Bank Financials Strengthen

The surviving bank stocks in the USA are stillpretty depressed and the apparent reductions in earnings were not gladlyreceived recently.  The good newshowever, is that we are two years past the melt down and the succeedingreorganizations and uncommon impacts of the financial statements.  This item explains it all very well.

Thus we may expect generalconfidence to be restored to these stocks and that includes Morgan Stanley andCitibank.  They also are really goodbellweathers for the reviving general US economy.

The fact that they have a ways togo to achieve a comfortable price structure opens speculative possibilities foroption traders in particular.

Looking Pretty in the Citi

It's a tough crowd, Citigroup (NYSE: C).

Citi shares fell more than 6% yesterday after reporting quarterlyearnings. Investors weren't impressed.

It's easy to see why on the surface. Quarterly profits came in at $1.3billion, or $0.04 per share. That's trivial even for this $5 stock and notenough to reinstate a healthy dividend likeJPMorgan Chase (NYSE: JPM) istalking about.

But dig a little deeper, and things actually don't look half bad.

This quarter's earnings were hit by a $1.1 billion accounting chargetied to the tightening of Citi's own bond spreads. This is the flip side of anasinine accounting rule that banks usedto juice earnings during the credit meltdown two years ago. Back then,bankruptcy looked like a real possibility, and the value of banks' debtplunged. Assuming they could theoretically buy their own debt back on the cheapand book the difference as income, banks and their accountants went ahead anddid so. Now that bank debt is increasing in value as the economy recovers,those phony profits are being reversed.

Put simply, the same accounting rules that made bank profits lookartificially good two years ago are now making them look artificially bad.

Without the accounting charge, Citi would have earned around $2.1billion, or about $0.07 per share. That's $0.28 per share annualized, whichworks out to a roughly 6% earnings yield on its current share price. Assume a50% payout ratio, and Citi could probably afford to pay a 3% dividend if theseearnings keep up. Not bad. 

It gets better. Citi's credit quality is improving at the speed ofsound. Nonperforming loans fell 36% in the fourth quarter from the same perioda year ago. Allowance for loan losses as a percentage of nonperforming loans --the cushion for future losses -- stands at 209%, up from 114% a year ago. JPMorgan'scomparable ratio is 190%. When Bank of America(NYSE: BAC) reportedresults last quarter, its same ratio stood at 135%. When preparing for badweather, Citi is in a league of its own among big banks.

And keep in mind how far these guys have come. It wasn't but two yearsago that many, including myself, were sure Citigroup was toast. Now here it isearning more than $10 billion for 2010, making it one of the most profitablecompanies on the planet. Granted, this has been on the back of unprecedentedbailouts and fiscal stimulus. But as CEO Vikram Pandit told employeesyesterday, "A year ago, no one would have believed we would have been ableto accomplish what we have." And he's absolutely right.

What to do if you missed the rally – "Investors are mostbullish in two years," reports Reuters – yet they've yanked $100 billionout of stocks funds since 2009. If you missed the rally too, you must get backin – safely. Follow along as a professional invests $250k in a long/shortportfolio of stocks, options, and ETFs. This is the first opportunity sinceJune 2010, by invitation only. Enter email below.

Fool contributor Morgan Housel ownsBank of Americapreferred. The Fool owns shares of Bank of America and JPMorgan Chase. Try anyof our Foolish newsletter services freefor 30 days. We Fools may not all hold the same opinions, but we allbelieve that considering a diverserange of insights makes us better investors. The Motley Fool hasa disclosurepolicy.

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