Pop culture, at the moment, is awash with movies, cable-T.V. shows and novels about modern-day vampires—the undead—trying to control (or indulge) their thirst for human blood. If this analogy is taken to its extreme, it’s pretty much a reflection of the state of the financial services industry. Investors may not be dead, but they are worried—worried about getting bitten again. (Sorry, had to push the metaphor to its illogical conclusion).
Citigroup, in particular, seems to be the company that most are presently worried about, despite the companies protestations to the contrary (we’re liquid and adequately capitalized, management says). Today, Wall Street and the press were openly speculating about Citi’s ability to function as an independent entity; its shares were down another 22 percent today—a 15-year low.
Smith Barney financial advisors are freaking out, says a Citi employee, because their clients continue to bombard them with concerns about the safety of their assets. Naturally, clients need to be schooled on the separation of assets (theirs aren’t co-mingled with the firm’s)—and undoubtedly that’s what advisors spend some part of their day doing.
But the reality is that there could be trouble on the horizon. Vikram Pandit’s remarks on Monday at the Town Hall Meeting for Citi employers did note some very positive trends: $75 billion in new capital since Q32007, a 10.4 percent Tier 1 Capital Ratio, a doubling of reserves and the like. (For the entire slide presentation, click here.)
That’s great, but investors are apparently wondering in unison: How much more capital will you need next quarter, when you have to report more bad loans—from commercial loans to consumer loans to mortgages? What investors are focusing on is page 21 of CEO Vikram Pandit’s otherwise uplifting presentation. What’s driving the selling is the repatriation of off-balance sheet vehicles, QSPEs and VIEs. These are much like special investment vehicles (SIVs). The qualifying special purpose entity structures contain $122 billion in credit card securitizations and $131 billion in the VIEs, or variable interest entities. The slideshow could come back to haunt; these vehicles may be repatriated to the balance sheet, basically leaving Citi with a thirst for more capital. (Again, apologies for the return of the vampire analogy.)
According to a report issued today from Portales Partners, a research firm in Manhattan specializing in financial companies, “The timing of these two potential repatriations remains uncertain, in their entirety, the repatriation of these two vehicles would almost offset the progress that has been made year-to-date.”
The year-to-date progress—in case you forgot—has been this: The company reports high allowances for loan losses—$24 billion, or 3.35 percent losses as a percent of loans—which is higher than JPMorgan Chase, Bank of America and Wells Fargo. It now has just $218 billion exposure to U.S. residential real estate loans (or 11 percent of assets), “0 percent” are option ARMs, the company says. Citi has $51 billion in liquidity (deposits plus long-term debt plus equity), worth about 63 percent of total assets. That works out to 111 percent of risk-weighted assets.
What can Citi do? It can’t raise money by issuing equity at the current share price (it would be ugly in its dilutive effects); selling businesses would help. Portales bets that Citi’s board today would vote to sell its German retail bank, thereby removing nearly $18.6 billion of assets from its balance sheet, book a $4 billion after-tax gain and add some 60 basis points of Tier 1 Capital, as indicated in the report.
The conclusion? Portales Partners doesn’t think Citi’s days as an independent entity are over—in fact, it states quite the contrary. “The bottom line is that we continue to believe that Citigroup will remain independent and that, by 2010, the company can emerge with over $2 a share in earnings power.” At around $4 a share, you’re buying Citi stock for two times estimated future earnings. “Fundamental value exists,” the report says.