Banks Are Worth What Their Stock Prices Say They Are

Several prominent bank analysts came out with statements yesterday saying that the largest US financial firms would post more heavy losses and that their accounting methods would obscure the worst of it. George Soros, the grand old man of the hedge fund business, repeated his belief that the banks are insolvent. If he is right, earnings are irrelevant.

All of these comments cast the Treasury as a collection of desperate people, cornered by the faltering financial system, who are willing to pull any rabbit that they can find out of their hats. This makes the new Geithner plan for public /private partnerships to buy toxic bank assets look like a carnival show. It was not heartening to see that the Treasury admitted that it did not have many takers for this new program, so it extended the deadline for applications by two weeks until April 24. Unfortunately, world class financiers keep track of things like dates. Those who have passed on the opportunity so far will not be rushing in just before the new deadline.

The Treasury also said it would allow smaller investment managers to have a chance to participate in the program, probably in the hope that a wider net will catch more fish. But, when the local community bank in Akron, Ohio is allowed to get federal money to buy toxic assets from Bank of America (BAC), it does not look good.

The reason for all of this fighting is that there is a disagreement concerning the fundamental values of the US money center banks. It has become a sign of sophistication for an institutional stock picker to say that a company’s stock value is zero. Recently, there have been research notes that say that GM (GM) is worth zero, and that Citi is. Saying something is worth zero is too easy. Most analysts have to give a range of prices and reasons for their upper and lower targets for share value forecasts. Saying something is worth zero is cheating. It takes away any meaningful analysis of the worst case.  Stock prices never trade in negative numbers.

Left out of the conversation about bank values are the actual prices of the stocks. It has been the standard proxy of value for decades and there is little reason to change this now. Experts will say that bank stocks were too high two years ago when they traded at their all-time highs. The financial results at the companies were pretty good then. When investors caught on that the party was over, they cut the market values of many of the companies by more than 95%. And, they did it quickly. A perfectionist would argue that investors should have seen the bad news coming. But, that is not unlike saying that stockholders should have seen the recession coming. If they had, the Dow might never have made it above 14,000.

Citigroup trades at $2.72 now. All the harsh talk from bank analysts pushed the stock down by less than 5% yesterday. That means a lot of investors gave the alarmists little credence. Maybe they want to see Citi’s first quarter earnings before they decide what the bank is worth. Since the stock is down from over $55 less than two years ago, no one is assuming that the bank is going to earn billions of dollars for the quarter. The question is probably how few billion it will lose.

The most powerful argument that bank experts make about why Citi is not valued correctly is that, first, no one has access to its books, and second, the bank has so many levels of debt and equity that no one can unravel what the convertible preferred and senior notes are worth, let alone the common stock. That point of view leaves out the most obvious aspect of valuing Citi’s stock which is that it is followed by thousands of experts. Cit trades over 400 million shares a day. With that much volume and that many experts, the market for evaluating the bank’s stock is probably as efficient as it is for any publicly traded stock in the world. Citi’s value changes by the second and on some days its market cap moves by over $1 billion in a few minutes. What analysts want their clients and the media to believe is that virtually all of the people who own and trade the bank’s shares are idiots. That could only be possible in a perfect world.

Douglas A. McIntyre