1 Reason JPMorgan Chase and Citigroup Aren’t Soaring Yet

Flickr / AlaskanDude.

Many of the big U.S. banks are much better capitalized than they were in the years just after the crisis, and they are also doing a good job of increasing their customer bases, credit card business, and other banking products. So, why are their stocks still trading at extremely low valuations?

In Citigroup's (NYSE: C  ) case, shares trade at just 88% of their tangible book value, compared with more than 110% of tangible book as recently as 2011 when the crisis was still fresh in our minds. The same can be said for JPMorgan Chase (NYSE: JPM  ) , with shares valued significantly lower than they were a few years ago.

C Price to Tangible Book Value Chart

What's the reason for this?
There is no single reason for the low valuations in the banks.

For starters, the recovery in the banks' fundamentals is still very much alive. Citigroup, for instance, has done an excellent job of winding down its Citi Holdings legacy assets so far, but there is still well over $100 billion in old assets on the balance sheet. Another possible explanation is the uncertainty and government influence lingering as a result of the crisis.

However, one of the big reasons the banks are not pulling in tons of profits is the poor performance of their fixed-income trading divisions, and revenue from bond trading in particular.

For the past several years, the banks with the largest exposure to bond trading have been on the losing side of the price action in bonds. Typically, banks with large fixed-income trading operations hold tens of billions of dollars worth of Treasury bonds.

But, according to recent data from the Federal Reserve Bank of New York, the banks actually had a negative position in Treasuries in March.

Why short Treasuries?
The price of bonds is correlated with the interest it pays out. When market interest rates go down, prices of existing bonds increase so their interest rates increase along with the market. Conversely, when rates rise, bond prices fall, so the interest they pay rises on a percentage basis.

By the banks not holding Treasuries, they were essentially positioning themselves for rising interest rates. It makes sense, since virtually every piece of news related to the Federal Reserve's taper or the rising market has been prediciting rates to climb steadily higher for the foreseeable future.

Unfortunately for the banks, the exact opposite has happened. Rates have fallen across the economy and bond prices have rallied. In fact, the average 30-year mortgage rate (a good indicator of the overall direction of interest rates in the U.S.) has fallen from 4.53% to 4.14% so far in 2014, according to Freddie Mac.

The effect on Citigroup, JPMorgan Chase, and the other banks
How badly the rising bond prices will hurt remains to be seen, but banks are already trying to prepare their shareholders for a big hit.

JPMorgan Chase has already warned it's second-quarter trading revenue is going to about 20% less than it was a year ago. Citigroup has said the decline could end up being even worse, projecting up to a 25% drop in trading revenue.

In addition to the falling bond prices, fee income from bond trading has been much lower. Simply put, less bonds are being traded. Some investors are undoubtedly reluctant to trade with the uncertain direction and volatility of interest rates, and some are just put off by the relatively low interest rates offered.

JPMorgan's fixed income trading revenue for the second quarter last year was $5.37 billion, so a 20% decline would mean more than $1 billion less in trading revenue.

Combined with the $5.06 billion in trading revenues for the first quarter, that would make this the worst half for trading revenues for the bank since the crisis ended and would represent about a 5% drop in total revenue for the company.

In a nutshell, the banks are still doing fine, but no thanks to their trading revenue. In fact, all of the growth in commercial banking, wealth management, and mergers and acquisitions we've seen over the past few years is merely serving to offset the declines in bond revenue.

These stocks beat the big banks...
Here's your chance to pocket big dividends. Over time, dividends can make you significantly richer. And guess what? The big banks are laggards when it comes to paying dividends. So instead of waiting for a cash windfall that may never come, check out these stocks that are paying big dividends to their investors RIGHT NOW. Click here for the exclusive free report.

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2985851, ~/Articles/ArticleHandler.aspx, 8/31/2015 11:55:59 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

Today's Market

updated 2 hours ago Sponsored by:
DOW 16,528.03 -114.98 -0.69%
S&P 500 1,972.18 -16.69 -0.84%
NASD 4,776.51 -51.82 -1.07%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/31/2015 4:00 PM
C $53.48 Up +0.20 +0.38%
Citigroup Inc CAPS Rating: ***
JPM $64.10 Down -0.03 -0.05%
JPMorgan Chase & C… CAPS Rating: ****