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Citi, Morgan Stanley Downgraded on Fed Taper Fear

In addition to downgrading Citigroup to a "hold" from a "buy" rating, O'Connor lowered his price target for the shares to $56 from $61, "to reflect the larger [price-to-forward-earnings] discount for the market sensitive banks (of 15-20% vs. our target group multiple of 11.5x) given lingering regulatory/legal risks, potentially more volatile capital markets revenues from a change in Fed monetary policy, and potentially lower long term growth prospects."

Many analysts are still quite positive on Citigroup because of the shares' discounted valuations to book value and forward earnings compared to most other large-cap banks, and also because of the potential for significant reserve releases and deployment of excess capital as the firm's runoff subsidiary Citi Holdings continues to wind down. 

Even O'Connor calls Citi "the most compelling long-term recovery play," however, he sees limited upside over the short term, not only because of changes in Federal Reserve policy, but because "regulatory and legal uncertainties remain headline risks."

A major headline risk for Citigroup and other bank holding companies with significant investment banking operations is next week's expected finalization of the Volcker Rule, which is meant to ban short-term "proprietary trading" by the largest deposit-taking U.S. banks.  Many of the largest banks have already shut down their proprietary trading operations, however, the final language of the Volcker-based regulations could sufficiently curtail the banks' hedging and market-making capabilities that they might consider spinning off their investment banking operations.  This would, no doubt, please many critics calling for a breaking up of the largest U.S. banks.

Morgan Stanley Downgrade

Morgan Stanley has been a runaway outperformer, with the shares rising 64% this year through Wednesday's close at $31.13.  The shares trade for 1.2 times their reported Sept. 30 tangible book value of $26.96, and for 12.3 times the consensus 2014 EPS estimate of $2.53.  The consensus 2015 EPS estimate is $2.97. 

Please see TheStreet's earnings coverage for details on the boost to the company's wealth management revenue following its assumption of 100% ownership of its former retail brokerage joint venture with Citigroup.

Stock quotes in this article: C, MS, I:BKX, ^GSPC 

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