What TARP Banks Are Investment Grade?

By Martin Hutchinson
Contributing Editor
Money Morning

A total of 10 U.S. banks have now repaid the preference share investments in them made by the U.S. Treasury Department's Troubled Assets Relief Program (TARP), thus demonstrating that the government thinks they are sound. A number of others have yet to pay back that federal infusion.

For investors, the question is this: Where do we go from here? Do we believe the government's clean bill of health on the 10 TARP escapees, and do we mark down the shares of the banks that remain in the government's debt?

The question is a simple one. But the answer is anything but clear-cut.

At the extremes, the question isn't difficult. Citigroup (NYSE: C) is being forced to raise $55 billion of capital through preferred stock conversion, and even then is not sure of survival. In addition to the federal TARP injections, Citi has benefited from a $300 billion guarantee of its assets. It has been forced to sell some of its major subsidiaries, including Japanese broker Nikko Cordial Securities, which it bought only two years ago. Its chief executive officer, Vikram S. Pandit, cost Citi $600 million when the bank lured him into the organization by buying out his hedge fund two years ago.

That hedge fund was subsequently closed. And it's by no means clear that Pandit has the skills needed to run a low-risk financial behemoth whose future should be oriented towards doing stuff that is very simple.

With Citi's stock trading at about $3.50 a share, investors may feel the chance is worth taking. But given the company's long history of serial financial disasters, it must be much more likely that the government will eventually be badgered by taxpayers into losing patience with the mess, resulting in its final dismemberment with little or no payoff for shareholders.

At the opposite end of the banking-bailout spectrum, at least two of the banks that have paid off TARP - U.S. Bancorp (NYSE: USB) and BB&T Corp. (NYSE: BBT) - seem to be in good shape, and indeed have expressed indignation at being forced to go through the demeaning TARP process at all.

Their shareholders should be equally indignant: Both banks have been forced to raise capital while their share prices were still depressed, and to slash their dividends from levels that had literally taken years to build up. It will be interesting to see whether either bank has the moxie to restore its previous dividend in full in the coming quarter. Doing so would be a sign of management that was both confident and shareholder-friendly - and of an outlook for each bank that was decidedly favorable.

Certainly, however tempting it may be for these banks to assert their strength by taking over weaker neighbors, their dividends should be fully restored as a matter of principle before they go out on any acquisition binges. The last few years have seen far too many self-aggrandizing management schemes that are engineered at the expense of shareholders, and a policy of acquisitions-before-dividend restoration would signal that management has still not received the message of how a responsible financial institution should be run.

If all the banks still in TARP were like Citigroup, and all those that had escaped were like USB and BBT, the government would have done a great job, and investors would have useful information. However, they're not. Among the escapees is Capital One Financial Corp. (NYSE: COF). Capital One has raised $1.5 billion in new equity, but it made losses in the first quarter and is a leader in the subprime credit card segment, surely close to the next epicenter of the ongoing financial crisis. It doesn't help that Congress has also passed a credit card reform act outlawing many of Capital One's favorite practices. In short, nothing will convince me that Capital One is a safe place for your investment dollars, and my best guess is that before the end of this year we will know that the government blew this one big-time.

In the final quadrant, those that have not repaid TARP but appear to be in good shape, we have Wells Fargo & Co. (NYSE: WFC) and PNC Financial Services Group (NYSE: PNC). Both appear to have been in relatively good shape from their own operations, but during the crisis bought banks of equivalent size to themselves that had made a mess of things: Wells bought Wachovia Corp. and PNC bought the Cleveland-based National City Corp. Their failure to repay TARP may mean that further problems are lurking under the hood in the banks they acquired; Wachovia, in particular, made an exceptionally foolish acquisition by spending an estimated $25 billion to buy the huge California mortgage bank, Golden West Financial, in August 2006.

But only time will tell. Both Wachovia and PNC are worth watching closely. If, during the next couple of quarters, only medium-sized problems surface, then it's likely that these institutions will emerge stronger from their deals and will be well worth an investment.

The bottom line: Keep an eye on Wells Fargo and PNC, but don't buy them yet. If either U.S. Bancorp (which is due to declare a dividend in the next few days) or BBT restores their previous quarterly dividends of 43 cents and 47 cents, respectively, back the truck up and buy!

[Editor's Note: Longtime global investing expert Martin Hutchinson has made a specialty of evaluating banking profit plays, and in recent reports has warned investors away from "Zombie Banks" and devised his own "stress test" to highlight the best profit plays in the troubled U.S. financial-services sector. Hutchinson brings that same creative analysis to his The Permanent Wealth Investor trading service, which uses a combination of high-yielding dividend stocks, profit plays on gold and specially designated "Alpha Dog" stocks to create high-income portfolios for his subscribers. Hutchinson's strategy is tailor-made for uncertain periods such as this one, in which too many investors just sit on the sidelines and watch opportunity pass them by. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]

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