The Bank Dead Pool

New York | Last week we pondered the fate of Citigroup (C) and several other global banks that have lost their raison d’être with a group of veteran treasury and operations managers. Will the bank built over the years to service the political inhabitants of the post-war Pax Americana survive another decade? Or will the relentless consolidation of the banking industry at the top continue by forcing the sale or breakup of C?

During the Cold War years and after, Citi was a very convenient institution indeed, a favorite haunt for intelligence operatives and central bankers. But the fact of official support did not prevent Citibank N.A. from making some truly epic operational errors, mostly tied to exotic offshore venues where the bank chose to do business. In many ways, Citi was the successor in fact to famed institutions as Pakistan’s Bank of Credit and Commerce International (BCCI).

The Mexico City money laundering scandal involving Citibank Private Banking and Raul Salinas de Gortari in the late 1990s resulted in years of litigation and the eventual ouster of John Reed as head of Citigroup. The removal of Reed ushered in the era of Chuck Prince, Sandy Weill and Robert Rubin, setting the stage for Citi’s 2008 collapse and government rescue. A series of international and domestic fiascos have followed, including the WorldCom scandal, rigging LIBOR and various other infractions of anti-money laundering laws and regulations around the world.

The incompetence and deception displayed by Citibank officials so grotesquely in Mexico in the 1990s was repeated over and over again in the US and foreign venues such as Buenos Aires, Lagos and London. The cost of these errors to C shareholders stretches into the tens of billions of dollars. As the official international support for Citibank ebbed, however, the bank’s patchwork business model began to show strain.

Today, after selling its Smith Barney asset management arm to Morgan Stanley (MS), Citi lacks a clear path for the future. The bank has limited domestic deposits to support its $2 trillion in assets and the largest OTC derivatives book of any US bank – at least in sheer dollar terms. The prize for the largest derivatives exposure of any large US bank per dollar of assets goes to Goldman Sachs (GS). But hold that thought.

We actually heard Jim Cramer last week encourage his viewers on “Mad Money” to have a look at C as an equity investment. No way Jose. With due regard to Jim, we’d say the Citi stock is toxic. We own the C TRUPs, but the common is dead money IOHO. Citi trades below book for a reason. As Dennis “Mr. Wonderful” O’Leary said this summer on CNBC’s Squawk Box about the large banks generally: “Dead Money.”

Investors are not paid nearly enough to take the outsize financial and operational risk that comes along with owning the Citigroup enchilada or risk and return. Simply stated, there is a reason why this stock trades below book, while asset peers such as JPMorgan (JPM) and U.S. Bancorp (USB) trade at a premium. The chart below illustrates the fact that C actually under-performs the average of the 125 large and smaller banks above $10 billion in assets that are included in Peer Group 1.

Source: FFIEC

To help focus our minds on the future, below we list the initial members of The Bank Dead Pool for 2020. This new feature from The Institutional Risk Analyst is inspired by the 1998 film entitled “The Dead Pool,” an American action movie directed by Buddy Van Horn and starring Clint Eastwood as Inspector “Dirty” Harry Callahan.

The banks included in The Dead Pool are large, mediocre performers with weak business models, poor disclosure of risks, feeble equity market performance and a history of outsized operational risk events. Indeed, these banks are so problematic in terms of financial performance and the frequency of idiosyncratic op-risk events as to be uninvestable, either by individual investors or another bank. Here is the initial list:

Deutsche Bank AG

The Goldman Sachs Group

Citigroup

To be in The Dead Pool does not mean that a bank is in danger of imminent failure. In today’s world, the most likely outcome of a large bank liquidity crisis is a government takeover and conservatorship by the FDIC as per Dodd-Frank. If our friends at the FDIC were not going to liquidate IndyMac in 2008, then they sure as hell aren’t going to liquidate a money center bank now.

That said, the members of The IRA Bank Dead Pool are basically dead money from an investment perspective. Zombies. Muertos. 死亡證書. Without significant business model changes and/or increases in capital and liquidity, we don’t expect to see these institutions operating in their current form five years hence.

The institutions in The Bank Dead Pool underperform their asset peers among global universal banks. They are unlikely to be acquired except in the context of a fire sale or government intervention. And all of these names have been given a “negative” assessment of qualitative and quantitative factors by Whalen Global Advisors LLC, using the standardized data published by the Federal Reserve Board and other agencies via the FFIEC.

The first of a series of IRA Bank Profiles is available for sale in our online store. The first profile is focused on Goldman Sachs. We write:

“The primary focus on the brokerage unit and on non-interest sources of income as part of the firm’s business model places GS at a distinct disadvantage compared with core deposit rich institutions like JPM and USB. Even Citigroup (C) and CapitalOne Financial (COF), which use brokered deposits to fund their consumer loan books, have cheaper funding costs than GS.”

Sure, there are other global banks that could be added to The Bank Dead Pool list. Screen for big universal banks with common shares trading at a discount to book value and little or no growth. As we go forward into 2020, we’ll be updating The Bank Dead Pool and publishing new profiles about these zombies as well as some of the exemplars among large US banks.