Bank Follow-up (Updated 7/20)

As a follow-up to Big Banks = Juicy Returns? comes some commentary today.

David Weidener discusses the other side of the financial conglomerate coin in his piece - Diversified but Diluted: Unlikely to ever be fully valued.

The bottom line is this: the big diversified banks do provide a steadier stream of profits, but they depend on being big and having scale. Because they have commoditized everything from brokerage services to home lending, they must continue to acquire smaller rivals to keep market share and maintaining the ability to buy in bulk.


Each quarter some businesses will do well at Citigroup, others won't and it's less likely that Citigroup will produce the kind of quarter recently produced by Goldman Sachs.


"It is safe to state that at virtually no time in the past 20 years has the market value of the large banking conglomerates equaled the sum of their parts," Punk Ziegel & Co. analyst Richard Bove wrote recently. "This includes many more companies than just Citigroup."

Conglomerates, supermarkets -- whatever one chooses to call them -- do not work as intended but they do work. In the corporate and institutional world bankers use the bank balance sheet to finance deals and win advisory assignments. In the retail world, bank customers do buy some other financial products from the same company.
Because they operate more like machines, big conglomerates create a marketplace for nimble and smaller competitors.

Updated on July 20th:

BofA, JPMC, Wachovia, and Citi all announced great earnings this week...and their stocks all moved nicely. Of the names, I think that JPMC has the most opportunity for near to mid-term price appreciation in their stock for many reasons - including the fact that they have lagged the market for the last five years while of BofA has experienced appreciation. Additionally, the cost reductions and the efficiencies of the new JPMC (that includes Bank One) have taken root.

The Wall Street Journal had a nice article on this stuff today.

Street Sleuth
Top 3 U.S. Banks Seek Organic Growth, A Luxury Smaller Rivals May Not HaveBy VALERIE BAUERLEIN and ROBIN SIDEL
July 20, 2006; Page C1

After years of making blockbuster acquisitions, the three largest U.S. banks are now concentrating on building from within, a strategy that should leave them in better shape than smaller, regional banks as the economy cools.

Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co.'s pursuit of "organic" growth comes as smaller, regional bank competitors continue to pursue mergers that they hope will help them combat a weaker outlook for traditional lending.

Second-quarter profit jumps reported yesterday by Bank of America and J.P. Morgan -- the second-largest and third-largest banks by stock-market value -- echoed the competitive advantage the two and the largest bank, Citigroup, could enjoy over smaller rivals whose narrower business lines had previously enjoyed investors' favor.

While that crucial gap has been narrowing for about the past two years, big banks like Bank of America and J.P. Morgan have been able to use trading operations, credit-card units and other businesses as shock absorbers for slower growth in core loans and deposits.

In contrast, regional and community banks are generally posting decent earnings growth but relying more heavily on the release of loan-loss reserves and unusually pristine credit quality.

To be sure, the biggest banks have little choice but to grow organically. Bank of America holds the regulatory limit of 10% of U.S. deposits and can't do a deal that would put them over that. Citigroup is just emerging from regulatory scrutiny; in April, the Federal Reserve cleared Citigroup to pursue acquisitions, lifting a yearlong restriction that was imposed following a string of missteps. J.P. Morgan is still assimilating its businesses following the $58 billion acquisition of Bank One Corp. in 2004. Prices of smaller banks in desirable areas are also high, as a takeover premium is baked into the share price.