Financials Weekly Notes: BofA, Goldman, Citigroup And Credit Suisse

Bank shares performed slightly better than the equity market as a whole last week, with the KBW Bank Index gaining a little more than 3% over the period in comparison to a 2% growth in the S&P 500 figure. While the week was largely uneventful in terms of macro level global developments, the banking sector gained from an improvement in investor sentiments thanks to reports that U.S. bank profits were near record levels in Q2 2014. ^[1] As banks have been struggling with their revenues in this low interest environment, the notable profit growth indicates that the banks are well positioned to churn out higher incomes once interest rates return to pre-recession levels.

European banks did not fare very well last week, despite news that the European Central Bank (ECB) will hand out €250 billion ($330 billion) in cheap loans to banks in the region. ^[2] Investors appear to be unconvinced that this latest measure by the financial regulator will do much to help the stagnating economic conditions seen across the Eurozone, at least in the near future.

Below are some significant events pertaining to major banks that were witnessed over this week.

Bank of America

Bank of America (NYSE:BAC) finally closed a deal with federal and state regulatory agencies over its legacy mortgage issues for a whopping $16.65 billion last week. The settlement addresses what was undoubtedly the largest legal overhang for the diversified banking group, most of which it inherited as a part of its acquisition of Merrill Lynch and Countrywide at the peak of the economic downturn. The settlement involves the Department of Justice (DoJ), SEC, FDIC, FHA, Ginnie Mae and Attorneys General of six states. This is the largest settlement ever by the DoJ with a single entity and includes a cash component of $9.65 billion, while the remaining $7 billion will be directed by the bank towards consumer relief over the coming years.

You can read more about the settlement and its implications for Bank of America in our article BofA Likely To Report Q3 Loss Over Record $16.65 Billion Mortgage Settlement. News of the settlement helped the bank’s shares gain 6% over the week to close at $16.13 – the highest level since April. We maintain a price estimate of $18.50 for the bank’s shares – 15% higher than the Friday close. This points to a market cap of $195 billion for Bank of America in comparison to the current figure of just under $170 billion. We estimate that the bank will report EPS of about 85 cents for the year, on revenues of just under $90 billion.

See our full analysis for Bank of America’s stock

Goldman Sachs

Goldman Sachs (NYSE:GS) became the 15th financial institution to settle the lawsuit filed against it by the FHFA over faulty residential mortgage-backed securities (RMBS) sold to Fannie Mae and Freddie Mac in the run up to the economic downturn of 2008. The premier investment bank chose to buy back the securities at a price of $3.15 billion rather than agree to a cash settlement. ^[3] Although the purchase price indicates a $1.2 billion premium to the current market value of these securities, Goldman can potentially reduce its losses by getting rid of them after they potentially add value in the near future. ^[4]

The bank has sufficient reserves set aside to cover this one-time expense, so its Q3 2014 figures are not expected to take a hit from the settlement. We estimate revenues of slightly over $35 billion for Goldman in 2014, and EPS of $14.53. We maintain a $185 price estimate for Goldman’s shares, which is 5% ahead of the $175 Friday closing price.

With this settlement, only three lawsuits remain from the 18 filed by the FHFA against global financial institutions in 2011 – those against RBS (NYSE:RBS), HSBC (NYSE:HSBC) and Nomura (NYSE:NMR).

See our full analysis for Goldman Sachs

Citigroup

Citigroup (NYSE:C) is reportedly mulling the sale of its retail operations in Japan due to the negligible profit margins in the country over the recent years. ^[5] The globally diversified banking group has a network of 33 branches in the Asian nation, which reported net income of just 1.34 billion yen ($12.9 million) in the last fiscal year. ^[6] While Citibank Japan’s poor loan-to-deposit ratio of less than 10% was already putting pressure on interest margins, the country’s monetary stimulus measures are expected to shrink the margin figures further this year.

Also, Citigroup’s private banking arm has been forced to stop selling investment in hedge funds and private-equity funds to its clients as a direct consequence of a recent deal with the SEC. ^[7] The “bad actor” rule, which was adopted by the SEC last year and restricts the participation of certain financial institutions in private offerings, went into effect when Citigroup’s $285 million settlement over the sale of collateralized debt obligations (CDOs) was approved earlier this month. The bank is seeking for a waiver from the SEC to be able to resume these activities.

We value Citigroup’s shares at $58, 15% ahead of the $50.93 closing price on Friday. Our analysis of the bank shows an estimated EPS of $4.25 for the year on revenues of $78.5 billion.

See our full analysis for Citigroup

Credit Suisse

Credit Suisse (NYSE:CS) took some heat from investors at the beginning of the week when it was revealed that the Swiss bank played an important role in selling investment securities that led to the collapse of the Portuguese banking giant Banco Espirito Santo. ^[8] The Portuguese bank was bailed out earlier this month after losses on securities sold by the bank through several offshore investment vehicles forced it into insolvency. Investigation into the bank’s failure revealed that Credit Suisse helped securitize the offerings for three of these investment vehicles.

Although it is alleged that Credit Suisse helped in the issuance as well as distribution of the securities, the second largest Swiss bank released a statement claiming that it never “distributed, sold or provided advice relating to the securities.” ^[9] The ongoing investigation does not bode well for the bank, which is already coping with issues of low profitability as it revamps its business model to comply with tougher regulatory requirements and changing market conditions.

We maintain a $33 price estimate for Credit Suisse’s shares, which is 18% higher than the Friday close of $28.06.

See our full analysis for Credit Suisse

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1. U.S. Bank Profits Near Record Levels, The Wall Street Journal, Aug 11 2014 [↩]
2. Eurozone banks set to borrow €250bn in cheap money from ECB, Financial Times, Aug 17 2014 [↩]
3. Goldman Announces Agreement with FHFA, Goldman Sachs Press Releases, Aug 22 2014 [↩]
4. Goldman to Buy $3.15 Billion of Debt to End FHFA Claims, Bloomberg, Aug 22 2014 [↩]
5. Citigroup Considers Sale of Retail-Banking Business in Japan, The Wall Street Journal, Aug 20 2014 [↩]
6. Citigroup Earning Less From Tokyo Than CEO Salary, Bloomberg, Aug 21 2014 [↩]
7. Citigroup Faces Curbs on Hedge-Fund Sales, The Wall Street Journal, Aug 21 2014 [↩]
8. Credit Suisse Caught Up in Espírito Santo Mess, The Wall Street Journal, Aug 17 2014 [↩]
9. Credit Suisse clarifies Banco Espirito Santo links, Financial Times, Aug 19 2014 [↩]