If you've been following the news lately, you'll note that the bulge-bracket firms have all released big plans to cut bonuses for employees. Citigroup (C) will experience some of the most severe cost-cutting, stating that it intended to reduce bonuses by up to 30% for its investment banking unit. Bank of America (BAC) is doing the same, pledging to reduce investment bank bonuses by 25% and setting a $150,000 ceiling for certain employee cash benefits.
Goldman Sachs (GS) didn't limit its own cost-cutting measures to investment banking, citing a weak demand for financial services as reason to potentially cut pay for all employees by over 26%. This is, of course, an effect of a general deleveraging of the financial industry as a whole. On the flip side, it seems to be making investors happy since margins are expected to improve.
As the government gets more involved in maintaining its vision of Wall Street, firms like Citigroup have to simultaneously pay closer attention to capital reserves while appeasing shareholders in a weak financial service and loan market. Since revenue expansion is nearly impossible for the big banks in this environment, Citigroup (and others) chose the only logical solution - cut the fat out of the paychecks.
In wake of the European debt drama of the latter half of 2011, the Fed imposed stricter standards in November on the banks which dictated that they had to survive harsher conditions with high default rates, an 8% decline in GDP, and 13% unemployment for the next round of stress tests. This may make it difficult for banks trying to introduce an attractive dividend for investors given all the challenges which have arisen, namely for Citigroup and Bank of America, which have bigger obstacles than their peers.
All of the banks with substantial interests in the loan markets have continued to see weak conditions for market growth, which is likely to pose another major problem. Citigroup's Securities and Banking division has been suffering immensely in the last year from the weakness of both loan and financial service demand. Investment banking revenue took it in the chin, declining an incredible 45% in the last quarter relative to the year before. Fixed-income revenue for Citigroup in the Q4 report declined 25% against Q4 2010. Worst in the division was the Equity Markets unit, which suffered a 71% year-on-year drop in revenue due to incredibly low volume in equity transactions.
A Citigroup spokesperson, Jon Diat, stated in November that the bank has intentions to pay a ~$.76 annual dividend (which would make the stock yield about 2.5%). Despite the bank's consistently rising income, there is only so much blood one can squeeze from a (shrinking) rock. As high as Citigroup's margins can potentially get with all of these pay cuts and layoffs, are we going to see a stock worth investing in after they introduce a dividend? A 2.5% yield on a stagnant high-beta bank is generally not considered a good risk-to-reward ratio given alternatives.
So if all goes well, near-zero yielders like Bank of America and Citigroup might soon be able to offer yields to compete with the likes of JPMorgan (JPM) which yields 2.7% on a similar P/E multiple to Citigroup. We might also see an impressive amount of share repurchases, which should induce some share appreciation. Nonetheless, I'm a bit skeptical that this recent round of compensation cuts alone will be enough to bring the dividends back. In addition, the sustainability of the income growth remains in question.
The actual market demand for investment banking has been severely damaged in the last year, which offsets much of the benefits that these recent compensation cuts will bring. Then, more importantly, the flat or declining revenues don't seem to pave the way for income growth down the road. Either that trend has to change, or earnings will flatten at some point in the future.
We will hopefully see a trend more prominently display itself in subsequent earnings releases for Citigroup and other banks, but one might have to be quite patient before seeing the kind of yields on these stocks that existed before the financial crisis. It's still a very tough time for the financial industry, and the government isn't exactly helping.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
