Citigroup Is Heading into the Single Digits 16 comments
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The strike price for the warrants Citigroup (C) issued to the Treasury is $17.85. Fortunately for the tax-payer, however, the warrants are exercisable at any time over a period of ten years. If Citigroup's third quarter financial report is any guide, the medium term outlook for its 5,342 million outstanding shares is rather bleak. Dilution above $18 is a non-issue.
The $25 billion perpetual preferred stock issuance to the Treasury has certainly improved Citigroup's Tier 1 capital adequacy ratio (8.2% prior to the bailout money). But what is at stake today is not Citigroup's solvency but the medium-term viability (and sustainable profitability) of its business model.
The fundamental inconsistencies of that business model were comfortably hidden as Citigroup recorded impressive profits in an extended era of growth in its key business segments. Each component of that model is currently under threat; but it is also perhaps the appropriate time to question the logic behind the integration of such diversified components in the first place. By their very nature, investment banking, derivatives trading, consumer banking, housing loans and wealth management are each qualitatively distinct activities, bearing highly specific risk-reward profiles, requiring the preparation of activity-specific financial statements. Today, as the amalgamated business model has started to contract and, in some respects, disintegrate, questions surrounding Citibank's profitability suggests that its shares should be headed towards $8 (and lower) within the first half of next year.
The accumulation of aggressive short positions at or above Wednesday's closing level ($12.63) will be more than justified by the flow of hard facts governing the true nature of the global recession in forthcoming weeks and months. What we already know is that Citigroup's credit costs in North America have risen sharply on the back of adverse unemployment, bankruptcy and housing statistics. This negative trend in domestic credit costs, which includes loan-loss provision, is expected to gather momentum shortly.
But Citigroup's worst nightmare today is grounded in certain core developments in the emerging markets where it is safe to assume higher delinquency allowances in consumer credit and housing finance in the fourth quarter. Of particular concern is the turmoil in currency rates, interest rates and counterparty risk which will cast a darker shadow over Citigroup's diversified banking model. It is common knowledge that Citigroup's units in the emerging markets have been heavily involved in derivatives transactions and structured products in local currencies for nearly two decades.
An implicit acknowledgement of the need to rationalize traditional banking methodologies was evident by the recent linking of a Nestle (NSRGY.PK) standby facility to credit default swap rates. The incorporation of default risk into loan yields by Citigroup is certainly logical, even overdue; and that logic is supported by the extensive loan-loss provisions Citigroup made in its latest financial disclosure. But if that logic is swept right across the bank's portfolio, a significant proportion of its corporate lending stands under-priced. If that is so, the capital adequacy ratio number is misleading.
Citigroup, in sync with the party-line on Wall Street, has not explained its exposure to the credit risk insurance marketplace, in North America and abroad. Nor has it fully disclosed how the risk on insurance-type contracts (credit default swaps, collateralized debt obligations or structured products) is calculated on its books. The better part of valour, therefore, is to read a healthy degree of bearishness into this uncertainty.
Finally, the $25 bailout money may prove to be more toxic than the doubtful assets within Citigroup's balance sheet. How the Treasury expects Citigroup to service the 5% per annum (first five years) dividend payment is anybody's guess, in view of the huge pressure on the real cost of credit (and under-priced loans) in the foreseeable future.
Stock position: Short C.
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This article has 16 comments:
Goldman and Citi are failed banks without taxpayer support. While you willsee some rise in stock price in coming months it will be short lived. They have announced the termination of 12,000 employees together and in the same breath they talk of their bonuses being reduced to a mere $20 million.
Why am I the only one that is outraged at any bonuses being taken by anyone on the Street as long as they are still owing the FED.
I don't think we can talk about individual capacity being the force behind the bonuses because anyone from Manpower could have achieved their results.
Why is this subject taboo? If anyone is to believe that governmental oversight has any teeth the bunuses have to be zero until the FED money is restored.
On Nov 06 08:14 AM mik123 wrote:
> Dead wrong. Citigroup was $23 on Oct. 1. There are only 2 analysts
> that don't like the stock. The press gives to much time to Meredith
> Whitney. Any analyst that preaches sell would have been right over
> the past 2 months. Look at companies hitting the mid teens like General
> Electric,Pfizer, Nokia,etc. Go to Yahoo Finance and look at Citigroups
> Analysts estimates and you will find 4 buys,9 holds,1 underperform
> and 1 sell. The lowest price estimate is is $14 and the high of $26.
> Your listening to the only sell analyst Meredith Whitney. She didn't
> give us any of the failed institutions ahead of time so why listen
> to her now.
And it may need some additional bailout money when it becomes clear that housing defaults are just the start of our troubles. Remember all those vacations and flat-screens consumers put on their credit cards? Well, it's time for them to pay up...with money they don't have. C's business model was to offer plastic to every guy living under a bridge...well, it's time for C to pay up for its folly.
Where are they going to make it?
The housing resets do not stop until 2012, the consumer is dying so there goes commercial real estate, and the credit card fiasco is just starting.
Now you tell me where they will make money above all of this coming decline.
headed towards $8??? how irresponsible of the statement without any financial support. If the actual value of the company is to be $8 in Q4, you are saying they need to lose $54B ($18 book value - $8 writer's estimated value X 5.4B shares) in this Q4 08 oct, nov, dec. come on, they just lost $2.8B this quarter and they were still kicking even losing $9.8B in Q4 07. How much are they gonig to lose in order for them to realize your estimated value of $8.
please quit your job or write something with edvience.
Why dont you be a little more creative than copy/pasting the same response at the bottom of every article on the website. You clearly have no idea what you are talking about when it comes to Wall Street and you clearly voted for Obama. You are most likely unemployed and are waiting for all of the government handouts.
You rely on the analist targets to invest? Just an FYI before AIG failed they had no sell ratings on them.......
TimothyC.
While I would normally agree with you on this the one clear thing is no stocks are trading on fundemintals right now. There is a perception the C has no idea what is on the balance sheet and right now perception is reality.
I enjoy reading some older articles to see if the author has made good calls or bad calls. I must say Mr. Saxena that you have done very well these past 4 months. On the Citi call you were right on the money. Single digits? It broke the buck!