The new CEO of thrice-bailed-out lender GMAC pulled down $1.2 million in pay and stock options for the 45 days he worked in 2009.  Bloomberg observed that on an annual basis GMAC’s Michael Carpenter was paid roughly the equivalent of Goldman Sachs’ (GS) Lloyd Blankfein, who runs the most profitable securities firm in US history and adeptly managed through the recession.

GMAC Inc., the auto and home lender that hasn’t posted a profit since 2008, gave Chief Executive Officer Michael Carpenter a pay package rivaling that of Goldman Sachs Group Inc. CEO Lloyd Blankfein, who runs the most profitable securities firm in U.S. history.

GMAC paid Carpenter about $1.2 million in salary and restricted stock for the month-and-a-half he was employed by the Detroit-based company last year, equivalent to full-year pay of $9.5 million, according to a regulatory filing yesterday. Goldman Sachs paid Blankfein $9.6 million for 2009. — Bloomberg.com 3/2/2010

A spokeswoman for GMAC defended the compensation saying that Carpenter’s pay is justified by his experience with large, complex financial services companies, such as Citigroup (C).  However, that explanation does not hold water for other executives at the firm who received multimillion dollar pay packages last year, including $7.7 million for Chief Risk Officer Sam Ramsey who has held his position since late 2007.  It is tough to argue that he has been anything but a failure at mitigating risk, and his pay is even more mind-numbing than is Carpenter’s.

Say what you want about Goldman Sachs and executive compensation, but it is much easier to understand Blankfein’s pay versus Carpenter’s.  Goldman Sachs Group has been hugely profitable recently and shareholders have seen 85% gain in the last twelve months.  They were among the earliest to repay TARP loans with interest, and thus the Obama Administration’s Pay Czar Kenneth Feinberg has much less say in executive compensation.

In contrast, GMAC has relied on three separate government bailouts totaling more than $17 billion due to the credit crunch and its exposure to mortgage and car loans.  They have reported a loss in each quarter since the fourth quarter of 2008, and the largest of those (loss of $3.9 billion) came in the most recent quarter.  To be fair, Mr. Carpenter was tapped to lead the turnaround and joined GMAC well into their struggles in mid-November 2009.  If he is able to engineer a turnaround at GMAC and repay the taxpayers, he will certainly justify his pay.  However, at this point, he must understand that he is under the microscope and to take such a high salary so early in his tenure is not a savvy public relations move.

“The conference call is still going on but earlier CEO Vikram Pandit said Citi enters 2010 with a strong foundation. Consumer credit remains an issue…”– CNBC’s The Call 1/19/2010

Citigroup (C) lost $7.6 billion in their fiscal fourth quarter which was in-line with estimates of a loss of $.33 per share.  Excluding one-time charges, particularly those related to paying back the TARP loans, Citi would have only lost $1.4 billion or just 6 cents per share.  The quarter ended a three quarter long streak of profitability, and shares opened slightly lower because they missed on top-line estimates with revenue of only $17.9 billion versus projections of $18.43 billion.  As of midmorning shares had turned positive along with the broader market because there are some encouraging signs of improvement from a bank that has earned the dubious title of “Zombie Bank”.

One thing Citi has going for it is the fact that the fourth quarter a year ago was just so awful.  A year ago, Citi reported a record loss of $17.3 billion or $3.40 a share as the company was mired in credit losses and write-downs.  In the past year, it was necessary for Citi to raise capital and streamline operations in a difficult period that Citi’s CEO Pandit described as “enormous progress.”  The tier 1 common ratio rose to 9.6% from just 7.3% a year ago, and tier 1 capital improved to 11.7%.  In regards to consumer credit, the credit card division costs dropped 10% from Q3, the lowest level since second quarter of 2008. Credit losses were down sequentially to $7.13 billion from $7.97 billion a quarter ago.  The slowing rate of credit losses is likely a product of improved economic conditions and the worst quality loans losses already having been realized in the last eighteen months.

Interestingly, with improving condition is its overall credit portfolio Citi only bolstered its loan-loss reserves by $706 million, and it can now cover just 6.1% of total loans.  The total loan loss provision stands at $8.2 billion, down 36% from Q4 last year and 10% lower sequentially.  This seems to fly in the face of the banks stated goals over the last year of trying to nurse the struggling bank back to health rather than aggressively grow earnings.  The lack of replenishment to their reverses for losses is clearly a bet that the economy is on the mend, and Citi may be underestimating the risk of a double dip recession.

We are maintaining our Fairly Valued stance on Citigroup even at this very low price level.  Will the bank be trading higher in three years?  We think there is a pretty good chance that it will, but there is still plenty of risk in these shares.  The first huge risk is the uncertainty of Citi’s earnings power going forward as a restructured company, and Vikram Pandit has been very clear that he would like to dispose of Citi Holdings which dragged down this quarter’s results losing $2.44 billion in the fourth quarter.  However, in the boom times these businesses were the high flyers for Citi, rather than the more stable Citicorp part of the business.  Wall Street is calling for the company to earn only eight cents in profit over the next year, which is pretty uninspiring.  Secondly, and perhaps more immanently, Citi is in the process of paying back TARP and believes they are adequately capitalized heading into 2010, and some of the important capital ratios seem to support that.  However, at the same time its loan loss provision is falling.  If you are among the set of investors that believes a double-dip is coming, than Citi is quite exposed to further balance sheet damaging losses.  In our view, Citigroup remains a risky investment and seems better fit for speculating on continued and robust improvement to the economy.

"But now there are only two banks left that need to issue stock to get out from under TARP, Citigroup and Wells Fargo, which denies it has to. But give me a break…With this stock offering, you’re getting Citigroup in a price that is far more beaten down than it deserves to be. And you have to take advantage of the discount…I want you to buy, buy, buy Citigroup." — CNBC’s Mad Money 12/14/2009

Recently, the largest banks in the country are following Bank of America’s (BAC) lead and exiting the TARP program through massive secondary offerings.  The latest to announce their intentions to repay the government loans are Wells Fargo (WFC) and Citigroup (C) and both will require billions of dollars of capital in order to accomplish this feat.  On Monday night’s Mad Money, Jim Cramer discussed why he thinks investors should buy into Citi on the secondary offering rather than Wells Fargo.  The Citi offering will be a gigantic $20.5 billion which dwarfs even Wells Fargo’s need for $10.4 and both of these will further dilute existing shareholders.  With the banks eager to lift the yoke of the increased government oversight that comes with TARP, it is a signal to the market that these formerly hobbled banks are returning to health.

Among Cramer’s reasons for buying into Citi over Wells is the banks strong presence overseas where the bank is respected far more than its tarnished reputation at home in the USA.  Furthermore, Wells has too much exposure to mortgage loans in California and other troubled mortgage loans through its acquisition of an east coast mortgage giant, Wachovia.  Cramer believes that the price, currently well below $4, is attractive and still far less than the company’s book value.  Cramer believes that this stock will triple by 2012 as the book value continues to improve along with its debt portfolio, and called the bank the "ideal speculation play".  He continues, "It’s like a lottery ticket with better odds of winning."

Despite Cramer’s enthusiasm for Citi, there are plenty of analysts who are not so bullish on this move.  Repaying TARP could in fact hurt the bank and their shareholders, as an article from Time Magazine suggests.

"But analysts say Citi’s rush to repay the assistance it got through the government’s Troubled Asset Relief Program (TARP) will make the bank weaker, not stronger. The move will reduce Citi’s capital ratios and hurt earnings; it may also accelerate a retreat of foreign investors from the company’s shares. Worse, the government is demanding stricter terms from Citi than it did from Bank of America on the repayment deal it struck just a week ago. The different treatment shows that the government remains more concerned about Citi’s finances than those of its rivals.

Veteran analyst Richard Bove of Rochdale Securities, who had been recommending Citi’s shares since the summer, downgraded the stock on news that it was going to repay TARP from a "buy" to a "sell" rating. "What does it do for the company? Management can increase [executive] salaries," says Bove, referring to the fact that Citi will now be free of the government’s compensation rules. "What else? Nothing." – Citi’s TARP Repayment: The Downside for a Troubled Bank, Time Magazine

Citi’s balance sheet will actually suffer as a result of the repayment instead of improving.  Recently recovered capital ratios will drop back to risky levels and no longer having government guarantees on some of the riskiest loans make the bank far more vulnerable to losses.  From a shareholder’s perspective, the massive dilution of this secondary offering is likely to reduce earnings per share by about 20% going forward.

At Ockham, we have had an Overvalued stance on Citi for the last few months.  This is not because the price is expensive because it clearly is not, but rather the fundamentals have been so hampered that the stock was at risk of a pull back.  Not to mention there has been massive dilution through all of the capital raising efforts that losses have necessitated.  Analysts anticipate earnings per share in fiscal 2010 of 7 cents, which makes the forward looking P/E multiple hardly cheap at more than 50x.  Any worsening in the condition of their debt (no longer guaranteed by the government) would put those slim profits in jeopardy, so even though Citi will now lose the stigma of substantial government assistance there is more risk to shareholders than before.  As Cramer suggests, this stock will almost undoubtedly be higher in 2012 and could very feasibly triple, but in the meantime it may be a bumpy ride.

The price to peak earnings multiple rose to 12.4x on Friday, which is the highest level this valuation metric has touched since September of 2008.  Positive macroeconomic data such as an unexpected, modest decline in the unemployment rate and increased productivity boosted the S&P 500 for the week .  In addition, pending homes sales were better than expected, providing another sign of stabilization in the housing market.  However, market gains were modest as November retail sales were slightly weaker than expected, which made some analysts less optimistic about prospects for the holiday shopping season.

Perhaps the most important development of the week was Bank of America’s (BAC) announced plan to repay TARP funding.  The bank currently owes the Treasury nearly $45 billion and will use a substantial portion of its recently-rebuilt capital reserves, as well as money raised through a planned secondary offering to repay that debt.  This is great news for taxpayers as BAC becomes the first of the “zombie banks” to lay out specific plans for repaying the government’s loans.  Bank of America’s decision to pay off TARP was received as bullish news as such a move would be inappropriate if the bank foresaw large future losses, but we think there could be an ulterior motive.  It is well known that Bank of America is currently in search of a new CEO, and government-imposed limits to executive pay appears to be complicating the bank’s search for a new Chief Executive.

The percentage of NYSE stocks selling above their 30-week moving average increased to 83% over the last week.  Our investor sentiment metric remains extremely bullish and we continue to believe that, over the coming weeks, it will revert to more normal levels.  This does not necessarily mean that that stock prices must fall in the coming weeks, but the pace of gains cannot continue unabated indefinitely.

Corporate insiders are clearly not bullish at the present time.  Based on the most recent data from finviz, insiders are selling far more than they are buying.  According to the last week’s data, insiders bought less than $12 million in stock while selling approximately $957 million, giving bears a whopping 82x edge in terms of dollar volume.  Since corporate insiders are generally considered “smart money”, it is instructive when they become

either overly bearish or bullish.  The overwhelming bearishness of last week’s insider trades suggests to us that they view the market as over-valued and view this as a good time to take some profits.

Our outlook on the market has been little changed for the last few weeks; we continue to believe that the current risk/return profile is unfavorable for committing additional resources to equities.  At this point, we see valuation as unattractive at current price levels, as the market has already priced-in a fairly robust economic recovery.  Furthermore, the recent bull market has shown remarkable resilience and sentiment has remained fairly elevated for a number of months.  We continue to believe that stocks are vulnerable to a pull-back and any unexpected piece of news could trigger an exaggerated response.  Insiders are selling, the dollar is weak and, despite a slight drop in the headline unemployment rate, the moribund labor market remains a real problem.  So far, the market has been pretty sanguine regarding the problems which plague this economy.  However,  if solid evidence of sustainable economic growth does not materialize soon, the stock market is vulnerable.  As such, at the present time we recommend that equity investors have a bias toward dividend paying, reasonably valued, defensive stocks.

Bloomberg opinion columnist Jonathan Weil has a talent for navigating balance sheets of often complex financial firms.  In his latest piece, he writes about Wells Fargo (WFC), the bank who rejected the idea that it needed TARP funds in the first place, yet has to date neglected to repay the government for the loan.  It is an interesting point as many investors, including a big one out of Omaha, have bought the stock of Wells Fargo because it held the mantle of conservative management among the too big to fail set.  Whether it is because of worse than expected loans made by Wachovia or their exposure to the real estate market particularly in California, the bank has not been among the first group to repay the TARP.  The Wachovia acquisition came with a large amount of loan guarantees from the government, so WFC lessened their risk where possible.

As Weil explains, the reason for the delay in repayment of government funding is plainly obvious when you start digging just a bit in the balance sheet.  Quite simply they haven’t got a significant capital cushion to pay back the TARP in a way that leaves them adequately capitalized for any future weakness.

Taking Account

Wells had about $37.4 billion of tangible common equity as of Sept. 30, by my math. Yet even that number is frothy, because it doesn’t take into account the fair-market values for most of the bank’s financial assets and liabilities, which the company discloses in the footnotes to its quarterly reports.

Factor in those adjustments, and Wells’s tangible common equity falls to $14.3 billion, or just 1.2 percent of the bank’s tangible assets. The main reason for the difference is that Wells said its loans as of Sept. 30 were worth $22.1 billion less than the carrying amount it showed on its balance sheet.

How can Wells repay its TARP money, when its capital cushion on a fair-value basis remains so thin? A Wells spokeswoman, Mary Eshet, responded to that question by saying: “We will work closely with our regulators to determine the appropriate time to repay TARP while maintaining strong capital levels.”

She added that “our capital position is improving,” which is true, even using the bank’s fair-value numbers. So far this year, Wells has raised $8.6 billion in a common-stock offering, reported a $4.9 billion increase in retained earnings, and slashed its common dividend.  — Bloomberg.com 11/18/2009

This is probably not news to anyone who follows Wells Fargo closely, but it does demonstrate that there is still quite a bit of risk in many financial stocks.  The last few years have left many of them much worse for wear and still vulnerable to any downturn in the market.  Not to mention that the relaxing of mark to market accounting rules has made their financial statements that much more difficult to decode.

Famed banking analyst Meredith Whitney has turned bearish and recently said that most banks are “grossly overvalued.”  She has become more bearish of late because she believes that the markets are pricing in a stronger 2010 than will actually happen.  In general, we tend to agree with her that the market has viewed the next few quarters with probably too much optimism for what we are seeing in the so-called real economy.  However, when it comes to Wells Fargo, we have a Fairly Valued rating on the stock for a long term investor.  Although, as Weil points out, the company may need to raise capital in order to be able to comfortably repay the TARP loans which would clearly be considered unfriendly to current shareholders.