Post Mortem
Posted January 15th, 2009 by ixpressmeThe Economist – Finance & Economics – Citigroup – A house built on Sandy – And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell: and great was the fall of it
“Too big to fail, too shit to buy” is the way some Citigroup insiders describe their employer. Not for much longer. On January 13th Citigroup announced that it had reached a deal to spin out Smith Barney, its broking arm, into a joint venture with Morgan Stanley’s broker. The agreement presages even more dramatic changes. The bank has brought forward its fourth-quarter results to January 16th and expectations are high that Vikram Pandit, Citi’s chief executive, will unveil plans to slim the bank further and faster.
The Smith Barney deal is already a watershed. As recently as November, Mr Pandit heaped praise on the broker and said he did not want to sell it. No wonder. Citi’s wealth-management business, of which Smith Barney is a big part, was the only one of its main divisions to post a profit in the third quarter. And it sat snugly with Citi’s universal-bank model, endorsed by Mr Pandit just weeks ago, of offering a full array of services to customers.
Citi will still receive its share of revenue from the joint venture, which overtakes the troubled Bank of America-Merrill Lynch combination as the world’s largest broker by number of advisers, but there is no question who will be in charge. Morgan Stanley is paying Citi $2.7 billion to take a 51% stake in the venture, which will be called Morgan Stanley Smith Barney, and has an option to take further stakes. James Gorman, now seen as favourite eventually to succeed John Mack as Morgan Stanley’s boss, will be the venture’s chairman.
Mr Pandit’s about-face reflects Citi’s continuing need for capital. Those quarterly results are expected to be the fifth in a row where Citi bosses own up to a loss. Although the bank has received two shots of government money and has a decent level of capital by some measures, its first line of defence, common equity, is thin. Mounting problems in its consumer and corporate loans, as well as some old wounds in its portfolio of mortgage-backed securities, threaten to erode it further. Selling Smith Barney, which creates tangible common equity of approximately $6.5 billion, is the quickest way of plugging the gap.
Gap-plugging alone does not constitute a strategy. Initial word of the deal sent Citi’s share price skidding on January 12th, as investors reasoned that the bank must be desperate if it was choosing to sell one of its best assets. Hence reports that more radical surgery is coming, with up to one-third of the bank’s assets being hived off to leave a slimmer Citi, focused on global corporate and retail banking.
Precisely what Mr Pandit has in mind is not clear, but it may be too late for an elegant retreat. Many of the businesses he would like to unload, such as Primerica, a seller of insurance, have been on the chopping-block for a while. Appetite will probably be keenest for the things that Citi would most like to keep—its retail-banking operations in Mexico and South Korea, say, or its suddenly sexy transaction-processing business. There is talk of setting up a separate entity to house the assets earmarked for sale, which could then be divested later. But that would still leave Citi with the problem of how to fill today’s holes in its capital.
Citi’s burst of activity signals two big, and necessary, shifts in thinking. The first is the final abandonment of the idea that has animated Citigroup since Sandy Weill engineered the merger of his company, Travelers, with Citicorp in 1998—that of the financial supermarket. The news on January 9th that Robert Rubin, a powerful voice in favour of the universal model, is to quit the board affirms the change. (The position of Sir Win Bischoff, the bank’s chairman, is also reportedly under discussion; Mr Pandit looks more secure, if only because no one wants his job.)
Not super at all
Universal banking need not fail. But smaller, focused organisations are easier to run than large, sprawling ones—Citigroup has more employees than the American navy and, apparently, greater destructive power. Mr Weill’s creation, backed by a host of executives, directors and investors ever since, has proved horribly flawed. Unlike HSBC, another giant, Citi has been built through deal making and it shows. Acquisitions were poorly integrated. Cultures overlapped rather than melded (the resilience of the Smith Barney name is one telling indicator). Risk management was dismal. The big balance-sheet was deployed recklessly. It may be inevitable that some banks are too big to fail; but the lesson of Citi is that they can also be too big to manage.
The second shift in thinking signalled by Citi’s manoeuvres concerns policy. November’s dramatic government intervention may have quelled fears that the bank would go under. But it has not stopped the bleeding at Citi, which remains focused on survival rather than on ramping up credit. Red ink laps around a host of other banks too. Full-year earnings at American banks are likely to be awful. Many eyes are on Bank of America, whose levels of tangible equity are also thin and, with Merrill Lynch and Countrywide to digest, is seeking billions of dollars in additional capital from the government. In Europe Deutsche Bank revealed a fourth-quarter loss of €4.8 billion ($6.3 billion) on January 14th, thanks in part to misplaced trading bets.
Recognition is growing that bad assets must somehow be purged from banks’ balance-sheets before they will freely make new loans. Citi has already had more than $300 billion of toxic assets ringfenced and guaranteed by the government; its apparent intention to create a separate entity for its unwanted assets is a more straightforward echo of the “good bank/bad bank” approach used in Sweden’s much-vaunted bail-out of the 1990s. In a speech on January 13th Ben Bernanke, chairman of the Federal Reserve, pointedly highlighted the continuing need for the financial system to shed its toxic assets.
That was the original purpose of the $700 billion Troubled Asset Relief Programme (TARP), approved in October, an effort that largely foundered on the difficulties of setting a purchase price for bad assets. The valuation problem has not gone away. Given the further deterioration in markets since the autumn, few believe that the $350 billion still left to spend from the TARP, if Congress agrees to release it, is anywhere near enough to absorb all the poison in the system. Even so, Citi’s shift in direction may signal that policymakers are looking again at the idea of bad banks. After all, one U-turn deserves another.
Source: The Economist
Tags: The Economist