5 big losers in the banking crisis

By Jim Jubak

Right now every time a bank announces earnings that aren't quite as bad as Wall Street expected, its stock rallies.

Citigroup (C, news, msgs) reported a loss of $2.5 billion and write-downs from credit losses of $7.2 billion on July 18. The stock, which had rallied ahead of the earnings report, kept on climbing. The two-day gain for July 17 and July 18? 10%.

On July 21, Bank of America (BAC, news, msgs) reported write-downs of $1.22 billion and said it had added $5.83 billion to its reserves for bad loans. The stock climbed by as much as 12% intraday.

That market action actually makes a kind of perverse sense. These stocks have been beaten up so badly that any news that signals something less than the end of the world is good news. Citigroup shares were down 49% from the start of 2008 to the beginning of the July rally in financials. Bank of America shares were down 53%.

Some of these stocks were down so far that even worse-than-expected news produced a rally. On July 22, Wachovia (WB, news, msgs) reported an $8.9 billion loss and cut its dividend for the second time this year. But with the stock down 71% for 2008, Wachovia's shares rallied on the news, climbing 7% that day.

Obliterated business models

These train wrecks make a great short-term trade -- if you can catch the bounce and avoid the next tumble.

But in the long term, I think it's a very different story. The stocks that have taken the biggest beatings from the financial crisis are exactly those you want to avoid -- for anything other than a short-term trade -- because these companies have suffered large and lasting damage to their businesses. They aren't going under in most cases, but they will lose markets and market share to other, less damaged competitors. Some will wind up being sold to their rivals.

What I'm going to call the losers of the financial sector have lost key people. They've had to sell off what once were key business units. They're undergoing reorganizations that will take years and will continue to distract management until they're completed. And, most important, because of their troubles, they're falling behind competitors that have been investing billions to seize new markets and lock up new customers instead of writing off billions in losses.

Buy these beaten-up stocks for the bounce, by all means -- if you can get the timing right. But remember that these financial companies have suffered lasting damage, making them long-term losers. Which financial companies would I put among the losers? Here are five, in alphabetical order. (In my next column, I'll give you five winners that are exploiting these the damage at these losers.)

American International Group

The company's AAA credit rating once gave American International Group (AIG, news, msgs) a huge edge over its competitors in selling insurance and other products. Before the financial crisis that began in 2007, only seven U.S. companies carried this highest of credit ratings.

American International was able to use the rating not only to raise money more cheaply than its rivals but also to convince customers that it was more certain to be around in the future to pay off insurance claims. That perceived extra margin of safety had helped American International sell to risk-averse consumers in the emerging economies of Asia.

But the financial crisis has cost the company some of its edge. Both Standard & Poor's and Moody's (MCO, news, msgs) have downgraded the company's credit rating. Instead of AAA, Standard & Poor's now rates it only AA, the fourth-highest category. That will cut into the company's growth rate in Asia, where competitors are sure to remind customers of the company's recent problems.

Exactly how much damage the company will suffer depends on how much bad news the company has left to announce. The company still has $18.3 billion in exposure to credit default swaps written on relatively risky BBB-rated collateral, for example. Further big write-downs and any further credit rating downgrades will cut the company's competitive advantage even further.

Citigroup

It isn't just that, so far, Citigroup has booked more losses than anybody else since January 2007. (Citigroup's total of $55 billion in the period, according to Bloomberg, is impressively ahead of No. 2 Merrill Lynch, at $46 billion.) It's that this crisis has reduced the company's vaunted financial supermarket strategy to a shambles. With the announcement July 21 that Michael Klein, the former head of Citigroup's investment bank, would leave the company, almost all the managers who had helped then-CEO Sandy Weill engineer the merger of Citigroup and insurance and brokerage giant Travelers are gone.

That's not surprising: Citigroup CEO Vikram Pandit has made it clear that he believes the merger was never fully executed, leaving the bank with a swollen cost structure and a mishmash of strategies. Pandit has said the solution is to finally execute that merger. When he took over from ousted CEO Charles Prince, Pandit announced he would shrink Citigroup's $2.2 trillion in assets by selling off $400 billion to $500 billion of noncore businesses and assets.

Continued: What is noncore?

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