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Investors feel ‘hangry’ for information over Citigroup’s ‘deficiencies’: Analyst

Mike Mayo - Wells Fargo Senior Analyst joins Yahoo Finance’s On The Move panel to weigh in on Citigroup’s $400 million fine over ‘longstanding deficiencies’ and preview big banks third quarter earnings.

Video Transcript

ADAM SHAPIRO: A lot of headlines here. We invite in Mike Mayo, Wells Fargo senior analyst, as well as our own Brian Cheung, who covers the Federal Reserve and banking issues for us. Mike, want to start with you on the $400 million fine that Citigroup is going to be paying for, quote, "unsafe and unsound banking practices."

Don't want to rehash what happened with Revlon and transferring of almost, what, $100-- $1 billion to the wrong client. But you used in a note to your clients the term "hangry" about how investors feel about Citi and this really avoidable kind of mistake. One, how do they recover from it, and can Jane Fraser speed up the process of doing that?

MIKE MAYO: Well, you know, I am hangry at Citigroup, meaning I am hungry for more information as to why this situation this situation went on for as long as it did and what they're going to do about it. And I'm angry that there was not more transparency about the deficiency in their systems.

So with my being hangry, I start to think about, why not install the new CEO Jane Fraser earlier? And if you do that, then maybe they can-- if I can make a new verb-- McKinsey-ize Citigroup, sell off assets, sell off non-US consumer, restructure, trim fat, increase the intensity, all these things that I've been talking about by attending the annual meetings in person for most of the last decade.

And to boot, you know, maybe we should consider clawbacks to pay because these system issues that led to this regulatory order didn't happen overnight. Now, the big picture is, they can recover. It's just as far as this situation here now, this is another black mark at a company that's been the worst performing, large US bank for the last 20 years or 100 years, however you want to describe it.

JULIE HYMAN: Mike, we're going to get Citi earnings soon. And as we get many of the banks reporting their numbers, do you have any hope that they're going to do any of what you're suggesting? And do we just sort of discount the earnings in the short term until Fraser takes over and potentially rights the ship?

MIKE MAYO: Well, that's why I think it would be a good idea to go ahead and bring in the new CEO earlier, so she can say, you know, that, hopefully, that, hey, she has a clean slate. She's going to take a fresh look.

And as opposed to what Citigroup said, you know, a few years ago, our restructuring is over, that was a ludicrous statement. How can a company say that the restructuring is over when they have worst in class efficiency, returns, and stock market valuation? And that was the chairman. That was the CEO. That was at the annual meeting. That was in the annual report.

And that was a wrong statement. Clearly, the regulators don't agree that the restructuring is over because they need to restructure a lot of their data processing operations.

Now, I'll pull the lens back, though. I mean, this is a company that's trading at half of book value. This is not the global financial crisis. This is not life threatening, as terrible as I think it is. And the fine is $400 million, which is very digestible.

Citi has been working on improving this. They're spending an extra billion dollars this year, so some of that is already in the run rate. And don't miss the forest for the trees. We estimate that the peace dividend for Citigroup, from once the war on COVID is won, will be $14 billion. And maybe they have to spend an extra $1.4 billion a year.

So the benefit of the eventual peace dividend from COVID is 10 times the level of the additional spending that might need to take place. And in addition, this regulatory order could be the ultimate catalyst to finally to get Citigroup to do a lot of those things that I personally have been saying for the last decade.

So Citi's hit rock bottom here. But this might be the bottom. And I think what you'll see with their earnings on Tuesday is their book value is still growing. And some of that peace dividend is already seeping into earnings.

And by the way, that's an industry phenomena because we think the industry will have a $200 billion peace dividend. Most of that is from lower credit costs because banks have built reserves more than ever before in history the first half of the year.

BRIAN CHEUNG: Hey, Mike, Brian Cheung here. So I want to shift gears to the big news from Morgan Stanley this morning, acquiring investment manager Eaton Vance in a stock deal worth $7 billion.

On the call, the M&A call this morning, you said that it's really paying a premium price for a premium company. Now I know you have a mug that says, "I like big." But when is it paying too much to get big and to get scale in this space?

MIKE MAYO: Yeah, this is my teacup. I don't like refilling my teacup too often, so I like big. It works for my tea. And it also works for my bank recommendations. So, you know, I think Goliath is winning. Bigger is winning in terms of market share in both retail and wholesale. Morgan Stanley has been a beneficiary of that in the capital market side of things.

And what a segue from Citigroup. So James Gorman came from McKinsey. And he McKinsey-ized Morgan Stanley the last decade. Changed the business mix more than any other large bank CEO. But it's one thing to restructure a firm, as he did last decade. And it's another thing to buy firms and then grow.

So I think that's a different skillset. And so when you're paying, you know, such a high price for a firm that's already operating well, that creates a new set of risks. So I would say the jury is out on the success of Morgan Stanley with Eaton Vance or its other acquisition, which it just closed on, E-Trade.

And exactly having said that, I do respect what James Gorman did last decade at Morgan Stanley. And I think that's what Jane Fraser, also coming from McKinsey, needs to do at Citigroup now.

So I think this is-- you know, I think the easy-- the low hanging fruit has been grabbed at Morgan Stanley. And this is more tricky business with what they're doing. Not high risk, it's just tricky for earnings. Whereas I think Citigroup has a lot of low hanging fruit.

And don't forget Citigroup still has an activist in its midst-- ValueAct. Last I looked, they own a billion dollars of stock. And we're looking for ValueAct to play a role behind the scenes, just like they did at Microsoft. So we think Citigroup today is Microsoft 2.0 in terms of the impact of ValueAct and with all the hangry investors out there, including myself.

ADAM SHAPIRO: Mike, I know in your recent note, you were talking about the need for Citi to invest even more in digital banking. But I'm curious-- going forward, as we look at earnings next week, where is growth? It's going to be different for each one of the banks.

But there's that Barron's headline, you know, "10 Reasons You Should Love Bank Stocks." I can't imagine you love all bank stocks. Which are the ones that you're looking? You've talked about Citi and potential for upside. Who else?

MIKE MAYO: Well, you know, I took Citi off my favorites list. Look, if you say buy or sell Citi, we're still buyers. I mean, half a-- book value and everything else. But we're going for the biggest banks and the highest quality banks. And so, you can get some large banks at some really good prices. And these are banks that have performed well over time.

So that's Bank of America, that's JP Morgan, that's US Bancorp, and that's PNC. And these are really nice entry points. And these are companies that either perform well through the last recession, or in the case of Bank of America, they've really embraced responsible growth. And they've up tiered. So I think this is the quality of the quality.

So, growth not at a reasonable price, but growth at a fantastic price. When I talk growth, it's less top line. You're not seeing a lot of top line growth. It's getting, you know, eventual earnings growth through efficiency savings. And that peace dividend of $200 billion in the industry, a lot of that should be coming through reduced credit costs and then efficiency.

JULIE HYMAN: Mike, it's Julie again. Sort of circle back to the beginning, but also take a look at the banks together. I mean, you have this Citigroup fine. You also have had some recent fines against JP Morgan.

And it's not as though the banks have always been viewed as the most reputationally strong industry in the United States. But it does seem like this year, they have been collectively taken down a peg. It doesn't feel like a great time for banks. Am I reading that wrong?

MIKE MAYO: Well, as a reminder, I was the first analyst to testify to the congressional committee on the causes of the global financial crisis. So I was proud to do that. I blamed the banks for the global financial crisis. They were the problem, OK?

Right now, from my perspective, I think banks are part of the solution and helping to bridge the gap between the pre-COVID economy and the post-COVID economy. And there's, like, the good-- what I call the good citizen expenses and costs at banks are, like, you know, $10 to $20 billion.

And so banks are waiving fees on deposits. And they're maintaining full employment at a few large banks. They're paying extra bonuses. And they're paying for those plexiglass shields to make sure people are safe. And they're donating more money to community groups. And JP Morgan announced a new program to make sure that minority groups get enough loans over the next several years.

So, from my perspective, having covered the industry for three decades, I think banks are doing more to serve stakeholders other than shareholders, more than any other time that I've covered. In fact, it's been a wealth transfer from the shareholders. Look how shareholders are doing-- miserably to customers, to employees, to the community.

So if they are getting knocked down a peg, I think it's not fair in total terms. In terms of the fines, yeah, one fine, $1 is $1 too much. But it still doesn't compare to the global financial crisis. And, you know, to hold any bank to the standard of perfection would be too much.

Now, in the case of Citigroup, I mean, this is serious. I mean, you have a consent order. That's something significant. But in terms of magnitude of abuses, it's like the industry was driving drunk during the global financial crisis. And now it's been jaywalking and in certain instances, like Citigroup, a bit more.

ADAM SHAPIRO: Mike Mayo is Wells Fargo senior analyst. We appreciate your sharing three decades plus of insight into the banks. But you've got the best coffee mug of anyone who's ever been On the Move. Show us one more time, Mike.

MIKE MAYO: OK, yeah, Goliath is winning. JP Morgan, Bank of America, big banks, I think, beat the other banks.

ADAM SHAPIRO: All the best to you, Mike Mayo. Thank you for being here.