans as of December 31, 2018, an increase of 3 percent over December 31, 2017.
During Citigroup’s conference call with analysts, it took two very timely questions. First, what will be the impact on it if Sears shutters all of its stores. Sears is currently in bankruptcy and a complete liquidation of the company remains a possibility. On the call, Citigroup downplayed any major hit from a Sears closure. Citigroup provides the Sears-branded credit card to its customers.
Citigroup was also asked about its exposure to PG&E, the large California utility under investigation for its equipment causing wildfires in the state in 2017 and 2018. The company has announced plans to file for bankruptcy by the end of this month. Its stock has lost 87 percent of its value since mid-November. CFO John Gerspach said on the call that its exposure to PG&E is going “to be manageable.”
Fortunately for Gerspach, he won’t be around to explain things if he’s wrong about big writeoffs for souring corporate debt. He’s announced plans to retire in March.
Top execs heading for the door are never a good sign at Citigroup. Sandy Weill stepped down as Chairman in 2006, after Citi’s lavish compensation had made him a billionaire. Three years later, the stock was trading at 99 cents and the bank needed the largest taxpayer bailout in global banking history.
JPMorgan Chase reported earnings of $1.98 per share for the fourth quarter, disappointing analysts who had expected $2.20 per share. The stock, a component of the Dow Jones Industrial Average, was trading down 1.45 percent in late morning trade.
As of the end of 2018, JPMorgan Chase reported $984.6 billion in loans with a $13.4 billion allowance for loan losses.
This wouldn’t be the first time that JPMorgan Chase might have underestimated losses. Its CEO Jamie Dimon famously told analysts in 2012 that the media scrutiny of its London derivative bets was “a complete tempest in a teapot.” The teapot turned out to be $6.2 billion in losses of its bank depositors’ money, gambled away in exotic, illiquid derivative bets, infamously known as the London Whale scandal.
Worse than that (if you can imagine anything worse than losing $6.2 billion in depositors’ money in the Federally-insured part of the sprawling behemoth) is that the Federal agency created under the Dodd-Frank financial reform legislation to monitor risk at the big Wall Street banks, the Office of Financial Research (OFR), dropped a bombshell in 2015, revealing what the London Whale trades were really about.
The report, written by Jill Cetina, John McDonough, and Sriram Rajan, says that the London Whale trades were undertaken to gin up its capital:
“JPMorgan Chase & Co.’s losses in the 2012 London Whale case were the result of CDS [Credit Default Swap] usage which was undertaken to obtain regulatory capital relief on positions in the trading book.”
The capital of big Wall Street banks is very much on the minds of their regulators and Wall Street watchers. Citigroup’s shares lost 30 percent of their value from the opening day of trading to the last day of the trading year in 2018. Goldman Sachs managed to best that, losing 35 percent of its share value. Morgan Stanley sagged 24 percent; Bank of America lost 18 percent while JPMorgan managed to take a more moderate 10 percent share price loss.
Warnings about the looming problem are starting to dot the media landscape. On January 10, the New York Times posted an OpEd to its website by Sheila Bair and Gaurav Vasisht. Bair is the former Chair of the Federal Deposit Insurance Corporation (FDIC) that insures the deposits of U.S. commercial banks. Vasisht is the director of financial regulation for the Volcker Alliance.
The duo warned about the following:
“The corporate bond market has swelled to nearly $7 trillion. The debt owed by businesses as a percentage of gross domestic product is at a record high. But the credit quality of investment-grade bonds has deteriorated. Underwriting standards on ‘leveraged loans’ to risky companies have eroded. And until recently, yields on junk debt remained low, a sign that investors are too willing to take on the risk of bonds held by companies with less-than-stellar credit.”
To underscore the last point, not one junk bond offering was able to come to market in December.
On December 7, Lael Brainard, a member of the Board of Governors of the Federal Reserve Board, delivered her own warning in a speech at the Peterson Institute for International Economics. Brainard has this to say:
“Credit quality has deteriorated within the investment-grade segment, where the share of bonds rated at the lowest investment-grade level has reached near-record levels. As of mid-2018, around 35 percent of corporate bonds outstanding were at the lowest end of the investment-grade segment, which amounts to about $2-1/4 trillion. In comparison, the share of high-yield bonds outstanding that are rated ‘deep junk’ has stayed flat at about one-third from 2015 to 2018, well below the financial crisis peak of 45 percent.
“In an economic downturn, widespread downgrades of these low-rated investment-grade bonds to speculative-grade ratings could induce some investors to sell them rapidly — for instance, because lower-rated bonds have higher regulatory capital requirements or because bond funds have limits on the share of non-investment-grade bonds they hold. This concern may be higher now than in the past, since total assets under management in bond mutual funds have more than doubled in the past decade to about $2.3 trillion this year. These funds now hold about one-tenth of the corporate bond market, and the redemption behavior of investors in these funds during a market correction is unclear. Bond sales could lead to large changes in bond prices and overall financial conditions if technological, market, or regulatory factors contribute to strains on market liquidity–a possibility that has been relatively untested over the course of the expansion.”
In short, it’s time to pay attention to the capital levels of Wall Street’s largest banks.
