Citigroup Is Too Important to Fail, Which Is Why It's a Great Long Term Investment

Richard Bove, a prominent banking analyst who obviously has a warm place in his heart for Citigroup (C), has initiated coverage on the company with a Buy recommendation and a price target of $4.00 per share. Never mind that C hit $4.50 just a few weeks ago; it is hovering around $3.00 now, so getting back to $4.00 in the next 12 months would be a substantial return on your investment if you buy the shares now.

While I always read analyst reports with a grain of salt (make that a bucket full of salt), in his latest research, there are some very important points that Mr. Bove makes which do a great job of explaining why the U.S. government has continued to prop up Citigroup, despite the public furor about mismanagement, irresponsible lending practices, and fat-cat executives that continued to draw huge paychecks even as the company’s performance and stock price floundered over the past several years.

Below are some highlights from Mr. Bove’s June 19th report (emphasis added by me):

• Some companies have developed such unique positions that their elimination would cause harm to their customers.

• I believe Citigroup is such an organization. Despite 10 years of almost continuous mismanagement, the company retains its position as the only truly international bank in the world. It does business in 140 countries and is on the ground in over 100. It offers a full array of banking services wherever it functions.

• Its payment services activities cannot be matched in this regard. The services it provides to the wealthy and powerful in all countries are also unique. Citigroup can move funds out of a failing country into dollars and the United States almost instantaneously.

• If Citigroup were not there, it would take decades to replace the company. Very few organizations ever reach a status whereby they simply cannot be replicated easily, or perhaps, ever. Citigroup is in that position.

What Mr. Bove is trying to point out here is that there is a lot more to Citigroup than what we typically hear about in the U.S. media. Citigroup is much broader than a mere U.S. lender that plunged too deep into the subprime mortgage market.

The company has numerous business lines that provide extremely valuable services to consumer, corporate and sovereign clients all over the world. To get a feel for Citigroup’s reach and connectivity with markets all over the world, spend a few minutes perusing their “business specific press releases” at www.citigroup.com. Every week, there are literally dozens of concrete examples of how Citigroup’s presence in local markets worldwide is vital to those geographies.

As an example, take Citigroup’s “Global Transaction Services” division. This business basically facilitates payment processing between governments, corporations and individuals globally. The unit has 65,000 clients, including the United States and other major governments worldwide. The division processes trillions of dollars in transactions every single day, earning incredible and sustainable fee income for the parent company on every transaction. With Citigroup’s physical presence in over 100 countries, Citigroup is the only provider that can meet the transaction processing needs of many governments, multinational companies, and other institutions (to understand Citigroup’s dominance in this field, you may be interested to know that the next most global bank is J.P. Morgan with a presence in only about 30 countries).

If Citigroup were allowed to fail, resulting in even minor disruptions in the transaction services operations, it could cause major problems for the clients it serves. Since those clients include governments and companies that many of us deal with every day, it would in fact hurt us as consumers if Citigroup could not deliver these services smoothly.

But herein lies the rub. Because Citigroup is so important to the smooth functioning of the global economy, if it were to fail, then the whole world’s financial system would be at risk.

The overly simplistic solution that has been proffered so many times it has become tiresome is that Citigroup should be “broken up”. And often they say “…broken up immediately”. Well guess what, that is what is actually already happening.

Of course, Citigroup has not come out and publicly announced it is breaking itself up. That would cause panic in the employee ranks and mass confusion in the investor community.

But in reality, what do you think the company has been doing now for the last three years? Just on the surface, it has shed Travelers Insurance, Smith Barney, Nikko Cordial Securities, Germany Retail Operations, data processing subsidiaries in multiple geographies and dozens of other businesses globally. Further, its “Citi Holdings” portfolio includes other significant businesses like CitiMortgage, Primerica and Citifinancial. These are apparently on the chopping block in the near future as well.

When all is said and done, Citi will be a leaner more focused company and the remaining businesses will be powerful generators of clean dependable revenue.

But it's important to recognize that the remaining company will also still be systemically important and thus too important to let fail. What will be needed then to keep a leash on this future Citigroup is a more well-educated regulator that truly understands the products and services Citigroup offers, and that employs real risk management professionals who can truly understand the risks associated with new initiatives. This regulator should not be charged with “breaking up” Citigroup if it gets "too big," but instead the regulator should ensure Citigroup stays focused on its core operations and that it does not start expanding again into non-core operations and complex financial products that have the potential of destroying the all-important core businesses when the fancy new products breach their risk profiles.

The future Citigroup, operating in the paradigm I have described above, will then provide tremendous value for shareholders. I currently only own a few thousand shares of C. But at $3.00 each, with a clear line-of-sight to the future business model and the explicit support of the U.S. government, I think the current share price is a bargain and I intend to load up before it's too late.

Disclosure: Long C, XLF.

Comments

[Warm_Paw:]

Bank earnings aren't being reported as they used to be.
Earnings are over positive to hype the economy.
Notice this crisis centers around toxic assets on bank balance sheets yet no one discusses the percentage of toxic assets unwound for each bank, or the amount of these assets left on bank balance sheets.
We have at least two more death spirals dealing with the unwinding of these assets. The public's obviously not to know that.
The public's to take the hit buying bank stocks so they can dump these mortgage backed securities.
The very idea Citi or Goldman want to give larger pay to bank execs has me wonder why the tax payer should be on the hook to bail them out.
Let them fail. Greedy pigs should get slaughtered. As for throwing the economy into a tail spin, it's inevitable.
These banks need to go the way of the car companies.
The real challenge is bringing manufacturing back to America.
Jobless people don't pay taxes.
The few working people won't be able to shoulder the burden.
Of course we could raise the tax rates on bankers and right the countries woes.
Cit group's going down. You better check earnings and compare them this qtr to earnings calculated before the FASB accounting rule changes.
In my opinion, Citi's a time bomb.
More pump and dump.
The DOW continues upward while the media continues to tell us things are tanking, but not as bad as they tanked last qtr.
The people are sheep to the slaughter.
You have yourselves to blame when you get wiped out.

Jun 24 10:01 AM

[Wreckdiver:]

I thought WaMu was too big to fail and it would certainly be bought by JPM. It was- but for pennies, not the $6 I paid for it. The same will likely happen to C. They are broke.

Jun 24 10:03 AM

[fed_alchemy:]

Chuck Prince and his board cronyism caused the mess..try a 90%clawback of earnings.I counter every point Dick made, UNWIND!!

On Jun 24 10:01 AM Warm_Paw
> You have yourselves to blame when you get wiped out.

Jun 24 10:20 AM

[Dr. Lamgol:]

Investors seem to ignore that Citi will be the third best capitalized bank in the world after the conversion. Now, why don't we go to basics:

Citi's TCE is $91.9B assuming full conversion, all outstanding shares after the conversion are 22.8 B, so the tangible book value comes to 4.03 . I think this pretty much explians Bove's target, at minimum Citi should reach that level (if it is not allowed to fail). Then the P/B ratio based on the TCE, which BTW is the most conservative estimate for P/B !, goes to ~ 0.75 ( 3.00 share price assumed)
Lets compare the P/B based on the tangible book value for all big banks
(source Thomson Reuters):
BAC : 0.63
JPM : 1.19
GS: 1.22
WFC: 1.40
Bank Sector: 1.53

The only missing piece in the puzzle is the re-assurance that Citi can make money again, if 2Q profits show upside surprise I am confident Citigroup can reach P/B of at least 1 , i.e. reach Bove's target.

Jun 24 10:28 AM

[jacob1:]

Finally an intelligent, well thought-out and researched article on Citi. While many people and t.v. pundits seem to make a living complaining about Citi, they do so without thinking too deeply, and because it's easier to take a shot at what really is yesterday's big target. But what they forget is that they are railing against a company that really no longer exists - Citi is not the same company from the Citi of three to five years ago, and in the coming year it will be even less. Where were these pundits before the meltdown, when their railing may have actually looked prescient and worth something, and made an important contribution? I guess that kind of critical thinking and analysis - ahead of the pack and ahead of the story - when it really matters, is much harder to come by. Yes, Citi's headquarters building and its logo are still there on Lexington Ave., but the management from those days has been overhauled, businesses have been shed, employee numbers look nothing like in previous years, and there is a revamped and entirely new business model that leverages a slimmed-down Citi's clear competitive advantages and global strengths. But I guess that takes too much effort and thinking for these pundits to see. Much easier to rail against some large edifice of a company in midtown that really no longer exists, then to look at the turnaround story and business model of what's essentially a different company, that has clear value and profit potential and bares little resemblance to the Citi of yesterday.

Jun 24 10:29 AM

[al s:]

Bove is clearly a crack addict that has not had his fix yet.
Let's see, we hace C the poster child for STUPIDITY AT MANY LEVELS and they today come up with another brilliant idea -- let's raise our costs !!!!!!

However poorly bonuses were managed, at least they were for extraordinary results that added to the bottom line. So, theoretically, you only got one if you contributed above and beyond the expected level of performance/results.

Now, C wants to, in effect, just pay out this higher level of compensation regardless of results on the grounds it is "competitively necessary". Sorry but aren't these the very same staff who nearly brought down this once great bank? And now you " have to pay them more" to ensure they will stay and continue to do the same thing they were always doing?
Doesn't that sound like the height of madness? There is more than a double digit unemplyment rate in these areas of finance/investment right now. Perhaps HE UGLY TRUTH IS THAT C CANNOT ATTRACT/RETAIN TALENT AND NEEDS TO PAY A PREMIUM BECAUSE EVERYONE KNOWS WHAT A CRAPPY MANAGEMENT STRUCTURE IS IN PLACE WITH THE DYNAMIC DUO OF PANDIT AND PARSONS at the helm !!!!!

The poor jerks in the retail bank, tellers loan officers, etc are not the focus of this grand scheme. No it's the derivitive guys, the special vehicle people, the folks that package and sell the toxic crap, the wheeler dealers who are at the center of all this. The poor babies cannot survive on a $500 k base salary and are threatening to go/have gone to competitors as well as boutique shops.

If, and that's a big leap of faith, Pandit and Parson had any brains or backbone, they would let them go and get back to the core businesses that once made C great.
But I don't expect that to happen so let's just nee.dlessly increase salary costs and drive down the common share price some more

Jun 24 10:30 AM

[nobby73:]

Citi may be too important to fail, but for the stock to start showing decent returns, we need to see signs that losses are being contained. So far, we have seen the impact of the mark-to-market assets causing so much damage, they change the rules to allow fair value. There are a huge number of loans on the books held at "optimistic" values, linked to commercial real estate and leveraged deals that are coming up. We have suggestions consumers will reduce balances and become more prudent with their credit cards, so another cash cow will run dry and the more exotic (or is that toxic) investment banking business may have gone forever. Citi won't "fail" but it won't stay as is, and the shareholders will shoulder most of the pain.

I bought at $2 and sold at $4 and it was an exciting time, but I'm glad to be out and have no intention of going back in soon... If Citi does get to something interesting like $5 a share, there will be so many other stocks that will do significantly better.

Jun 24 12:21 PM

[j_remington:]

Citi can exist (not fail) but the shares could be anywhere between $1 and $4. This article is useless in regards to trading C stock.

Jun 24 02:06 PM

[The Simple ...:]

As has been observed elsewhere, Citi common is trading like a very long term option on the shares. It's certainly not a core holding, but at $3, why not put some speculation capital into it, and see where it goes in a few years?

Jun 24 02:06 PM

[Tincho Sibi...:]

Why would I want to have more exposure to the US Govt? Have you ever seen a govt. business competitive enough in a market? Is that why these guys want to regulate the market?.........IF YOU ARE THE US GOVT...WOULD YOU NOT USE THE GLOBAL DEPOSITS FROM CITIGROUP TO FUND YOUR TREASURY NEEDS?

Jun 24 04:09 PM

[js_mcknz:]

At some point the govt will tire of throwing money down the Citihole, and decide what's good for GM is good for the Citi -- equity will be wiped out, and the "new" Citi will be full of promise....

Jun 24 10:35 PM

[tradingdayz:]

Nice article. Citi is not going to fail, and I think we al know that, those without some irrational hatchet against government or bailouts. It won't fail primarily because too much went into keeping it alive--35 bill and this amount took the brunt, and seriously, they would have asked for more in round two if they thought they needed more--that was the time to get what you asked for, so likely they are happy. Prince Talal is happy since the stockholders made good on his losses through the brilliant manouvering of Mr. Pundit. Where is the problem folks? Now stock price, 4$? why not? What are you crazy? their tier one is fine, a little low, they have less exposure to mortgage than b of a, they are going to make money, but just no tons of it since their favourite derrivative toys have to be put away till uncle leaves--The stock will be more like 6$ by end of year--but I don't expect it to climb much beyond that for two more--they will get the survival certification award in the 3$ till end of year. actually I think they will see 2$ within the month after reporting--5 $ for one month--any takers? I'm still testing this model so go ahead and kick it and bash away. my other pick is lyg--loyd's for a doubling by year end.

Jun 24 11:59 PM

[User 305589:]

Hm, and I guess the same logic applied to fannie and freddie. they haven't failed, too, sort of. Just the common shareholders lost pretty much everything.
As for Citi's return to profitability, I guess the recent hike in salaries of upto 50% will not really help the bottom line.
good luck with that citi gamble. i prefer investing, though, and that's why i won't touch this stock for quite some time to come.

Jun 25 09:09 AM

[Angry Banker:]

Check out my latest article regarding the salary increases. Total compensation will not change, just the mix between bonuses and monthly salaries. Therefore, the current initiative to retain talent is cost neutral. And don't start on about how Citi's "talent" caused this mess in the first place. Almost every single senior executive who commandeered the ship through Q4-2007 (when the company started posting its losses) is gone. Pandit started his job in December of that year and has been working his a$$ off ever since to right the ship. Oh and by the way, he's currently taking $1 a year until the company returns to sustained profitability. Is that bad for expenses too?


On Jun 25 09:09 AM User 305589 wrote:

> Hm, and I guess the same logic applied to fannie and freddie. they
> haven't failed, too, sort of. Just the common shareholders lost pretty
> much everything.
> As for Citi's return to profitability, I guess the recent hike in
> salaries of upto 50% will not really help the bottom line.
> good luck with that citi gamble. i prefer investing, though, and
> that's why i won't touch this stock for quite some time to come.

Jun 25 09:42 AM

[tedstr:]

Citi preferreds is the way to play it. 11%-12% while you wait for things to improve. 11% is just fine with me for the next 10 years.

Jun 25 01:58 PM

[doubleshortetf:]

Now this is funny...

Don't you all know that the common share holders will get WIPED out when the Feds take over Citi? Listen, reality is that Citi is INSOLVENT. More TARP money to resuscitate just means more warrants for Hussein (O's real middle name) and Tax Cheat Timmy.

My prediction is that Citi longs will soon become BAGHOLDERS like GM longs.

Jun 25 02:51 PM

[Living4Divi...:]

C is a Nationalized Bank, therefore not at risk for insolvency/failure.

only at a risk for being poorly run/poor growth/ no dividend like many other State Owned Enterprises.

Jun 25 04:48 PM

[Tony Daltorio:]

Citi, like many other major US financial institutions, will eventually get sucked into the black hole of oblivion. After the government pours trillions more dollars into Citi and others and it still does nothing to revive these zombies, they will eventually abandon the effort.

Investment into any US financial stocks is only good for people looking to lose all of their money and perhaps experience bankruptcy in their own personal lives.

Jun 25 05:09 PM

[User 305589:]

provided, of course, that citi doesn't need to make another conversion of preferred stock into common. The risk that such event will occur down the road is way too high for my taste.


On Jun 25 01:58 PM tedstr wrote:

> Citi preferreds is the way to play it. 11%-12% while you wait for
> things to improve. 11% is just fine with me for the next 10 years.

Jun 26 03:08 AM

[User 305589:]

''Total compensation will not change, just the mix between bonuses and monthly salaries. Therefore, the current initiative to retain talent is cost neutral.''

oh, cost neutral - based on what? On the bonuses for the year 2007 (paid out in 2008) when huge bonuses were granted everywhere for paper profits that by now have turned into huge losses amounting to hundreds of billions - with more of the same to come?

If it really were cost neutral - then why any change at all? the industry is in a severe downturn (except for Goldman) after yerars of excessive profits and yes, that means cuts in compensations, especially when a company teeters on the brink of bk. That other banks, namely JPM; MS, BofA etc raised their basic salaries to retain ''irreplaceable talents'' is outreageous! It is all paid for by the taxpayer, ultimately, because without TARP and the ultra low interest rates granted by the Fed (which in essence are subsidies paid for by the taxpayer for the banks) these compensation hikes won't be püossible at all and in fact all of these banks, including Goldman would long be bankrupt!
And don't tell me about all the ''irreplaceable talent'' that has to be retained at any cost. This is as laughable as it gets. Working in bankinfg and asset management myselves, I have met very, very few people in the industry who are truly ''irreplaceable'' and need to be retained no matzter what. It is just a complete farce where overpaid bankers continue to get taxpayer-subsidised fat paychecks for providing - what added value to society??



On Jun 25 09:42 AM Angry Banker wrote:

> Check out my latest article regarding the salary increases. Total
> compensation will not change, just the mix between bonuses and monthly
> salaries. Therefore, the current initiative to retain talent is cost
> neutral. And don't start on about how Citi's "talent" caused this
> mess in the first place. Almost every single senior executive who
> commandeered the ship through Q4-2007 (when the company started posting
> its losses) is gone. Pandit started his job in December of that year
> and has been working his a$$ off ever since to right the ship. Oh
> and by the way, he's currently taking $1 a year until the company
> returns to sustained profitability. Is that bad for expenses too?
>

Jun 26 03:22 AM