The Housing Chronicles Blog: Citigroup: a giant shakes

Wednesday, January 16, 2008

Citigroup: a giant shakes

When the Citigroup tower was built in the 1970s, it had a terrible flaw: it could topple over in hurricanes because some decisions in construction in design meant it might not withstand even 70 mile-per hour winds. Thus, a secret plan exposed in The New Yorker in 1995 (and the subject of a documentary) was initiated to replace bolts with welds throughout the 915-foot building at night during a 3-month period, eventually making it one of the safest buildings in the world.

Now that the structural shaking at Citi has more to do with finance than engineering, The Economist ponders if this is a 'kitchen sink moment' or if more bad news lies ahead:

VIKRAM PANDIT has just celebrated his 51st birthday, but this will not be the best week of his year. His first set of quarterly results as boss of Citigroup was one for the history books, for all the wrong reasons: a record net loss of $9.8 billion, driven by a whopping $18.1 billion in pre-tax write-downs and credit costs on exposure to subprime mortgages. This was more than even the most pessimistic analyst had forecast—although gossip had pointed to $20 billion or more. “Clearly unacceptable,” admitted Mr Pandit.

Worse, it is no longer just collateralised-debt obligations and other complex securitised products that are hurting the world’s largest bank (by assets if no longer by market value). Credit cards and other consumer-finance businesses are deteriorating fast as America’s economy flirts with recession. Citi reported a $4.1 billion rise in credit costs in its American retail operations for the quarter and indicated that losses will grow. It does not help that a hefty 13% of its loans are to subprime borrowers. Corporate lending also looks wobbly. And Citi is on the hook for billions-worth of loans for leveraged buyouts. Since the markets turned, these have proved hard to shift on to other investors...

Mr Pandit is also offloading “non-core” assets—and people. Some investors want Citi to abandon its financial-supermarket model and break itself up. That is unlikely, for now. But a deep review of its businesses is under way, and several are likely to go. In investment banking it is moving to safer, lower-margin, businesses in both debt and equities. Mr Pandit recently appointed an “expenses tsar” (the second in a year). Tens of thousands of jobs will go. There is a long road ahead: with costs already bloated, expenses grew by 9% in the quarter, stripping out acquisitions.

There is the odd silver lining. Citi still does well in emerging markets, wealth management and its advisory business. As only a mid-ranking player in commercial property, it can expect to do less badly there than some. But it will be galling to see rivals such as Bank of America—which last week bought Countrywide, a big and troubled mortgage lender—snap up potential bargains while Citi puts its own house in order.

So what's next?

Is this really Citi’s kitchen-sink quarter, or might it get even worse? As a new boss, it is in Mr Pandit’s interest to shove as much bad news as possible into his first set of results, knowing that the blame will go to Chuck Prince, his predecessor. He can then take credit if the write-downs prove too pessimistic, and if the assets are in fact worth more than they seem.

That remains a possibility. Lacking a better benchmark, banks have resorted to using the ABX index of mortgage-related derivatives when working out how much to mark down their investments. But hedge-fund managers think that the ABX may have been driven down further than warranted by fundamentals because so many financial firms have used it as a hedging tool. If so, banks could be over-estimating their losses.

It is, though, a huge if. Other banks face similar difficulties. Merrill Lynch’s results, also to be announced this week, are likely to be grim. That bank is to get another $6.6 billion capital injection. And with America’s economy softening (retail sales were unexpectedly weak in December, falling by 0.4% from the previous month) it looks as if new, possibly bigger, problems are on the way. For now there is no shortage of opportunistic investors willing to help lame lenders. But it is impossible to tell whether they are making shrewd investments or throwing good money after bad.

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