My View On JPM, Citi, BAC, And Wells Fargo

Follow-up to July and September articles

The question of bank capital adequacy has profound implications to bank investors.

My July article highlighted JPMorgan Chase & Co (JPM) CEO Jamie Dimon’s statements made during the bank’s 2Q earnings call. He bemoaned “ridiculous regulatory requirements” which he deemed “capricious, arbitrary.”

My September article provided fact-based data intended to help investors understand the capital debate and its implications.

As 2022 closes out, it appears Dimon’s worries were justified.

New Vice Chair for Supervision: Michael Barr

Jamie Dimon spilled his guts about capital adequacy on July 14, a day after the US Senate approved the appointment of Michael Barr to Vice Chair of Supervision for the Federal Reserve Board of Governors.

Pictured above, Barr, a lawyer by training, has bounced back and forth between academic and federal government jobs in Treasury and the State Department over the past 25 years.

His work in the Clinton administration focused on community development and the Community Reinvestment Act.

While working in the Obama administration, Barr helped craft Dodd-Frank legislation as well as the Consumer Financial Protection Bureau.

Investors may recall that the CFPB was Sen. Warren’s pet project coming out of the Great Panic of 2008-2009.

There is no evidence that Barr has worked in private enterprise or directly in the banking industry, but there is abundant evidence that he is smart and well-regarded by the Progressive wing of the Democrat party.

“Why Bank Capital Matters”

“Why Bank Capital Matters” is the title of the December 1 speech Barr gave to the American Enterprise Institute.

Here are key quotes from the speech:

• “We have very strong capital levels today”
• “History shows the deep costs to society when bank capital is inadequate”
• “Larger, more complex banks pose the greatest risk and impose the greater costs on society when they fail”
• “Higher capital requirements help to ensure that larger, more complex banks internalize this greater risk and counter-balance the greater costs to society by making these firms more resilient”
• “Despite complex regulatory risk-weights, or simple leverage ratios, or the internal models used by banks, at bottom bank capital ought to be calibrated based on that humility, that skepticism”
• “Risk-based capital requirements are important tools; however, they are complex, underinclusive under some conditions, and like all capital requirements, can be gamed”
• “The stress test — along with strong supervision — can serve as a check on excessive bank risk-taking”
• “It is critical that our capital regime is forward-looking”
• “We are currently evaluating whether the supervisory stress test that is used to set capital requirements for large banks reflects an appropriately wide range of risks”
• “I have no firm conclusions to announce today”

Barr made one other comment worthy of consideration:

“In theory, companies should be indifferent to the mix of equity and debt they use to fund themselves, since the creditors of a safer firm will lend to it at lower rates and shareholders of a safer firm will accept a lower return on their investment.”

My interpretation of Barr’s comments

1. Barr used this speech to confirm to Senator Warren that he is addressing her capital adequacy concerns.
2. Barr’s comment that banks “have very strong capital” seems incongruous with the essence of his speech which clearly indicates that he is “skeptical” that banks, do indeed, have enough capital. It is possible he referenced “strong capital” so as to not impugn the work of the Fed staff he inherited from his predecessor.
3. When Barr says “we are currently evaluating” the stress test, I interpret this to mean that his fresh, new ideas are needed to know for sure that banks are adequately capitalized. Banks should expect material changes to the stress test in 2023.
4. Banks should not be surprised to see new twists in the 2023 scenario, and these twists likely will be designed to uncover greater risks heretofore undetected by prior stress tests.
5. By acknowledging “complex regulatory risk-weights,” while at the same time describing the need for “humility” and “skepticism,” Barr is signaling that he will propose a simpler capital adequacy measure. You can take it to the bank that this simpler measure equals more capital.
6. To have a “forward-looking” capital regime is certainly important, but the devil is in the details (and politics).
7. Finally, Barr’s academic discussion of the “theory” of debt versus equity may suggest that he will discount some portion of the debt that currently is captured in capital adequacy measures. (Investors should always worry when academics engage in debt vs. equity theories, especially when academics conclude that more capital thrills investors who are happy to take less return for less risk.)

Implications

1. Jamie Dimon was right to worry the day after Barr was appointed.
2. When the Fed announces stress test results in late June (assuming Barr’s team can build out its desired severely stressed scenarios on schedule), expect to see some number of banks fail the stress test, a phenomenon unseen in recent years.
3. Here is the most serious implication to investors in JPM and Citigroup Inc (C): Since both banks currently have buybacks on hold, it is hard to imagine any dividend increases or share buyback announcements from them between now and when the 2023 stress tests are announced.
4. In effect, Barr’s approach to re-engineering the stress test puts efforts by Citi and JPM to distribute more capital to shareholders on ice.
5. This is not to say Citi and JPM are the only banks impacted by Barr’s appointment in the short-term, but clearly, these two banks seem to be at the front of the capital adequacy debate.

Investment outlook four big banks

At best, I see the stock prices of the nation’s biggest four banks treading water over the first half of 2023.

The big banks face several material challenges:

• Capital Requirements are now up in the air given Barr’s appointment; investors will not have a clear view of the capital picture until stress test results are announced, which at the earliest, will be late June 2023.
• Credit metrics will weaken coming out of 2021-2022 when the industry’s Provision expense fell to record lows. I am not at all surprised or overly concerned for the four biggest banks as a reversion to the Provision rate mean was inevitable. (However, I remain concerned for certain lenders like Capital One Financial Corp (COF) as I warned investors in September 2021.)
• Rising interest rates will exacerbate credit metrics as the Fed has its way in slowing the economy and spiking up unemployment. Bank of America Corp (BAC) will be least impacted of the four banks in this regard because of its client selection model; Citi will be most impacted given its relatively large exposure to credit cards.
• Rising interest rates will help Bank of America the most among the four banks; Citi will be hurt the most as it lacks strong core deposits.

Hold JPMorgan Chase

Hold at today’s price: $131. I bought a few shares most recently when JPM fell below $110. I am currently not dividend reinvesting but would do so <$110. My view of JPM has not changed since January 2022 when I wrote about JPM’s strong liquidity, capital, and earnings power. At a current cost basis of $62, JPM is an anchor holding in my long-term buy-and-hold bank portfolio.

Avoid Citigroup

Avoiding at virtually any price. Rather than beat a dead horse, readers interested in my view of Citi can read my December 2021 and November 2022 articles.

Accumulate Bank of America Preferred

Accumulating the BAC Preferred (BAC.PL) <$1200 and very cautiously adding a few shares of the common under $32. These positions were taken as a follow-up to my September 2022 article on BAC. My simple analysis is that this preferred is reasonably safe and has decent upside if/when rates decline. I am probably a seller >$1300 for reasons outlined in this November 2021 Seeking Alpha article. Current yield 6.02%, quarterly dividend of $18.125, goes ex-dividend December 30.

Avoid Wells Fargo

Wells Fargo & Co (WFC) puzzles me. My January 2021 article was bullish, noting that I was a seller of WFC Puts and holder of a few common shares at $29-$30. My view of WFC began to change when the stock price jumped above $50 in Q1 2022. I took profits at that time convinced the share price had jumped too high too fast.

Since then, two events have left me concerned about WFC as a long-term holding.

The first, and an event that hardly anyone but me seems to be worried about, was the surprising exit of the bank’s Chief Risk Officer (announced in January, effective in June). I hate seeing a CRO leave at a time when there appears to be a lot more work to do. (That said, the CRO was 55-years of age, the same age I was when I retired from BAC, so I can understand the motivation to move on with life if the decision is one of lifestyle.)

My second concern is the crazy magnitude of the CFPB settlement announced just a few days ago. A $3.7 billion settlement is probably justified, but it is further evidence of just how deep a hole WFC is in.

Yes, clearly under CEO Scharf’s leadership, the bank is climbing out of the hole, but I am struggling to calibrate just how far they still need to climb. In January 2021 I enjoyed acquiring WFC shares <$30, I am not interested in them today >$40. If WFC retraces <$35, my interest may be peeked.

Two key questions are:

1) Will WFC get the asset cap lifted in the aftermath of the CFPB announcement? (I doubt it because the asset cap is the OCC’s call, not the CFPB’s, but we’ll see.)

2) Will WFC be able to accelerate capital distributions to shareholders during the first half of 2023? (I doubt it in light of the Barr speech but hope to be proven wrong.)

CAVEAT

The foregoing is my opinion which I share for the purpose of getting feedback and questions that challenge my ideas and assumptions.

Every investor needs to do his/her own due diligence before investing as well as determine their risk profile. I am risk-averse, preferring to invest in the nation’s best banks which reliably earn returns exceeding cost of capital.