Citi-Morgan: A Complete Merger Makes More Sense Than a Partial One

This is like digging a not so old event when Morgan Stanley (MS) wanted to get absorbed within Citigroup (C) during Sept. 2008 due to lack of liquidity and mounting losses. A much needed capital infusion from Mitsubishi, Japan and the US Treasury gave MS the ability to sustain the crucial period of last quarter.

In five months, things have reversed course. And now we are at a stage when there are talks of Citigroup aiming for a joint venture between its brokerage house Smith Barney and Morgan Stanley. The root causes of the reverse course are essentially the same: much needed capital/liquidity, loan losses, lower loan to equity ratio.

I personally think that a complete merger of both the firms would make more long as well as short term sense rather than just their brokerage business. Some of the reasons are:

1) Citigroup needs more capital on its balance sheet in the short term. Morgan Stanley on the other hand has the highest Tier-1 capital ratio among all the financial firms at around 18% (much higher compared to the likes of JP Morgan). MS shrinked its assets to around $680 Bn from around $980 Bn in the last quater and has liquidity at around $170 Bn.

2) Morgan Stanley has a business model problem unlike Citigroup. MS never imagined a revenue of just $4.6 Bn in the last quater for MS compared to around $16 Bn in previous quarters. The two together may create a better retail and investment banking model.

3) The current deal of Smith Barney is in a way a losing game for Citi (other than providing short term capital) and isn't such a winning game for Morgan Stanley (remember we are in recession).

4) Last quarter was a period of consolidation on Wall Street with Bank of America (BAC) acquiring Merill Lynch and Countrywide, JP Morgan (JPM) acquiring Bear Sterms and Washington Mutual and Wells Fargo (WFC) acquiring Wachovia. It's not hard to imagine that Citigroup and Morgan Stanley separately would face significant growth challenges and competition in the long run even if they can survive in the near term (which they will).

5) The argument that Citi is too big to manage is totally moot. Citi's balance sheet is much lower compared to the consolidated Merrill and BAC. Citi and Morgan Stanley together would represent a balance sheet with assets of around $2.5 trillion which is comparable to consolidated Merrill and BAC.

6) Finally, the most important aspect is that both Citi and Morgan have a uniformity of goals and objectives which is to grow in retail banking.

Disclosure: Long JPM