Article for future reference:52,000 colleagues were about to lose their jobs last week, Citigroup traders awaited the axe with a little of the black humour Wall Street is famous for. Bankers joked that Somali pirates were offering 1 cent a share for the troubled bank, if staff agreed to wear eye patches. Those with any money left were betting on how much lower their employer’s shares would go. By Friday Citi shares had fallen 60% - in a week - to levels last seen when many of those traders were still in high school.
After one of the worst weeks in the bank’s history, Citi’s officials are spending the weekend drawing up plans to prevent a repeat. The government and big investors are being lobbied to make an investment that might soothe the markets. If they fail to find a blue chip backer, odds are that, come Monday, the slide will start again. It’s a frightening fall for a bank that was, until recently, the biggest, most powerful financial services firm in the world.
Citi boss Vikram Pandit started last week on an upbeat note, addressing the firm’s 350,000 staff worldwide via a teleconference, self-styled as a cosy sounding “town hall meeting”. “We will be the long-term winner in this industry,” he said. Then came the announcement of the job cuts. In New York the redundancies started in capital markets and investment banking but this is a global firm and thousands of jobs are going in India and Germany - and several hundred are on the block in London.
The sackings failed to appease the market and Citi’s share price kept falling. Even after Saudi investor Prince Alwaleed bin Talal, a big Citi backer, pledged his support for the bank and Pandit, the shares kept falling. They closed on Friday at $3.77, a price not seen since 1995. Last November Citi’s shares traded at over $30.
Even after last week there is no end in sight. Pandit said the last three months of this year would continue to be challenging and warned of more trouble in 2009. Mounting losses from mortgages, credit card loans, and complex debt instruments could cost the bank another $3 billion (£2 billion) in the fourth quarter, according to Fox-Pitt Kelton analysts.
Citi is hardly alone in its troubles. The stock markets have turned against the rest of the banking sector too, but critics argue Citi has made a bad job of handling a difficult situation.
Last month the company was left looking flat-footed in a bidding war for Wachovia, a financial services firm. Pandit was seen to have been outmanoeuvred by rivals Wells Far-go - further ammunition to critics who say he has neither the street smarts nor the experience to pull Citi out of a hole.
But even after this decline some analysts doubt Citi will go under. The bank has some $75 billion in liquid assets on its books. Unlike earlier victims of the credit crisis, Citigroup has access to the government bail-out programme. It also qualifies for bailouts from the Federal Deposit Insurance Corp (FDIC) and the Federal Reserve.
“We are not seeing anyone lining up to take their money out of Citibank. It’s not Northern Rock. Will counterparties trade with them? I haven’t heard any rumours to the contrary,” said Brad Hintz, analyst at Sanford Bernstein. Hintz said Citi was the victim of markets that are “relatively crazy”.
But if the likelihood of Citi going bust is small, so are its options for reassuring the market. One obvious option – a merger with another large bank – might be too much for regulators put off by the giants already created by the credit crisis. “You already have too many really large banks. Who would you merge it with? The other ones already have their own problems,” said Hintz.
Goldman Sachs is looking to grow its deposits but such a huge deal would fundamentally change its business. Would JP Morgan want, or be allowed, to swallow another bank after taking on Bear Stearns and Washington Mutual?
Hintz said regulators might simply advise Citi to “sell some things”. Citi’s back-office processing business or credit card division could go. The other option is to tough it out.
Citi has been toughing it out for some time. When Pandit took over last December he inherited a company in crisis. “If you want to blame someone, blame Chuck Prince,” said one Wall Street banker.
Prince, Pandit’s predecessor, was the appointed heir of Sandy Weill, the architect of Citigroup’s global ambitions. Through a series of ever larger mergers Weill built Citi into a financial behemoth spanning everything from credit cards to investment banking and wealth management. The idea was to create a company big enough to weather any storm. And if size was all that counted, Citi would be safe. Last year sales topped $124.4 billion, not far off the GDP of Morocco. The company operates in 140 countries and deals, in one way or another, with all of the top 500 companies in the world.
Prince, a lawyer by training, steadied the ship after Citi’s disastrous dance with World-Com, Enron and other notorious firms. But he failed to position Citi for the next boom while betting heavily on the next bust. Citi’s expenses got out of control, it failed to keep up with its rivals in the good times and still managed to make the same bad bets on sub-prime loans that have shaken the banking sector to its core.
The irony, not lost on the firm’s executives, is that in many ways the financial sector has swung back to Citi’s model of doing business. In the boom Citi’s rivals were smaller, more focused and nimble; Citi was a lumbering dinosaur. Now the credit freeze has acted like the ice age in reverse and left the dinosaur standing. Both Leh-man and Bear Stearns are bust and even Goldman Sachs has converted into a banking holding company.
“It may not be relevant to investors at this moment, but, ultimately, it will be recognised that the current executive team at Citigroup was not part of the decision-making group that got Citigroup into difficulty,” Ladenburg Thalmann analyst Richard Bove wrote ina note to clients last week.
He argued that Citigroup had done “quite a bit” to put its house in order. The bank was first to begin raising capital and taking writedowns to reflect the true value of its assets. “When the write-offs are over the strengthening of the institution will be evident,” wrote Bove.
Others are less kind. The betting on Wall Street is that Pandit is out in six months unless Citi’s fortunes change. “Prince failed to do anything except to get Citi into more trouble on the way up. Pandit doesn’t seem to have much ofa clue about what Citi should do on the way down. Where’s the leadership here? What is the plan?” said one rival banker.
He said the argument that stock markets were short sighted and missing Citi’s charms was “bogus”. “There’s a reason Citi is trading for a fraction of its old share price and it’s not all down to the credit crisis.”
Quick impressions: Still more downside at $3.77 (the price fall simply ignored all the possible good news like 52,000 job slash cuts, Alwaleed's buy, and no bank runs on Citi's deposits yet). Since punt can go to zero, am waiting at $2 before I consider adding.
Some possible reasons why it could go to zero. Existing shareowners gets nothing as part of condition to rehabilitate Citi. Regulator actions have been shape shifting since the start of this crisis, and noone can guarantee they won't change their minds later when they realized the problem is different that what they thought.
Some possible reasons why it would not rise despite being beaten down. Citi decides to tough it out. Sell out the business processing division or credit card division. Or end up with nothing like the old Citi.
Some possible reasons why it could rise in the medium term. This is the strange part. So far, news have not yet reported exactly why Citi is in a huge problem. The share price has taken a dive (huge dive) - perhaps news will come out later.
Since we don't yet know, there is a small chance that it might be able to ride out this storm. Stress small. Mr Market is very rarely wrong. So, my own likely scenario is that Citi will be altered substantially, and existing shareowners affected big time. 80% haircut possible. So, if Citi fair value is $40, consider this to be equivalent to $8, i.e. don't look at entering at 50% of this figure. Or if target is $20, consider equivalent to be $4, i.e. don't look at entering unless it drops to $2.
Beware of averaging down. 1% capital at $8 will lose the most 1% capital, which to almost all traders is acceptable. Even to Graham as well.
Contrast 1% capital at $6, which then averaged down at $5 (1%), and then at $4 (1%), and then at $3 (1%). Average is $4.50, but has 4% capital invested. If it goes to zero, then, lost 4% capital. Borderline now whether it is acceptable or not.
Contrast 20% capital at $2. Average price is good, but if Citi goes to zero, lose all 20% capital. Can you withstand a loss of 20% capital in the worst case scenario?
Understand impact on Average Price. 1% capital at $8 can quickly go down to below $4.0 average price if averaged down at the right time and at the right price. For example, if price falls to $2, adding 2% capital will bring down the average price to $4. (1%x $8 + 2% x $2)/3% = $4.
Or 1% capital at $8 can quickly go down to $3 if add 5% capital since (1%x$8 + 5%x$2)/6% = $3. But then, have some chance that these 6% can go to zero.
So, final answer depends on your Risk/reward tolerance. A very individual thing. Remember, there is no certainty in the stock market. And "hope" is a very dangerous thing.