Citi Is a Dog: Go Long at Your Own Risk

A fellow author at Seeking Alpha has ventured to recommend Citi (C) as a great long term investment, ostensibly on the grounds that it is too important to fail and implicitly backed by the government, among other considerations of global scope and overall market share. To avoid the hazards of paraphrasing, you may access this article in its entirety here.

Meanwhile, the Office of the Controller of the Currency has published statistics as of Q4 2008 showing derivative exposure as a percentage of risk-adjusted assets - classifying the top banks that in their opinion are overexposed to default risk. Citi stands at a whopping 286%.

Government subsidization of a failing institution is a terrible criterion for long-term investment because rather than being based strictly on growth prospects, management practices and fundamentals, it relies on fickle political headwinds. Citi fails on all counts. Suckling at the government teat doesn't count as a growth strategy. Vikram Pandit & Co. do not inspire confidence at all, and trading at below book value doesn't count as a fundamental in my book.

The mark-to-make-believe accounting fraud perpetrated by the FASB is allowing major banks and financial institutions to acknowledge revenues under circumstances that would have taught Arthur Andersen a thing or two. An estimated $2.5 billion worth of profits reported in the first quarter by Citi can be attributed to lowered revenue reporting standards, and the results of the much-touted stress tests were negotiated downwards substantially before public release.

The 'adverse assumptions' (which included 8.9% unemployment) that the stress tests were based upon have already come to pass since the civilian unemployment rate is now 9.4%. The Bureau of Labor and Statistics expects the unemployment rate to hit 10% before end-of-year 2009. Meanwhile, the International Monetary Fund expects writedowns of $2.7 trillion on US-originated assets before the end of 2009, out of a worldwide total of $4.1 trillion.

Investors lost their shirts buying Fannie Mae (FNM) and Freddie Mac (FRE) at the beginning of 2008 because they incorrectly assumed that they were ex officio risk free in spite of the fact that they don’t carry the same full faith and credit guarantees as Treasury debt. They saw the spread between Fannie / Freddie debt and US treasuries of comparable duration, dived right in, and were slaughtered when Fannie and Freddie collapsed later in the year. This is what happens when you ignore real fundamentals in exchange for government speculation.

If you want to buy Citi's preferred stock because you like the current yield as an income play and you're not too concerned about short term fluctuations in price, I can understand. Even so, there are much better, and safer, alternatives, such as the John Hancock Preferred Income Fund II (HPF) or the BlackRock Preferred Income Fund (PSY).

Better companies have had their stock prices stagnate for years in spite of high liquidity, consistent cash flows, little to no debt and strong management- Microsoft (MSFT) and IBM (IBM) come to mind. Citi has none of the above. As for all those who object that many traders made a fortune buying Bear Stearns Cos at $2 a share and cashing out at 10, I would like to point out that there were just as many investors who went in at $10 and watched it go to 2- after they were stopped out, I hope.

To say that Citi is “too important to fail” and ergo a “great long term investment” is an intuitive leap. I wouldn’t necessarily short it, however. The burial grounds of Wall Street are littered with the bones of recent traders who went toe to toe against the government, and we’ve been seeing all sorts of suspicious activity in equity index futures where huge countertrend positions appear out of nowhere just before the market closes. Nonetheless, Citi’s a dog, and just because it’s too big to flush down the toilet doesn’t mean it belongs on my dinner plate.

Disclosure: No positions.

Comments

[Angry Banker:]

Good article. But consider this as well. With Uncle Sam owning 34% of the company, even with fickle politicians messing with the levers, don't you think Obama's a smart enough politician to want to try make sure the government gets a good return on his investment (he did in fact back off of the 90% bonus tax after after he let his liberal cohorts get some more populist support from their ranting and raving)? With such a highly motivated owner, who also holds the power to give Citi every competitive advantage over other firms with no government ownership, it may actually be a good thing to have Uncle Sammy as a fellow investor.

Jun 25 09:49 AM

[Marli:]

Good point.

But the dark side of too big to fail...is too heavy to carry. If Citi gets hammered again when the prime rate, commercial real estate, alt-a and option ARM mortgages that are still in the pipeline start blowing up due to increasing unemployment into 2010, the stock could take a massive beating. At that point, you might be able to grab some lucrative bargains on Citi's high-yielding preferred, but I'd hedge my common stock positions.

Jun 25 10:11 AM

[fwi:]

Excellent article--I akin investing in Citi like investing in the US post Office. Neither is a good idea.

Jun 25 11:05 AM

[mals:]

Given the price of Citi stock, the risk of a small investment like 1000 shares or so is worth it. The payoff if Citi gets its act together will be huge.

Jun 25 12:10 PM

[nobby73:]

Well said, too big too fail does not make the ordinarys a good buy. The juice was there at $1, not $3.

The risk for equity holders is further dilution, rather than the bank "failing", the govt position as the main shareholder does give some support, but they are also de facto lender of last resort and if Citi needs additional funding, this may come in exchange for more prefs or warrants, that mean the government gets it's money back, but shareholders get flushed down the pan.

Jun 26 05:06 AM

[ATWshop:]

Excellent point nobby73! The biggest concern for any common stock owner should actually be that the government will cover their exposure and leave the rest of the shareholders holding the wrong end of the stick.... this should be a red flag to individual investors.

Jun 26 06:57 AM

[Archman Inv...:]

There are those who are experienced traders (not me) who will probably make a career out of trading this stock. Then there are those who will conned into buying the stock by the financial media (not me)
And finally there are those who will buy this stock simply because they are such lousy investors in the first place. Stocks to them are a lottery ticket out of Wal-Mart employment, or they desperately need stocks to go up in order to re-coup the 80% losses they suffered by buying whatever stocks their bald headed idol on TV told them to buy.

There are just so many other investment opportunities out there I do not know why anyone would bother with C

Jun 26 09:10 AM

[newbietech:]

"They saw the spread between Fannie / Freddie debt and US treasuries of comparable duration, dived right in, and were slaughtered when Fannie and Freddie collapsed later in the year."
The author seems to be conflating bonds and preferred securities here.
Those holding FNM/FRE bonds of comparable duration made out handsomely.

Jun 26 09:31 AM

[MGA_1:]

I'm a little too chicken, but I want to short citi right now. They got a one time windfall with the change to mark to model, but that ain't gonna last. The are several more years of real estate debt to clear out for all of these banks...

Jun 26 10:39 AM

[newbietech:]

"If you want to buy Citi's preferred stock because you like the current yield as an income play and you're not too concerned about short term fluctuations in price, I can understand."
As I understand it, almost all the preferred stock is getting converted into common stock. Those who will not agree to convert risk losing the dividends they are getting on the Preferred stock.

Jun 26 11:06 AM

[DrinkingBird:]

I doubt the feds would let Citi go belly up, I really don’t see C going anywhere for quite awhile. I bought a few shares in the 3.00 range just for a fun bet though.

Jun 26 12:27 PM

[Living4Divi...:]

When has Uncle Sam ever wanted or demanded a good return on his investment??


On Jun 25 09:49 AM Angry Banker wrote:

> Good article. But consider this as well. With Uncle Sam owning 34%
> of the company, even with fickle politicians messing with the levers,
> don't you think Obama's a smart enough politician to want to try
> make sure the government gets a good return on his investment (he
> did in fact back off of the 90% bonus tax after after he let his
> liberal cohorts get some more populist support from their ranting
> and raving)? With such a highly motivated owner, who also holds
> the power to give Citi every competitive advantage over other firms
> with no government ownership, it may actually be a good thing to
> have Uncle Sammy as a fellow investor.

Jun 26 02:50 PM

[aarc:]

Ask yourself a question:

Will you be shorting Citi at this price level?

What is the probability you are going to make lots money in less than 6 months, 12 months, 3 years, and/or 5 years shorting Citi at current share price of $3?

What is the probability you will lose money in those time periods by shorting Citi now?

Now, do the right thing.

Jun 26 05:01 PM

[bcncv:]

All good points. It's also worth noting that just because a company will be around as an operating unit in 10 years, doesn't mean the common equity will be worth anything. Look at GM.

I view this stock kind of like Sirius/XM. It might be worth owning a very small number of shares as a speculative play, but the possibility of your investment moving to $0 is significant.

Jun 27 03:34 PM

[FloridaBoy2:]

Thanks for the article,

Citi has been in the basement before but I think this time is different.
it is a huge, complex entity and I am not sure anyone really knows what is going with the balance sheet. 34% government ownership does not auger well for investors. There are plenty of other banks that have real investment potential.

I am long HBAN, and a couple of other regionals. The new CEO bought 300,000 shares on the open market when he took the job and another 550,000 during a secondary offering. Other insiders bought heavily too. I think this has more potential than Citi. Well run regionals will acquire assets at favorable prices from other regionals as the industry consolidates. I am not pounding the table, just making a statement.

Jun 28 06:07 AM

[rockydog:]

I am long C w/ 7250 shares. It's true my investment is hard to look at on paper, and that C gets thrown under the buss in the news nearly every day thus far in 2009, but the largest bank in the world is no GM. C is doing the right thing to fix its problems. Yes, some argue C is slow to act, but at the end of the day problems are fading away quicker then you think, and this bank is positioning itself to leap forward once again as a premier entity being "the most well capitalized bank in the world." It will be hard to deny C is moving in the right direction when the earnings come out end of July.

You have to dare to go where others won't to make F-U. money. C at $3 per share is a steal, and may never happen again in our lifetimes.....

Jul 07 12:56 PM

[Ricard:]

Good article. Yours and angrybanker's article give great perspective on this stock. The best move would probably be to stay away from something this volatile, but the trader in me demands satisfaction.

I think you're both right, in that the government will provide support to this company, but will not be an astute enough manager to turn it into a jewel of an investment. That said, I see it trading in a range while this mess gets sorted out. If there is any...*any* sign of re-privatization of this firm largely intact, then it certainly has the possibility of recuperating 1/4 of its share price from the 2007-8 highs. That places a stock like this (under that rosy scenario) at around $15 - given 25% dilution, that places its market cap at about a 1/3 of its peak.

If not, then I'm sure the government will keep it propped up - C at $1 was due to possible liquidation concerns or complete nationalization a la AIG. Neither occurred, and both become less of a possibility with each passing day. I think the shock is over, and downside potential is low. However, upside beyond $15 is probably just as low.

Good luck to anyone brave enough to test these waters.

Jul 09 08:27 PM

[Ricard:]

My apologies...misquoted this number. Assuming dilution is 75%, then $5 is around fair value.

On Jul 09 08:27 PM Ricard wrote:

That places a stock like this (under that rosy scenario)
> at around $15 - given 25% dilution, that places its market cap at
> about a 1/3 of its peak.

Jul 09 09:39 PM