Drastic restructuring on the cards; next test in April, when it reports Q4 earnings
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(NEW YORK) Don't think of the US government's new investment in Citigroup as cash; think of it as time.
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Citigroup will save US$2 billion a year now that it doesn't have to pay the government dividends. But what the move really does is give the bank a bit longer to prove itself viable - and do some ruthless restructuring, analysts say.
As the recession deepens, the big problem facing Citigroup - souring loans - is only getting worse. Citigroup, which hasn't turned a profit since the fall of 2007, will face its next test in April when it reports first-quarter earnings. CFO Gary Crittenden told investors last Friday that overall January results were 'strong', but would not rule out that Citigroup might need to raise more capital.
Citi is likely to get much of that capital by selling businesses around the world - and, analysts say, become a fragment of its former self.
'We can call it an orderly liquidation,' said Dennis Logue, a finance professor at the Tuck School of Business at Dartmouth and the chairman of a New Hampshire community bank. 'Citi is very, very complex. The whole might be worth less than the sum of the parts.'
'They've got to downsize the company,' said banking industry consultant Bert Ely.
Citigroup and the Treasury Department reached a deal last Friday that will give the government up to a 36 per cent stake in the struggling bank. The government, along with other private investors, will convert some of their US$45 billion in preferred stock into common shares. If the maximum amount of preferred stock is converted, current common stockholders will see their ownership stake fall to about 26 per cent.
Citigroup's executives acknowledged the hit to shareholders, but said the point of the deal was to restore the market's confidence in the bank.
'In the end, our business is about confidence,' CEO Vikram Pandit said in a conference call with investors. 'As a matter of fact, the entire financial system depends on confidence, and we wanted to take definitive steps to put all capital issues aside.'
The problem is, the market knows Citigroup received no new capital on Friday. The conversion to common stock will create a wider equity base aimed at keeping investors calm as the economy deteriorates - but Citigroup still has US$45 billion in Troubled Assets Relief Program (TARP) funding, the same amount as it did before. The switch to common stock will help boost Citigroup's 'tangible common equity' (TCE), Wall Street's and Washington's new favoured gauge of banks' health.
But analysts say solid TCE alone won't lure investors.
Rochdale Securities analyst Richard Bove pointed out that two hypothetical banks could have the same TCE even if one has all its assets in Treasuries and the other has all its assets in sub-prime mortgages. Clearly, the first bank is more stable than the second - but TCE does not reveal that, he said.
And, according to Mr Ely, 'the mere conversion of preferred to common doesn't really change anything. It's just a paper transaction.'
The government earlier last week said it would conduct what it calls 'stress tests' to determine banks' solvency in extreme economic situations. Even if Citigroup passes the government's 'stress tests' by boosting its TCE, Wall Street is not confident yet that it will pass the economy's tests. Investors' scepticism was obvious last Friday as Citigroup shares plunged US$1.02, or 41 per cent, to US$1.45.
Some analysts, including Rochdale's Mr Bove, argue that Citigroup is solvent, and a victim of accounting rules that place too much emphasis on the current market value of assets. Because no one wants to buy soured mortgage-related assets that banks including Citi hold, their values have plunged - although the loans underlying many of them are being paid.
But Porter Stansberry, MD of Stansberry & Associates Investment Research, estimates that Citigroup faces hundreds of billions of dollars in losses. He says the government is heading down a path with Citi similar to the one taken with American International Group Inc.
AIG has received US$150 billion in loans from the government, which now has a 80 per cent stake in the insurer. AIG could end up being broken into multiple units as early as this week, according to reports. As part of the potential break-up, the government could end up controlling most of the separated units.
Treasury officials and Federal Reserve chairman Ben Bernanke have said there are no plans to nationalise banks, but Mr Stansberry said the government's conversion of Citi stock 'is a precursor to effectively nationalising the bank'. Eventually taking over the bank, the government would fund the bank's losses as they continue to mount, while selling pieces when they can to help offset the losses, he said.
Citigroup, criticised for years for being too multi- tentacled, has already sold off several businesses over the past several months, including a controlling interest in its Smith Barney brokerage, its German retail banks, and its Diners Club credit card franchise.
It has also split into two parts, Citicorp and Citi Holdings - effectively undoing the merger that created the company in 1998.
Citicorp holds the company's 'core' businesses like retail banking, investment banking, credit cards and transaction services, while Citi Holdings runs the company's riskier assets, the consumer finance franchises and asset management.
What complicates a major break-up is that what Citigroup is best at is being global.
Citigroup's uniqueness, CFO Crittenden said in his call with investors last Friday, is in its cash management network around the world that allows multinational companies to get paid by their customers and pay their suppliers. There are many Citigroup services resulting from that: investment banking services, trade financing, and corporate loans. And those businesses must be supported by deposits.
The Citicorp portion of the bank encompasses that 'end-to-end business model', Mr Crittenden said. 'All of that fits together. It doesn't make any sense to break any piece of it off.'
Tuck's Mr Logue said, though, Citigroup could easily sell off more assets than it currently plans to and still be a worldwide institution. 'You can be a global bank without having all the moving parts that Citi has,' he said. -- AP
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