Sandy Weill’s “Mea Maxima Culpa”

Sandy Weill, the man who almost single-handedly did more to obliterate Glass-Steagall now admits that he made a most grievous mistake. Those watching him on CNBC on the morning of July 25, 2012 were treated to a rare peak inside a confessional booth as the architect of today’s Citigroup admitted his folly. He now realizes that what he did was wrong and needs to be reversed.


Weill now believes that banks need to return to pure banking, whereby they accept deposits and make loans. Brokerage firms need to return to executing trades on behalf of customers, positioning securities to facilitate those trades, and taking risk positions within the boundary of reasonable leverage ratios.

It is time to begin the process of dismantling these financial behemoths. Citibank, Bank of America, JP Morgan, Wells Fargo, and others can dispose of their nonbank enterprises by simply issuing shares in those nonbank entities to existing shareholders. At the same these financial shopping centers need to reduce or eliminate the use of derivatives that have cast a giant cloud over their financial statements. While the institutions adhere to the belief that their long and short derivative exposures should be can be netted out, the stock market strongly suggests that market participants favor focusing on gross exposures since the counterparties are of questionable financial strength.

Forgive me father for I have sins - as a commercial banker, I discovered a loophole in the law that allowed me to be the first person to establish a brokerage firm as an operating subsidiary of a bank holding company in 1979. My application, regrettably, provided a pathway for others to follow. The loophole allowed limited brokerage services; however, in the 1990s those powers expanded geometrically thanks to favorable legislation and rulings.

People who were not trained as commercial bankers became CEOs of the nation’s largest banks, and they proceeded to transform those entities into unmanageable financial organizations or financial supermarkets. Sandy Weill was the poster child for that era and when he retired he left a crippled organization as his legacy. If the banking industry had a Hall of Shame, he would be a leading candidate to be the first person installed. Too bad it took him so long to get religion and see the truth!

Back From The Brink

The financial media is awash with speculation about major bank holding companies increasing dividends and/or buying back shares. While regulatory authorities have acknowledged that bank balance sheets are healing, those same regulators need to remember how difficult it was to raise bank capital within the past few years. Similarly, bank holding company board members need to carefully balance the care and feeding of shareholders with the need to re-establish sound dividend policies that will not have to be reversed.

An overly aggressive dividend policy runs a serious risk of financial embarrassment in the event that a dividend has to be cut in the future. A better option would be for a bank holding company to pay modest quarterly dividends and then augment them with a year-end extra dividend based on the full year results.

A review of the financials for Bank of America, JP Morgan, Citigroup, Wells Fargo, and U.S. Bancorp for the period from 2005 through the third quarter of 2010 suggests that none of them are strong enough to buy back shares. They all remain highly levered financial institutions that have benefited from a period of artificially low interest rates.

These five bank holding companies have significant amounts of goodwill on their balance sheets as a result of acquisitions and accounting treatments accorded by U.S. GAAP. Goodwill is represents the excess of the purchase price of an acquired entity over the fair value amounts assigned to assets acquired and liabilities assumed. Even though goodwill must be tested for impairment every year, its true value is very questionable and excluded from tangible common equity and Tier 1 capital calculations.

As of September 30, 2010 goodwill accounted for 35.60% of Bank of America’s common equity, 32.21% of U.S. Bancorp’s, 29.35% of JP Morgan’s, 21.35% of Wells Fargo’s, and 15.65% of Citigroup’s. Given the significant amounts of goodwill, the degree of financial leverage among the five aforementioned bank holding companies was gauged by reducing their common equity by goodwill and then expressing that more tangible amount as a percentage of total assets. This methodological approach revealed that Wells Fargo had the lowest degree of financial leverage at 7.49%, while JP Morgan had the highest at 5.48%. In between were Citigroup at 7.01%, U.S. Bancorp at 6.53% and Bank of America at 5.85%.

This brief analysis strongly suggests that it would be folly for the major bank holding companies to buy back shares of their common stock and/or establish large dividend payouts so soon after perching on the financial abyss. The general public, as well as shareholders, would be better served by these companies using their earnings to support loan growth. This generation of bankers needs to understand that the public’s appetite for bailing out banks has been satiated for the foreseeable future. Banks must therefore be operated with more common equity and less financial leverage.

Pac-Man Game Ends for Bank of America

The Pac-Man era of banking in the United States has ended for Bank of America. Its transformation from the once sleepy North Carolina National Bank (NCNB) of Charlotte, North Carolina into the largest bank in the nation was truly remarkable. It was made possible by the fact that it was well capitalized with a clean balance sheet at a time when other banks ran into financial difficulties.

NCNB’s first big acquisition was the purchase of First RepublicBank Corporation of Dallas, Texas from the FDIC in 1988. That was followed by the purchase of over 200 thrifts and community banks, many through the Resolution Trust program. Included in those acquisitions was C&S/Sovran Corp of Atlanta in 1991 and at that time it renamed itself NationsBank. It continued its bank purchasing spree by acquiring Maryland National Corporation in 1992, BankSouth in 1995, Boatmen's Bancshares in 1996, and Barnett Bank in 1997.

It was able to acquire and assimilate banks with a speed that took competitors’ breath away. Transitions from old to new management happened swiftly and numerous people lost jobs as cost savings were maximized.

The flurry of acquisitions culminated with the merger of NationsBank and Bank of America in April 1998. The fact that Charlotte, NC was named the official headquarters of the merged entity spoke volumes about the leadership of Hugh McColl, who retired in 2001 after naming Ken Lewis his successor. McColl had been CEO since 1983.

The smooth transition in leadership following the merger and McColl’s departure brought with it a five year period during which management focused its attention internally on integration and efficiency. In 2004 Ken Lewis decided it was time to once again enter the bank acquisition arena as BAC acquired FleetBoston Financial Corporation. Fleet itself was the product of the Pac-Man The Providence, RI based Fleet morphed itself into the seventh largest bank in the nation by the time of its merger.

The year following BAC’s acquisition of Fleet it acquired MBNA Corp., the world’s largest independent credit card issuer. In 2007 it purchased ABN Amro North America Holding Company, which was the parent of LaSalle Bank Corporation.

These bank acquisitions and mergers were blessed by regulatory authorities who embraced the resulting loan diversification and economies of scale as beneficial to the commercial banking industry. The regulatory authorities became so enamored with loan diversification among industrial categories that they allowed Pac-Man banks to operate with significantly lower equity capital ratios. They also allowed them to fund their assets with a greater portion of borrowed funds (fed funds, brokered CDs, commercial paper) than other commercial banks.

Historically, the Federal Reserve Board always examined the concentration of resources that would result within a Standard Metropolitan Statistical Area (SMSA) from a bank merger. It, however, never considered a national problem that might arise from a given bank reaching a certain size. It is doubtful that the top four commercial banking organizations would have been allowed to reach today’s level of 60% of all commercial banking assets if the Fed considered the systemic problem issue.

The first move that drew unwanted attention to BAC and caused people to question Ken Lewis’ leadership was BAC’s purchase of U.S. Trust in late 2006 from Charles Schwab Corp. The purchase price was $3.3 billion and was $600 million more than Schwab had paid for it in 2000. Furthermore, U.S. Trust was rumored to be for sale for more than two years following the July 2004 departure of Schwab Chief Executive David Pottruck.

The acquisition of U.S. Trust and its $94 billion in assets enabled BAC to claim that it had more assets under management, $261 billion, than any other bank. It was apparent that Lewis prized bigness.

In August 2007 BAC made what it dubbed a $2 billion strategic investment in Countrywide. This was done through a 7.25% non-voting convertible preferred security, with a conversion price of $18 per share. On January 11, 2008 BAC then announced that it would acquire Countrywide Financial Corporation for $4 billion. This announcement stunned the financial community, because the embattled Countrywide was the widely accepted poster child for the rapidly bursting real estate bubble.

These two Countrywide transactions marked the beginning of the end for Ken Lewis. Stockholders lost faith and dumped the stock, while the financial press had a field day questioning his decision making ability. He doggedly insisted on closing the transaction in the summer of 2008 even as evidence mounted that the residential real estate market was collapsing.

He wrongly thought BAC’s underwriting standards immunized it from credit problems sweeping the nation. Accordingly, he jumped at the chance to meet with John Thain on September 14, 2008 and agree to buy Merrill Lynch. That was the final nail in his coffin.

The consensus was that BAC grossly overpaid. This view was later confirmed when Lewis told Paulson and Bernanke that BAC needed assistance to complete the deal, because of unforeseen losses in Merrill’s portfolio. Lewis agreed to complete the acquisition only after he allegedly received heavy handed threats from government officials.

The sad thing is Lewis has said that the strategic plan was that one day the organization would include a major investment bank. They had actually thought about Merrill Lynch and its army of brokers. That must have seemed like an incredible dream for a bunch of people from the mountains of North Carolina. Unfortunately for Ken Lewis the dream of owning a major investment bank came true.

The chance of fully integrating Merrill Lynch and Countrywide into Bank of America is remote. After all, Bank of America couldn’t assimilate Charles Schwab which it bought in 1981 and sold back to Schwab in 1987 after a contentious six years.

Commercial banking and investment banking have vastly different corporate cultures and compensation. The Glass-Steagall wall may have crumbled, but the culture wall remain intact.

BAC needs to return to the basics of commercial banking whereby it makes loans and investments that it keeps on its balance sheet. It needs to focus on getting payments or additional collateral on existing loans and investments, while making new loans and investments.

No resources need to be spent on looking for acquisitions. Instead, BAC should consider selling some assets, especially Merrill Lynch, and repaying the U.S. Government as soon as possible. It’s time for banking’s version of Pac-Man to rest while it recovers from a serious case of financial indigestion.

Storm Clouds Gather

Bank stock investors have seen their investments soar during the past six weeks. The percentage gains in bank stocks have dwarfed all general market indices.

Citicorp ( C ) stock rose from the ashes of $0.97 per share on March 5th to an inter-day high of $4.48 on April 14, 2009. During relatively the same period, Bank of America
( BAC ) rose from its all-time low of $2.53 to $11.58; J P Morgan ( JPM ) rose from $14.96 to $33.70; Wells Fargo ( WFC ) rose from $7.80 to $19.67, and US Bancorp (USB) rose from $8.06 to $18.01.

Bank stocks initially perked-up when bank officials made favorable comments about their earnings for the first two months of 2009. They really took off, however, when WFC reported robust earnings for the first quarter, which were well above street estimates.

The observed volatility in the bank stock sector reflected the extremes of despair and optimism regarding a financially fragile economy. Nowhere has the battle between market bulls and bears been more evident.

For the past six weeks the voices of Paul Krugman, Nourel Roubini, Dylan Rattigan, Meredith Whitney and others have been muffled as their calls for nationalization were widely dismissed. Of course it didn’t hurt that Rattigan lost his perch, Whitney switched jobs, and Roubini was abroad for much of this time.

These pundits are about to be replaced by the angry voices of people being led to believe that the time for Washington to be reigned in is now. A coalition of commentators who favor small government and balanced budgets has chosen April 15, 2009 as the day to launch taxpayer protests against Federal bailouts. In general, the people leading this movement believe that the United States would be far better off if we allowed banks and businesses to fail.

It is highly likely that this populist movement will gather momentum as the unemployment rate rises and tent cities become more prevalent. Federal Reserve Chairman Bernanke has said that the economy will recover as long as we have the political will. At present, the likelihood of getting another spending bill through Congress is remote. As the anti-bailout movement gathers momentum, the possibility of additional spending packages will disappear entirely as the nation’s political will disappears.

If the current stock rally proves to be short-lived and the anti-bailout forces gather momentum, then the nation will be in for a long, hot summer of discontent and civil unrest. In such an environment, people working for specific organizations could become targets of discontent just as AIG executives have.

Bank Nationalization Fever Wanes

Remarks by Federal Reserve Board Chairman Ben Bernanke allayed fears of the federal government nationalizing major banks. Appearing before the House Financial Services Committee he said the major banks were not in jeopardy of failing and nationalization was not necessary.

Bernanke stated that nationalization is when the government seizes the bank, zeros out the shareholders, and manages the bank; and, they don't have anything like that planned. His remarks caused a significant rally in beaten down bank stocks.

The positive comments by the Fed Chairman came the day after President Obama’s optimistic State of the Union address. Their remarks were the first meaningful statements to effectively offset the cries for nationalization that had been increasingly dominating the print and cable media.

The loud voices favoring bank nationalization have suffered their first major setback. Those opposed to nationalization hope this is the first of many defeats that the talking heads will receive going forward. Baseless rhetoric by inexperienced pundits has simply become too much for the nation to bear.

A Name Can Hurt

On December 11, 1930 the Bank of United States failed setting off runs on numerous other banks that had refused to come to its aid. It was only one of the 352 banks that failed that month but its failure had worldwide repercussions, because many thought it was owned by the federal government. It was actually a relatively small state-chartered bank with slightly over $200 million in deposits located in New York City. But - it had an imposing name!

In the aftermath of that confidence shattering failure it was determined that no newly chartered bank would be allowed to use “United States” in its name. Of course that did not affect the Bank of America, which was already operating under that name.

Those now shouting fire in the bank theater would do well to read about the failure of the Bank of the United States. That bank was not nearly as large or as important as its name implied, but its failure helped usher in the last depression as it helped erode confidence at home and abroad.

By contrast, the Bank of America is a truly dominant bank that holds more than 10% of the total deposits of the entire banking industry. It claims that 50% of the people in the Unites States are customers of the Bank of America.

Those talking heads who daily spread the view that the Bank of America needs to be nationalized so that this economy can turn around are, at best, illinformed. They have no background in banking and they fail to appreciate the shock such an announcement would have domestically and internationally.

Bank Nationalization Opponents Need To Thank Greenspan

Alan Greenspan, the former Chairman of the Federal Reserve, who many view as the primary culprit for today’s economic problems, has come out of hiding to express his views on the subject of bank nationalization. Greenspan told The Financial Times “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.”

Opponents of bank nationalization should thank Greenspan. After all, who in their right mind would rely on the views of a person weighed down with an admittedly broken economic model. He greased the skids for this slide into the abyss; he does not hold the solution.