Credit Suisse has a note out urging caution on Citigroup shares due to regulatory hurdles.  Their logic bears noting as it can be useful for other U.S.-based banks.

On Monday the CS analysts met with Citi management, who were somewhat cautious. The CS note indicates that regulatory changes in the U.S. are likely to mandate higher capital ratios and this necessarily will constrain returns on capital, not just at Citigroup but elsewhere in banking.

Another question involved deferred tax assets (DTAs), which I brought up last week. Citi said only $13 billion of the $38 billion in DTAs were counted against Tier 1 capital, meaning any writedowns to capital will have much less affect on Tier 1 capital. About $14 billion in DTAs were related to Citi’s burgeoning loan loss reserves; so the tax losses have not yet been triggered. This may give Citi time to earn money in order to use the DTAs. Again, the key with Citi’s DTAs has to do with how much it earns going forward. If it does not earn enough money, the deferred assets will have to be written down.

In general, banks are now entering a less favourable regulatory environment.  Moreover, in March, many bank stocks were trading below tangible book for the first time since 1990, at the height of the last major credit crunch in the U.S.. After a more than doubling in bank stocks from March lows, this is no longer the case and it will be harder to beat now elevated earnings estimates.

Meredith Whitney has said she expects the large cap bank stocks to underperform due to some of these hurdles and sees a relative value play in regionals.  However, a lot of CRE and loan construction exposure remains at regionals and the continued seizure of 3 or 4 banks every week by the FDIC points to distress.

I continue to believe upside in bank shares is limited all around.

Related posts:

• How well capitalized is Citigroup?
• How is Citi going to deal with $38 billion in deferred tax assets?
• The Citigroup Bailout: a blogosphere post-mortem
• Citigroup and Redecard: shedding international assets
• Rubin resigns from Citigroup

In a recent post, “How is Citi going to deal with $38 billion in deferred tax assets?,” I pointed to a Reuters article which called into question Citigroup’s ability to earn enough money to prevent its having to take a charge for an incredibly large deferred tax asset. That post generated a response from a Citi representative who emphatically defended Citi’s capital position with a chart comparing Citigroup to other large global financial institutions.

Below is that chart:

As you can see from the chart, based on Citi’s reported public accounts, the company is well-capitalized. Moreover, even hedge fund operators like John Paulson who maid a mint on shorting financials in 2007 and 2008 now think Citi is in much better condition. Paulson was known to be buying shares in August.

You could agree or disagree with Paulson about whether Citigroup is a buy at its present share price. And you could argue that Citi should be taking the charge that Willens suggests. But the fact is, Citi has been recapitalized – at taxpayer expense. And that’s more the point here. 

Citigroup has received more money from the government ($45 billion) than any other bank in the U.S., none of which has been paid back. Moreover, the government was forced to not just forgo dividends on its preferreds but also convert these into common equity and provide debt guarantees for the company. Absent government money, Citigroup is the worst capitalized big bank. Absent government money, Citigroup would not exist.

Even still, Citigroup cannot be nearly as profitable as it once was because it has been forced to sell assets in order to achieve its ratios. Yet, it is an organization with almost $1.9 trillion in assets and is certainly still too big to fail.

I see Citigroup as emblematic of the problems we face in dealing with large systemically dangerous institutions. They insist that we return to some semblance of business as usual after they have received massive bailouts without any clear timeline when those monies will be repaid – if ever. Meanwhile, it is far from clear what these institutions would look like if the collateral they put up for loans received from the Federal Reserve and the rest of their assets were marked to market.

I, for one, think the big banks have made it. I said so as far back as April. I may not like the way they have been recapitalized, but I am in little doubt that they have been.

But Citigroup and Bank of America in particular have gotten there with great help from taxpayers. All of the too-big-to-fail financial behemoths exist because of government largesse. That high-level executives of these organizations show little contrition or remorse for having cost our economy tremendously is the saddest part of this crisis.

Disclosure: I have no financial positions in Citigroup or any other financial services company.

Related posts:

• My take on the latest Citigroup bailout
• The Citigroup Bailout: a blogosphere post-mortem
• Rubin resigns from Citigroup
• Credit Suisse cautious on Citigroup due to regulatory hurdles
• Citigroup and Redecard: shedding international assets

Citigroup has been losing tens of billions of dollars over the past two years as the financial crisis has unfolded. If one considers the government capital that Citi has not paid back, the bank is clearly the weakest of the four largest legacy banking behemoths in the United States. Earnings results this year demonstrate that their raw earnings power is no match for the likes of JPMorgan Chase or Wells Fargo. Moreover, their capital base has been impaired, causing them to have to sell assets, reducing their earnings power further still.

Unless something miraculous happens over the next few years, they are not going back to the glory days of $20 billion yearly net income. That’s why their mountainous $38 billion deferred tax asset is a problem.

Reuters explains:

Citigroup has a roughly $38 billion deferred tax asset, which essentially represents expected cash flow from future tax benefits. Accounting expert Robert Willens said on a conference call late last month that he expects the bank to write the asset down by about $10 billion in the fourth quarter. That would represent about 7 percent of the bank’s net worth as measured by the reported value of the company’s shareholder equity.

What is going on here is a result of the fact that companies keep two sets of books – one for the taxman and one for public statements.  On the tax books, they pay more taxes upfront than we see in their public accounts (I know it sounds dodgy but I am sure a tax accountant can explain). By deferring the tax liability, companies reduce the net present value of the tax charges. Everybody wins except the taxman, right? 

Well, not exactly.  If Citigroup cannot make enough taxable income in future periods to cover these deferred tax assets, they are going to have to take a charge and write down the asset immediately. That is what Robert Willens is pointing to. If he is right, Citigroup would have $10 billion less capital as soon as Jan.1, 2010. And given they are perhaps the least well-capitalized of the stress test 19 except GMAC, that’s a problem.  It would certainly constrain their lending capacity.

But, of course, Citi officials have already come out to put any fears to rest.

"We are comfortable with the valuation," Kelly said, adding that the bank looks at its deferred tax asset at the end of each quarter. About $16 billion of the deferred tax asset must be realized by around 2016, and the rest has a much longer time frame, Kelly added.

Whew. For a second there, I was starting to think Citi needed another bailout.

By the way, Bank of America has a similar problem.  They have a huge net operating loss (NOL) carry-forward from their acquisitions of Merrill Lynch and Countrywide Financial. If BofA cannot make enough taxable income to use all of their NOLs which are now assets on their balance sheet, they too will have to take a ‘valuation allowance’ a.k.a a hit to earnings.  The net deferred tax assets at BofA (incl. NOLs) were $19.6 billion according to their 3Q 10-Q filing.  See the note below (click to expand).

As you would suspect, “The Corporation has concluded that no valuation allowance is required.”

Source

Bank of America SEC filings – BofA website

Related posts:

• Credit Suisse cautious on Citigroup due to regulatory hurdles
• How well capitalized is Citigroup?
• JPMorgan has record revenue and $2.7 billion in profit
• Is Citi being forced to downsize by Obama?
• Are Citi and BofA gaming the Geithner Plan already?

And you thought the bailouts were over and market discipline might be restored.  Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

The company, formerly the financing arm of General Motors, was one of 19 institutions to submit to a capital adequacy programme led by the Federal Reserve and completed in May. That determined that GMAC had a shortfall, which will now be provided by the government in the form of preferred equity, according to two people familiar with the situation.

As widely expected, GMAC has been unable to raise the necessary capital in the market and the company – which will take on fresh lending responsibilities when it merges with Chrysler Financial – was seen as vital to the government-led restructuring of the US automotive industry and deserving of more funds from the $700bn troubled asset relief programme.

“When we laid out the stress tests, we expressly said that some additional Tarp capital may be needed given the severity of the downturn – this capital need is not new information,” said an administration official.

“But the transparency brought about by the stress tests allowed all other institutions to raise the capital required by the stress tests to ensure these firms could withstand a more severe economic scenario than anticipated,” the official said.

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk.  Bailing out GMAC is a moral hazard plain and simple.

But, what’s done is done. The GMAC case does, however, give a lot more credence to my view that Citigroup’s actions are being dictated by government. As I indicated when the stress tests were done in April, firms were going to get some time to raise capital and if they didn’t, the government was going to move on to Plan B (debt-for-equity swaps, nationalization, and FDIC seizure). Expect to see more indications that other financial companies with capital shortfalls are falling under the government umbrella.

Related posts:

• Bank by bank breakdown of stress test results
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks
• GMAC: Loosening credit standards in the teeth of recession
• GMAC gets a helping hand
• GMAC chairman resigns effective immediately

This comes via the NYTimes:

To the Editor:

Re “Volcker’s Voice, Often Heeded, Fails to Sell a Bank Strategy” (front page, Oct. 21):

As another older banker and one who has experienced both the pre- and post-Glass-Steagall world, I would agree with Paul A. Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense.

This, in conjunction with more demanding capital requirements, would go a long way toward building a more robust financial sector.

John S. Reed
New York, Oct. 21, 2009

The writer is retired chairman of Citigroup.

Interesting.

Related articles

John Reed on Glass Steagall: Then & Now – Real Time Economics

Related posts:

• Was repealing Glass-Steagall the cause for the present Depression?
• How globalisation led to universal banking in America
• More on why big capital markets players are unmanageable
• Obama caves to pressure on consumer financial protection
• Is Citi being forced to downsize by Obama?

It seems that not a day goes by when you don’t hear about some asset sale in Citigroup’s far-flung empire. Of all the major too-big-to-fail institutions, it is easily the most troubled: the poster child for everything that is wrong in finance in America.

But, when President Obama’s Pay Czar Kenneth Feinberg stepped in to limit pay at Citi and six other failed institutions living off of taxpayer largesse, I noticed something that made me wonder if there was more going on than meets the eye at Citi.  I am starting to think Citigroup is being forcibly dismantled by the Obama Administration as a condition of its bailout. Could there be some bailout strings of which we are not yet aware?

Why is WFC not getting pay caps?

The thing I noticed was Wells Fargo’s name missing from Kenneth Feinberg’s list. The seven companies now subject to pay caps are: Citigroup, GMAC, American International Group, General Motors, Chrysler Group and Chrysler Financial. But, last time I checked, Wells Fargo was suckling from the government breast via a $25 billion TARP payment. What gives?

The only logical conclusion one can make is that the Obama Administration has excluded Wells Fargo because it is a healthier institution than the pay-cap seven. I agree with that assessment despite a downbeat post on Wells earnings last week. The headwinds from Wachovia are significant. But the underlying earnings power of Wells Fargo’s franchise is of a different caliber than Citigroup’s. If you saw Citi’s earnings report, it was a disaster in banking, credit cards, trading, you name it.  Everywhere, Citigroup was getting killed.

So clearly, in looking at the too big to fail banks, something quite awful is still amiss at Citi (and at BofA to a degree) that is not at Wells Fargo or JPMorgan Chase (Goldman and Morgan Stanley are not really banks).

Remember those stress tests?

The question then is: what do you (the government) do about the problems at Citi, and, to a lesser degree, Bank of America? Well, we have answer number one: pay caps for executives. And don’t think Ken Lewis left Bank of America on his accord, despite his huge golden parachute. We could be seeing some of his cash clawed back. I suspect, however, there is more for these multi-bailout offenders.

Think back to the bogus stress tests from this past spring and summer. I was pointing the finger at Citi and BofA then, saying these stress tests were just a cover-up to buy these organizations more time. If they weren’t able to make the grade in that time, more draconian action would be warranted. My logic was as follows:

The leaks about who failed the stress tests are already starting.  Who got a big fat ‘F’?  Apparently, Citi and BofA for starters.  But is that any surprise?…

See, the stress are just a scheme to make us think the Federal government is actually doing something about the under-capitalized banking system in the U.S.. In reality, the Obama Administration is just buying more time in order to let us grow our way out of this problem…

Based on what Summers is saying, the stress tests are not designed to really test anything. They are designed to make it seem like the government has things well in hand so that we can grow our way out of this crisis with the help of government stimulus and debt.

Now, Summers and Geithner are not stupid. They do have a backup plan here. As I said in a recent post, not everyone is going to pass, and indeed, some banks have failed. What does that mean? It means these banks will be given some time to come up with the capital necessary to be adequately capitalized. If they cannot do so, the government will have to explore other options. This Plan B could include debt-for-equity swaps, nationalization, and FDIC seizure.

So, Geithner and Summers are hoping FDIC-subsidized funding, toxic asset removal, fiscal stimulus, quantitative easing and all the other measures now in place will kick in and provide a recovery – and solve the banking problem. However, if the problem is not solved, there is plan B – debt-for-equity swap, nationalization, or asset seizure.

In my view, we should be going to Plan B right from the start rather than going through this jerry-rigged sham of a stress test.

Everyone beat the clock… except Cit and BofA

Now, time is up. All of the big banks raised boatloads of capital months ago. If Citi and BofA aren’t ready to hand back TARP funds yet… then they may never be. It is time for Plan B.

Remember back in May when all the big banks ‘passed’ the tests and immediately went to the capital markets for more capital after their share prices had doubled, tripled and quadrupled? That whole process was by design. We were supposed to have some ‘stress tests,’ followed by a clean bill of health, all in an effort to get those stock prices up so the banks could sell shares to shore up their capital base (the exact same thing has just happened in Sweden, by the way. See here and here).

Every bank CEO which could escape TARP, ran as fast as he could away from the government and the TARP facility. Only the truly capital-constrained remained under TARP, namely Wells, BofA and Citi. Wells is going to earn their way out of this one (which George Soros feels is exactly what should happen). Obviously, Citi and BofA are a different story. Hence the pay caps. But, I suspect there is a lot more.

Citi pullback and asset sales

Let’s concentrate on Citi because I have written a lot about their asset sales over the last year. They are the big bank which is truly deleveraging the most. They are selling everything they can to raise cash. Here’s a short list. Please tell me ones I have missed.

• Sale of German retail bank (Jul 2008)
• Morgan Stanley-Smith barney deal (Jan 2009)
• Lending halt in Denmark (Feb 2009)
• Sale of Brazilian assets (Feb 2009)
• Sale of Japanese business Nikko (May 2009)
• Potential disgorgement in Mexico (Oct 2009)

I am sure there is a lot I am missing here. Nevertheless, it is clear that the Citigroup of 2011 or 2012 will be a shadow of its former self. I suspect the same is true for Bank of America as well.

But, it strikes me as likely that these sales – at least the ones in 2009 – are being dictated by the Obama Administration. Citibank may not be selling purely because they need the capital and it makes strategic sense to do so. The coercive power of government may be standing shotgun over this.  All of the chatter between big banks and government is being done behind closed doors, so we can’t know what the true pre-conditions of the BofA or Citigroup bailouts were.

My operating assumption to date is that the government recklessly gave the banks all of the bailout money and backstops, asking next to nothing in return – all largely because they are captured by the financial services lobby. But, I would like to think there were at least some strings attached and that we are now beginning to see what those strings are.

Related posts:

• JPMorgan has record revenue and $2.7 billion in profit
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• Ten big banks receive approval to repay TARP funds
• How is Citi going to deal with $38 billion in deferred tax assets?
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks

This is my translation of a Dutch-language article which appeared today in Belgian daily De Tijd. Let’s see if this news is picked up in the U.S.

Citibank Belgium never should have recommended the controversial Lehman Brothers investments to its customers. So states the writ of the Brussels public prosecutor on the case.

The collapse of Lehman Brothers lost more than 4,000 Citibank customers, 128 million euros. The public prosecutor accuses Citibank of a “conflict of interest". "The bank had apparently instructed a higher-level committee to work toward the wholesale transfer of ordinary savings account money to Lehman Brothers."

According to the prosecutor, this is the reason Citibank used "misleading" advertising and many other “tricks” to systematically sway customers to exchange their savings for Lehman products, concealing the bank’s true risks, returns and capital guarantees. The court now demands that Citibank pay back the full 128 million euros, plus interest and fees.

Political reactions
MP Hans Bonte (SP.A) is very pleased that the Brussels public prosecutor also came to the conclusion that Citibank sold investments of the now bankrupt Lehman Brothers in an "unfair and irresponsible manner.” "That is what we have charged for months and years," said the Socialist opposition figure. The most important thing for him now is that all victims be identified and if possible obtain compensation.

Better would be if Citibank itself took on its responsibility and reimbursed customers who lost their savings, Bonte said in reaction to the news.

He believes that the Government should draw lessons from the case. According to Bonte, it is clear that something wrong with the supervision of the banks by the Banking, Finance and Insurance Commission (CBFA). Immediately he called for legislation on the appeals claim, so that a lawsuit could be filed in this case for the 4,000 victims.

Commerce Minister Vincent Van Quickenborne (Open VLD) called on Citibank again to choose an efficient settlement instead of letting it come to a possibly long and damaging process. The Minister also notes that the victims who have yet to take civil action be informed of the impending trial, so they also can take part in the civil action.

He recalls that he last year he ordered the Economic Inspectorate investigate the way Lehman Brothers products were advertised and sold by Citibank . This dossier was turned over to the prosecutor in December.

Although the analysis of the Economic Inspectorate showed that there are about 4,000 potential victims, there are only 1300 who have reported to the Inspectorate or the prosecutor. At the request of the Minister, the prosecutor and Economic Inspection examined how the remaining 2700 known victims can be informed about their rights before the start of legal proceedings. They have now been notified by letter.

The trial starts in December. Van Quickenborne hopes that as many people as possible can file civil claim to be compensated for their loss. He immediately repeated his "resolute" call to Citibank to not let it go so far and to choose an efficient settlement.

Source

Parket snoeihard voor Citibank – De Tijd

Related posts:

• Citibank has cut all lending in Denmark
• Lehman pension shortfall is a foreshadowing
• Lehman Brothers to post $3 bln loss; sets $6 bln stock sale
• Lehman missed out on $5 billion from Korea
• Dick Fuld feels horrible about Lehman collapse

Back in March when the US Government felt compelled to bail out out Citigroup, Tracy Alloway over at FT Alphaville noticed a curious thing – Citigroup had effectively been nationalized.

No, they were not seized by government, but Citi was controlled by government.  The Feds had 36% of shares outstanding, which in many cases is considered to be a controlling interest for a government (for instance, until the Open Skies Treaty pushed the level to 49%, foreign carriers could not take more than a 25% stake in any airline as this is considered a threat to national security).  That matters because of Banamex.

From Alphaville on 2 Mar:

Does the US government’s 36 per cent stake in Citi violate Mexican ownership laws? Have we got our countries confused? No.

Citi owns Banamex, a Mexican bank with circa 1,200 branches and 2.6m checking accounts. And Latin American finance blog Inca Kola sees a fight brewing over the Southern subsidiary:

The nub of the issue revolves around Mexican law, which states in crystalline manner that foreign governments cannot own more than 10% of any bank that operates inside Mexico. It’s as clear as a bell and on the statute. So as Banamex is a wholly owned subsidiary of Citigroup (C paid $12.1Bn or so back in 2001 for the bank) if the US Gov’t takes its 36% stake in Citigroup then it will be a larger-than-10% shareholder of Banamex, something against Mexican law. Won’t it?

Mexico’s National Banking and Securities Commission is therefore investigating, while Banamex is saying that the North American Free Trade Agreement will (somehow) protect it.

The next day Bloomberg reported that Mexican law makers had decided to pursue a bill to force Citi to disgorge itself of Banamex because of it was a government –controlled entity.  Then this story disappeared from the mainstream press. 

Now, as background, after the recession of 1991, Citicorp was bailed out by Prince Waleed of Saudi Arabia because it was in danger of failing. Low interest rates and the money from Prince Waleed did the trick and Citi experienced a remarkable recovery – and eventually the broader economy did as well. In fact, recovery was enough that Alan Greenspan attempted to raise rates fairly rapidly (this was before policy asymmetry at the Fed because the norm). The result was the Tequila Crisis and the near bankruptcy of Mexico (see my post “1995” for more.)

Banamex , the 2nd largest Mexican bank, was made insolvent due to the Tequila crisis. And what do you know, Citi swooped in to buy it lock, stock and barrel. Spain’s BBVA later took over the re-privatized Bancomer that had been nationalized after the Latin American Debt crisis in 1982 (also induced by rising rates in the US).

These incursions into Mexico have caused outrage. Why should foreigners own the two largest banks in the country? So, the topic of Nationalized Citibank has been percolating for a while in Mexico. And it has just resurfaced.

From Breakingview.com:

Mexico’s high court is set to decide this week whether to hear a case brought by a contingent of Mexican senators that Citi must offload Banamex because a foreign government owns more than 10 percent of its stock. They want the court to decide whether the finance ministry had the constitutional right to decree in March that the United States government’s 34 percent slice of Citi was acceptable because it was intended to be short term.

So Citi is hardly up against a wall just yet — and it reckons any decision to force a sale would breach the North American Free Trade Agreement anyway. But if push comes to shove, the bank should be prepared to put up more of a fight than it did for Phibro.

Quite frankly, America is used to treating Mexico – all of Latin America, really – like its poor cousin. This displays a lack of respect that many there find galling.  If Citi is forced to disgorge itself of Banamex, it will be interesting to see not how Citi reacts, but how the Obama Administration reacts since he wants to present a new American image on the world stage.

By the way, below is a hilarious video of ‘Nationalized Citibank’ that captured the mood in America back in March when the bailout happened.

Related posts:

• Does Obama have the legal authority to take over Citi?
• Citi: looking for as much as a 40% stake from the government
• Will Mexico suffer contagion?
• Citigroup and Redecard: shedding international assets
• Is Mexico imploding?

While Citi and BofA are getting taken to the woodshed for double secret probation, JPMorgan Chase is showing record revenue of $25.6 billion and a large profit of $2.7 billion.  As profit is up 36% from a year earlier and 27% from just last quarter, you can see that JPM is now firing on all cylinders.

The contrast between the performance at JPMorgan Chase and Goldman, who reported Tuesday and the beating that BofA and Citi are taking at the hands of regulators demonstrates which big banks are weak and which are doing better.  Goldman and JPMorgan have already returned their TARP funds and are free to return to business as usual.  Goldman has increased risk to pre-crisis levels according to Value at Risk (VaR) measurements and are due to give out record bonuses.  Meanwhile, JPMorgan Chase saw its loan loss reserves fall 2% from Q1 to Q2.

Citi is up tomorrow. Expect a huge contrast to what we have seen from Goldman and JPMorgan Chase. 

Also expect some serious regulatory steps as well. As I indicated in April’s post “Stress tests reveal Citi and BofA need more capital, but you knew that already,” some banks were going to pass the stress test while others would fail. I also said then that debt for equity swaps, nationalization or FDIC seizure were going to be on the table, if the failing banks didn’t get the necessary capital from the private market. Citi and BofA have both failed the stress tests and have not gotten enough capital.  So the Feds are going to move in and take action- and we’ll get a sense of what kind of action tomorrow.

The only remaining question is Wells Fargo.  They have not paid back their TARP money but I still suspect they are doing better than Citi and BofA.

Related posts:

• JPMorgan: Beats expectations despite writedowns
• Is Citi being forced to downsize by Obama?
• Ten big banks receive approval to repay TARP funds
• Will banks exiting TARP take back their toxic waste now?
• How is Citi going to deal with $38 billion in deferred tax assets?

If you haven’t noticed, the Treasury department seems to be leaking the results of the stress tests to reporters at the Wall Street Journal.  Richard Bove, a well-known bank analyst was on Bloomberg Radio this morning talking to Tom Keene and said he knows they have been leaking.  Yves Smith was on top of this a few days back.  With the results to be released tomorrow, we now pretty much know who the winners are and who the losers are.

The losers are Citigroup, Bank of America, Wells Fargo and GMAC. Bloomberg reports:

Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and GMAC LLC are among the companies judged to need additional capital according to results of regulators’ stress tests on the 19 largest U.S. banks.

Bank of America has the biggest shortfall, at $34 billion, according to people familiar with the matter. Citigroup’s requirement for deeper reserves to offset potential losses over the coming two years is about $5 billion, people with knowledge of that bank’s results said. Wells Fargo requires about $15 billion, while GMAC’s need is $11.5 billion, one person said.

Goldman Sachs Group Inc., Morgan Stanley, MetLife Inc., JPMorgan Chase & Co., Bank of New York Mellon Corp. and American Express Co. were deemed not to need additional funds, the results show.

Stocks rallied after the news, sending the Standard & Poor’s 500 Financials Index to its highest level in four months. The results are the culmination of weeks of investigations, led by the Federal Reserve, into the banks’ lending practices, funding strategies and securities and loan portfolios.

“The markets are telling us we’re in a recovery and the banks are beginning to heal,” William Isaac, former chairman of the Federal Deposit Insurance Corp., said in an interview today. The end of the stress tests after “three months of water torture” is providing investors some relief, he said.

The regulators put an emphasis in their reviews on tangible common equity. Citigroup’s assessment reflects the New York- based bank’s previously announced plan to convert some of its preferred shares into common stock.

Spokespeople for all of the 10 banks declined to comment.

It’s not as if any of these banks really are losers here.  This charade was pretty predictable. I said as much last week. 

Just one look at the credit ratings and stock prices of the 19 banks and financial institutions in the stress tests will tell you which are the weak institutions. So, why the charade?

Based on what Summers is saying, the stress tests are not designed to really test anything. They are designed to make it seem like the government has things well in hand so that we can grow our way out of this crisis with the help of government stimulus and debt.

Now, Summers and Geithner are not stupid. They do have a backup plan here. As I said in a recent post, not everyone is going to pass, and indeed, some banks have failed. What does that mean? It means these banks will be given some time to come up with the capital necessary to be adequately capitalized. If they cannot do so, the government will have to explore other options. This Plan B could include debt-for-equity swaps, nationalization, and FDIC seizure.

Of those banks that need more capital, Bank of America was up 15%, Citi 14%, and Wells 13%.  Only GMAC suffered.  The word on the street is that investors are happy with the results and relieved that more capital is not needed. Congress and taxpayers won’t need to pony up either.  That’s a relief!

Bove doesn’t seem to think this is good news however.  Another Bloomberg story quoted him as seeing this as negative for expanding credit:

Forcing banks to boost capital in the midst of a recession will cripple lending and may delay a recovery, said Richard Bove, vice president and equity research analysts at Rochdale Securities in Lutz, Florida.

“How are they going to assist the American economy if they are shrinking?” Bove said today in an interview on Bloomberg Radio. “If you make all those banks shrink, which is what you’re really doing by forcing them to add capital, how are they going to lend money?”

Regulators determined Bank of America Corp. requires about $34 billion in new capital, the largest need among the 19 biggest banks subjected to government stress tests, according to a person with knowledge of the matter. Other institutions require capital as well.

“If you go beyond these 19 banks to the next 20, which is what they are going to do, you’re going to knock some of those banks out of business,” Bove said.

“By the time you finish, my guess is you will at least knock at least 150 banks out of business in the United States, shrinking the banking industry in the middle of a recession at a time when you want them to provide more lending to grow the economy,” Bove said. “It makes no sense at all.”

In theory, Bove is correct, but there have been significant reports that Bank of America is selling non-core assets and that they will convert all of their preferred stock into common in order to meet the tangible common equity guidelines laid out in the stress tests.  So, ultimately, even Bank of America, the most under-capitalized of the banks is not going to have to raise any outside capital.  This is why bank shares were up big-time.

But, wait a minute.  Isn’t the preferred, equity that Bank of America already has on its balance sheet?  Why is moving items around like a massive shell game going to make this organization better capitalized?  Paul Kasriel has the answer. It’s called accounting alchemy (pdf):

Congress currently is in no mood to authorize more funds to help recapitalize the financial system. The Treasury says this will not be a problem. If financial institutions need additional capital from the taxpayers to remain solvent, the Treasury will simply shift the preferred shares it already owns in financial institutions to common equity shares. Voila – capital adequate financial institutions! Really?

Consider Balance Sheet One of hypothetical Gotham City Bank. Assets equal liabilities plus common equity. That is good for starters.

But suppose the Treasury believes that Gotham should have a ratio of common equity to total assets of 10% rather than the 5% it currently has. No problem. Treasury will just convert $5 of the preferred shares it owns in Gotham to $5 of common equity. This is shown in Balance Sheet Two. Now Gotham is well capitalized, right? Wrong. The depositors and the bond holders always were in line in front of the preferred shareholders in case Gotham had to be liquidated. So, moving $5 from the preferred equity category to the common equity category does not make the depositors and bond holders any better off. Are taxpayers any worse off? Not really. If Gotham’s original $5 of common equity was not going to be enough of a cushion to protect depositors and bondholders, then taxpayers were not going to get all of their preferred-share holdings back anyway.

Now suppose that $30 of Gotham’s loans and investments become uncollectible, as shown in Balance Sheet Three. This means that all of Gotham’s common equity has been wiped out. In fact, Gotham now has an equity "deficiency" of $20. No problem, according to Treasury. It will simply convert its remaining $10 of preferred equity to common equity. That won’t cut it in this case. As shown in Balance Sheet Four, Gotham still has a common equity deficiency of $10. In other words, if Gotham were to be liquidated, there are only $70 of assets to pay off $60 of deposits and $20 of bonds. Either the Treasury would have to come up with $10 of new funds or bondholders would have to take a 50% haircut. If the Treasury wanted to keep Gotham open and with a ratio of common equity to total assets of 10%, Treasury would have to inject $17 of new funds, all of which would be common equity. In other words, Treasury, meaning us taxpayers, would own 100% of Gotham.

In sum, Treasury’s plan to enhance the capitalization of some financial institutions by beating preferred equity shares into common equity shares is accounting alchemy.

Problem solved. There will be no train wreck. Move along, nothing to see here.

Related posts:

• Bank by bank breakdown of stress test results
• At least six banks need more capital under stress tests
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• What the stress tests reveal about Obama’s thinking on banks
• GMAC has been nationalized

With the stress test results coming out, it is a wonderful thing for Citigroup that it has been able to sell its Japanese brokerage unit to Sumitomo Mitsui, and at a good price of $7.8 billion.

Here’s an excerpt of the FT story:

Citigroup on Friday sold its Japanese brokerage and some parts of its local investment bank to Sumitomo Mitsui Financial Group (SMFG) as part of a deal worth Y774.5bn ($7.8bn) that will boost the troubled US bank’s capital.

Japan’s third largest bank is paying Y545bn for Citi’s Japanese securities business, which is mainly comprised of Nikko Cordial Securities, and a further Y28.5bn for Japanese-listed securities held by Citi.

Additionally, Citi is to receive Y201bn in cash by either retaining excess cash held in Nikko Cordial or by receiving repayment of debt owned by the Japanese brokerage to Citi.

The acquisition of Nikko Cordial, which catapults SMFG to the top ranks of Japanese securities companies, is a further step in the re-ordering of Japan’s financial landscape.

This deal will reduce assets and raise capital, all very much necessary for Citgroup as it is the bank where all eyes will be focused when the stress test results are made public.

Sources
Citi sells Japanese unit for $7.8bn – FT.com

Related posts:

• Citigroup and Redecard: shedding international assets
• JPMorgan has record revenue and $2.7 billion in profit
• Japan circa 1996 – forgotten already?
• Citigroup and Morgan Stanley: the City Morgue is now open
• Unscathed Japanese banks on the prowl

The leaks about who failed the stress tests are already starting.  Who got a big fat ‘F’?  Apparently, Citi and BofA for starters.  But is that any surprise?

Regulators have told Bank of America Corp. and Citigroup Inc. that the banks may need to raise more capital based on early results of the government’s so-called stress tests of lenders, according to people familiar with the situation.

The capital shortfall amounts to billions of dollars at Bank of America, based in Charlotte, N.C., people familiar with the bank said.

Executives at both banks are objecting to the preliminary findings, which emerged from the government’s scrutiny of 19 large financial institutions. The two banks are planning to respond with detailed rebuttals, these people said, with Bank of America’s appeal expected by Tuesday.

The findings suggest that government officials are using the stress tests to send a tough message to struggling banks. Bank of America and Citigroup have been the highest-profile problem children in recent months, but it is unlikely that they are the only banks the Federal Reserve has determined might need more capital.

Just three months ago these two mega-banks were on the verge of collapse and needed yet more cash to sustain them.  So, the ’stress tests’ haven’t provided any new information.  But, ah, there’s that last sentence: “it is unlikely that they are the only banks the Federal Reserve has determined might need more capital.”  Who else might need more dosh?

Industry analysts and investors predict that some regional banks, especially those with big portfolios of commercial real-estate loans, likely fared poorly on the stress tests. Analysts consider Regions Financial Corp., Fifth Third Bancorp and Wells Fargo & Co. to be among the leading contenders for more capital. Wells Fargo declined to comment. Representatives of Regions and Fifth Third didn’t respond to requests for comment made late in the day.

Government officials say their meetings about the stress tests with bank executives over the past few days conveyed preliminary results and that discussions were expected to continue this week about specific findings. They also say that banks directed to raise more capital shouldn’t be viewed as insolvent.

Come again? Banks directed to raise more capital shouldn’t be viewed as insolvent? Then what is the purpose of the stress tests, pray tell?

Instead, the capital is intended to cushion the banks against potential future losses under dire economic conditions. Federal officials say they won’t allow any of the top 19 banks to fail.

Still, it is unclear how flexible the government will be about adjusting the results, especially as banks plead their cases individually. Banks have until the middle of this week to lodge their formal responses to the tests. Bankers expect that will set the stage for several days of intense negotiations between the banks and their examiners.

Ah, I see, it is all a sham.

It sounds a lot like a test where the student banks who just failed go to the teacher regulator with mommy and daddy bank lobbyists in tow to see if they can get their grades changed higher. See, the stress are just a scheme to make us think the Federal government is actually doing something about the under-capitalized banking system in the U.S.. In reality, the Obama Administration is just buying more time in order to let us grow our way out of this problem.

According to MIT Professor and former IMF Chief Economist Simon Johnson, this is very nearly what Larry Summers said in a Feb 24th speech at the Inter-American Development Bank. Summing up Summers’ statements, Johnson says:

Summers made five points that reveal a great deal about his personal thinking – and the structure of thought that lies behind most of what the Administration is doing vis-a-vis the crisis. Some of this we knew or guessed at before, but it was still the clearest articulation I have seen.

1. All crises must end. The “self-equilibrating” nature of the economy will ultimately prevail, although that may take massive one-off government actions. Such a crisis happens only ”three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.
2. We will get out of the crisis by encouraging exactly the kind of behaviors that “previously we wanted to discourage” two years ago. It is “this insight, this view” particularly with regard to leverage (overborrowing, to you and me) that “undergirds the policy program in the United States.”
3. There is a critical need to support financial intermediation and to ensure it is adequately capitalized, with a view to the risks inherent in the current situation. He then said, with a straight face, that the current bank stress tests are designed with this in mind.
4. Growth in the 1990s and more recently was based too much on finance (this appears to be a relatively new thought for Summers). The high and rising share of finance in corporate profits “should have been a warning”. The next expansion should be based less on asset bubbles and more on investment in key public services.
5. The financial regulatory system “in fundamental respects has been a failure”. There have been too many serious crises in the past 20 years (yes, this statement was somewhat at odds with the low frequency of major crises statement in point 1).

Just one look at the credit ratings and stock prices of the 19 banks and financial institutions in the stress tests will tell you which are the weak institutions. So, why the charade?

Based on what Summers is saying, the stress tests are not designed to really test anything. They are designed to make it seem like the government has things well in hand so that we can grow our way out of this crisis with the help of government stimulus and debt.

Now, Summers and Geithner are not stupid. They do have a backup plan here. As I said in a recent post, not everyone is going to pass, and indeed, some banks have failed. What does that mean? It means these banks will be given some time to come up with the capital necessary to be adequately capitalized. If they cannot do so, the government will have to explore other options. This Plan B could include debt-for-equity swaps, nationalization, and FDIC seizure.

So, Geithner and Summers are hoping FDIC-subsidized funding, toxic asset removal, fiscal stimulus, quantitative easing and all the other measures now in place will kick in and provide a recovery – and solve the banking problem. However, if the problem is not solved, there is plan B – debt-for-equity swap, nationalization, or asset seizure.

In my view, we should be going to Plan B right from the start rather than going through this jerry-rigged sham of a stress test.

Sources
Fed Pushes Citi, BofA to Increase Capital – WSJ
Larry Summers’ New Model – The Baseline Scenario

Related posts:

• BofA, Citi, Wells and GMAC biggest losers in stress test leaks
• At least six banks need more capital under stress tests
• Reinhart: Not everybody can be above-average in stress tests
• Ackman and Stigliz talk Stress Tests with Charlie Rose
• What the stress tests reveal about Obama’s thinking on banks

This comes from French-language Swiss daily Le Temps:

Over 50% of respondents in Geneva surveyed by the HEG School of Management believe that the bankruptcy of a large institution is likely.

The Swiss political world is clearly convinced that it will never let one of the major banks in the country go bankrupt. Despite the rescue of UBS by the Swiss Confederation and the Swiss National Bank (SNB), 53% of the approximately 550 people surveyed by the Haute Ecole de Gestion (HEG) in Geneva in the first quarter 2009 estimate it “likely” that a major bank will declare bankruptcy. This proportion was only 37% last June.

Clearly either the citizens have it wrong or Switzerland is in big trouble. Along those lines, I have another poll for you (click through to the site to vote): Will Citigroup eventually escape this crisis without a drastic reduction in size?

Let us know what you think.

Related posts:

• The Swiss get on the QE2
• Switzerland threatened with bankruptcy
• UBS woes with IRS have Swiss worried
• Swiss Franc at Dollar parity?
• Michael Panzner: regional banks in trouble

Here we are just days out from the announcement by Treasury Secretary Tim Geithner that the Obama Administration will be buying up so-called toxic assets as originally planned by Henry Paulson during the Bush Administration.  The initial reaction has been one of euphoria as most asset markets responded positively to the news.

Now that the dust has settled somewhat, another reaction is taking place behind the scenes and it looks an awful lot like banks — specifically Citigroup and Bank of America — are gaming the system (hat tip Yves, Tom and Barry).  Note my highlighting:

As Treasury Secretary Tim Geithner orchestrated a plan to help the nation’s largest banks purge themselves of toxic mortgage assets, Citigroup and Bank of America have been aggressively scooping up those same securities in the secondary market, sources told The Post.

Both Citi and BofA each have received $45 billion in federal rescue cash meant to help prop up the economy and jumpstart the housing market.

But the banks’ purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.

One Wall Street trader told The Post that what’s been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay.

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

The secondary market represents a key cog in the mortgage market, and serves as a platform where mortgage originators can offload mortgages in bulk that have been converted into bonds.

Yields on such securities can be as high as 22 percent, one trader noted.

BofA said its purchases of secondary-mortgage paper are part of its plans to breathe life back into the moribund securitization market.

“Our purchases in [mortgage-backed securities] increase liquidity in the mortgage market allowing people to buy a home,” said BofA spokesman Scott Silvestri.

A Citi spokesman declined to comment, though people familiar with the bank say it argues the same point.

You can read the rest of the Post article to see the full details. Of course, I am sceptical here. But, for the sake of argument, let’s assume Citi and BofA are telling us the truth as to their true motivations.

One must still ask the question: why are BofA and Citi, two of the weaker large banks in the U.S., aggressively buying up the same toxic assets which have already caused them huge writedowns? Here’s another one for you: if Citi and BofA are so bullish on these Mortgage-backed securities, why weren’t they buying them aggressively two weeks ago or last month? What’s changed between then and now?

I’ll tell you what has changed: the Geithner Plan. See, the U.S. government has pledged to purchase these toxic assets from banks like Bank of America and Citigroup. That means Citi and BofA know full well that they aren’t going to be holding these assets for long. So why are they buying? A couple of reasons:

1. The Geithner Plan effectively pledges to insure the purchases of these assets against downside risk.  This implicit put option means the sale price will be higher than a free-market transaction.  In essence, this is a transfer of money from taxpayers to both the selling and investing organizations.  Therefore, it behooves sellers to sell more assets.
2. The auction process is non-binding meaning the selling organizations do not have to sell if they don’t like the price offered.  In effect, this means the sellers have yet another option: the right but not the obligation to sell at a specific price.  This is the definition of a put option.  That means sellers are going to transact only if the sale does not force them to writedown the assets too much. Of course, they have received this option free of charge.  

Now, if you were Citi or BofA, wouldn’t you be looking to get the most out of this process as well? Their actions are wholly predictable. Nevertheless, their actions demonstrate the problems with this plan i.e. that we are about to see a massive transfer of money from taxpayers to banks. The interesting thing about all of this is that most Americans won’t necessarily know that these implicit options are embedded in the transaction structure unless they are familiar with derivatives.

My take on this is similar to Barry’s: Citi and BofA’s actions demonstrate yet again why the government must take control of the organization and get rid of existing management. Neither the Bush Administration nor the Obama Administration has been willing to do so.

For more on embedded options in the Geithner plan see Steve Waldman’s piece, Degrees of recourse.

UPDATE 1150AM ET: The Economist has this to say:

These assets can’t be comparable to ones for which the Geithner plan is designed, because that plan is designed for assets for which no secondary market exists. If a secondary market does exist, then presumably there’s no need to discover prices—we can just look at them—and there’s no question about which banks are solvent. I don’t see how Bank of America can go out and by a bunch of MBS on the market, then turn around and auction them based on the idea that they don’t know what they’re worth.

Right? What am I missing?

Source
Citi, BofA buying back laundered loans at lower rates – NY Post

Related posts:

• Roubini: Nationalization “fully on the table” in Geithner’s Plan
• Is Citi being forced to downsize by Obama?
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• S&P downgrades BofA
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks

From Justin Fox of Time Magazine:

FDIC chairman Sheila Bair doesn’t think a full government takeover of Citigroup and other multinational financial institutions is practical or even possible. Here are her reasons, as summarized by Pete Davis:

1. The legal authority to take over large banks does not currently extend to multinational financial conglomerates;
2. The FDIC lacks the funding to conduct such a massive bailout;
3. Other countries have regulatory oversight of these financial conglomerates too, and they may object to a U.S. takeover.

Perhaps we are getting the reason Geithner and company are reluctant to take on Citi: they have no deposit base for the feds to step in on relative to their asset base.  Remember, Citi wanted to buy Wachovia for more deposits. The domestic bank Citibank simply does not have that many deposits. The nearest Citi branch — which I use — is actually only 6 blocks from my house. But, it operates largely in the Tri-State area of New York, New Jersey and Pennsylvania and has little presence outside.  Justin Fox puts it well:

To repeat: Citigroup has liabilities of $1.797 trillion. The deposits that the FDIC has some responsibility for (up to $250,000 per depositor) add up to $241 billion. So we have this reasonably sensible system for winding down troubled banks, but when it comes to the most troubled big banking company in the country, said system only covers a fraction of the overall operation. Which leads to a couple of conclusions:

1. I get why the administration is so reluctant to take over Citi completely.

2. I don’t get why we all (I’m including myself in this) thought it was okay to allow the creation and growth of gigantic financial companies for which we had absolutely no plan for winding down in case of trouble.

And remember the problem with Banamex, which Citi owns.  The Mexicans could see Citi as state-owned.  After all, the TALF considers 25% the state-owned threshold.

This banking crisis gets more interesting by the day.

Sources
How much of Citigroup could the FDIC actually take over? – Time
Bana-vexed – FT Alphaville

Related posts:

• Chart of the Day: Citigroup
• Seven more bank failures brings total to 64
• Is Citi being forced to downsize by Obama?
• FDIC shuts down Haven Trust and Sanderson State
• Two more FDIC Friday Night Specials brings total to 55 failed banks

Beim is a Columbia Business School professor. He was there back when I was at Columbia, although I don’t remember being in any of his classes.

Basically, he thinks Citigroup needs to be shrunk down and sold off in pieces.

Before he became a Professor, Beim worked as an Investment Banker at First Boston and Dillon Read, two white shoe firms that are now defunct, absorbed into the Swiss giants Credit Suisse and UBS respectively. He also was at Bankers Trust, now a part of Deutsche Bank.

Related posts:

• Did Sweden really nationalize its banks?
• Are Citi and BofA gaming the Geithner Plan already?
• Citi: looking for as much as a 40% stake from the government
• Doubling down at AIG
• Are European banks sitting on 16.3 trillion in toxic assets?

Oppenheimer has a research note out today that calls Tim Geithner an “evil genius. (hat tip Scott)” The genius moniker comes from the steady creep up the capital structure, giving Geithner access to huge pools of money as the Treasury dials for dollars. The evil part has everything to do with the pain this strategy is going to mete out to preferred shareholders and, eventually, bondholders.

The end of Oppenheimer’s piece is worthy of a quote as it demonstrates great analysis from a team that just lost start analyst Meredith Whitney.

Geithner’s Message to the Capital Markets

In his actions if not his words, Secretary Geithner is saying something very pointedly to all the key capital-market participants, and he is saying it to all participants industry-wide–not just Citi shareholders:

To common equity shareholders, he is effectively saying this: “You will be treated fairly and you will be allowed to raise substantial new equity at the reference price, which is roughly the prevailing price at the time that I took office. However, if you bought a $2 or $3 bank stock in hopes of earning leveraged, warrant like returns, on the assumption that Treasury would supply infinite capital and liquidity on favorable terms in perpetuity, guess again. You will be diluted until the right-hand side of the balance sheet has a reasonable mix between common equity and more senior capital.”

To preferred and subordinated debt holders, Geithner is effectively saying the following: “If the bank holding company in which you hold capital instruments is in dire need of common equity capital, then come to terms with them or we will do it for you! You knew at the time that you purchased this paper that they were not FDIC insured deposits, but rather capital instruments of a bank holding company. If the company in which you invested is in dire trouble, you too should share some of the pain and not expect 100 cents on the dollar.”

To the short-sellers of bank stocks, Geithner is effectively saying this: “Take your profits and go home; you cannot drive another major BHC stock to zero. We will never let another Lehman Brothers catastrophe happen. If need be, we will drill through the next $18 billion of preferred equity which would add another percentage point to the TCE ratio, and if that is not enough then there is another $192 billion of Citigroup holding company debt obligations which can be converted and add another ten percentage points to TCE (all of which at $3.25 per share would result in another 65 billion shares being issued), but at the end of the process, however far it needs to go, we are going to end up with a viably capitalized, publicly traded company trading under the “C” symbol. The only thing that is really at issue how many shares of this stock will be in circulation at the end of the process. It is this way with Citi, and it will be this way with any other large BHC.”

Source
Geithner’s Evil Genius, Intraday Report – Oppenheimer (no link)

Related posts:

• TARP dividends are killing bank profits
• The Citigroup Bailout
• Some banks not paying TARP dividends
• Buffett to invest in General Electric
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks

The big news other than GDP falling off a cliff is the confirmation that the Obama Administration is going to bail out Citigroup for a third time.  The market reaction this morning was quite negative, causing index futures to sell off even before the GDP number hit the tape.  Citigroup itself dropped as much as 50% in pre-trading.  Why?  Here’s my take.

Citigroup is a troubled financial institution that would be seized by the FDIC if it were a small institution or that would be forced into the hands of another company if it were a large institution.  However, it is neither.  Citigroup is a colossus that spans the globe with its tentacles in everything.  Therefore, Citi receives special treatment.

Now, if Citi were small, shareholders would be wiped out and receive nothing as the FDIC grabbed its assets and sold them off like it has done with some 20-odd institutions to date during the crisis.  If Citi were large, like Wachovia, it might be forced into the hands of another large institution, with shareholders getting pennies on the dollar.  Effectively, they would be wiped out.  However, everyone knows that neither of these options were available, so Citigroup’s share price was artificially inflated by a belief that the organization would benefit in some way by government intervention.

The government has intervened.  However, it is now crystal clear that shareholders will not benefit. They will either be diluted by government ownership or they will be wiped out through eventual nationalization — an option still denied by the Obama Administration in spite of the facts.  The shares had benefited from uncertainty because Citigroup shares are really just  options on a government bailout.  Now that the uncertainty has diminished, those options are worth significantly less.

As to policy, one should be very disappointed.  In my view, the market has sold off largely because the ad hoc bailout policies initiated by Hank Paulson under President Bush have been continued under President Obama.  This makes investment in any financial services industry company difficult.  

Will the government pony up more funds?  Will they nationalize?  Will they seize the assets?  Will shareholders be wiped out? Will bondholders take a haircut?  Each new decision made by the U.S.  Government provides zero clarity on all these issues.  The only thing that is clear is that taxpayer money will continue to be used to prop up troubled institutions for the forseeable future.

In such an environment, one is well-advised to stay away from shares in the financial sector. Investors are beginning to understand this logic.  This is why shares are selling off across the board.

Related posts:

• The Citigroup Bailout
• How well capitalized is Citigroup?
• The Citigroup Bailout: a blogosphere post-mortem
• Citigroup grabs Wachovia on the cheap
• Does Obama have the legal authority to take over Citi?

Citigroup is looking to raise capital and shed assets in order to deleverage and prevent a worst-case outcome for the financial institution. Case and point is the fact that the company is putting its Brazilian subsidiary Redecard on the block for sale:

Citigroup Inc., the New York-based bank bailed out by the U.S. for $52 billion, plans to sell its stake in Brazilian credit card processor Redecard SA through a public offering, according to a securities filing.

Citigroup registered with Brazil’s securities to sell shares of the Sao Paulo-based company, without setting a price for the offering, according to the filing from Redecard. Citigroup owns 17 percent of Redecard, a stake worth 2.94 billion reais ($1.24 billion) based on today’s closing price.

Chief Executive Officer Vikram Pandit is shedding Citigroup’s businesses to free up capital after the bank posted a record $18.7 billion loss in 2008. Last month he said he planned to sell the bank’s CitiFinancial consumer-finance and Primerica life-insurance units as soon as the market permits, and struck a deal to sell majority control of the bank’s Smith Barney brokerage to Morgan Stanley.

Redecard, the Brazilian processor of payments for Mastercard Inc., is down 6.5 percent in the past 12 months, compared with a 41 percent drop in Brazil’s Bovespa index. The stock climbed 3.89 reais today to 25.66 reais. Citigroup shares, which have plunged 90 percent in the past year, dropped 3 percent today to $2.52.

Citigroup spokesman Mike Hanretta in New York didn’t immediately return a call for comment.

A few days ago, I noted that Citi had stopped lending in Denmark and had cut credit lines in the UK. This is all part of a push by Citigroup to shed non-core assets. Reports that Citi is to get rid of Nikko Citigroup in Japan are hitting the headlines as well.

What remains unclear is whether Citi is making these moves just to stave off a worst-case outcome (i.e. bank failure). These sales certainly make the company easier to sell or nationalize.

Souirce
Citi to Sell Redecard Stake in Brazil Public Offer – Bloomberg.com

Related posts:

• Rubin resigns from Citigroup
• How well capitalized is Citigroup?
• Citigroup gets $7.8 Billion for Japanese unit
• Credit Suisse cautious on Citigroup due to regulatory hurdles
• Citigroup talks with US Government as bankruptcy looms

This news is just in from the Wall Street Journal. Obviously, all of the activity we have seen with Citi’s foreign subsidiaries of late has been in preparation for sale or nationalization. I expect this to be the big news when markets open tomorrow. Note: this will mean massive dilution for shareholders, so it is unclear how the markets will react to the news. I will update this post as information becomes available.

Citigroup Inc. is in talks with federal officials that could result in the U.S. government substantially expanding its ownership of the struggling bank, according to people familiar with the situation.

While the discussions could fall apart, the government could wind up holding as much as 40% of Citigroup’s common stock. Bank executives hope the stake will be closer to 25%, these people said.

Any such move would give federal officials far greater influence over one of the world’s largest financial institutions. The proposal was made by Citigroup to its regulators. The Obama administration hasn’t indicated if it supports the plan, according to people with knowledge of the talks.

The talks reflect a growing fear that Citigroup and other big U.S. banks could be overwhelmed by losses amid the recession and housing crisis. Last week, Citigroup’s share price fell below $2 to an 18-year low. Bank executives increasingly believe that the government needs to take a larger ownership stake in the institution to stop the slide.

Under the scenario being considered, a substantial chunk of the $45 billion in preferred shares held by the government would convert into common stock, people familiar with the matter said. The government obtained those shares, equivalent to a 7.8% stake, in return for pumping capital into Citigroup.

The move wouldn’t cost taxpayers additional money, but other Citigroup shareholders would see their shares diluted.

The talks thus far have occurred largely between Citigroup and its regulators, the Federal Reserve Board and the Office of the Comptroller of the Currency, to clear the way for the plan to later go to the Obama administration.

A larger ownership stake by the federal government also likely would fuel speculation that other troubled banks will line up for similar agreements.

Bank of America Corp. said Sunday that it isn’t discussing a larger ownership stake for the government. “There are no talks right now over that issue,” said Bank of America spokesman Robert Stickler. “We see no reason to do that. We believe the goal of public policy should be to attract private capital into the bank, not to discourage it.”

Citigroup’s low share price already reflects, at least in part, a fear among shareholders that their stakes might be further diluted. A government move to take a big stake in the bank could backfire, potentially spurring investors to flee other banks, even healthier ones.

There’s no universal agreement on what constitutes nationalization of a bank. In the U.K., the government already owns 43% of Lloyds Banking Group PLC, and last week it moved to increase its ownership of Royal Bank of Scotland Group PLC to 70% from 58%. Those two banks have been classified as “public-sector entities,” and as much as £1.5 trillion ($2.136 trillion) of their liabilities have been moved over to the country’s balance sheet.

The White House has knocked down recent speculation that the government is preparing to nationalize several large U.S. banks.

The U.S.’s intentions with Citigroup remain unclear. For instance, it’s not yet known whether the government would seek a stronger hand in the New York’s company’s management or day-to-day operations.

As part of the plan, Citigroup officials hope to persuade private investors that have bought preferred shares — such as the Government of Singapore Investment Corp., Abu Dhabi Investment Authority and Kuwait Investment Authority — to follow the government’s lead in converting some of those stakes into common stock, according to people familiar with the matter. That would further bolster an obscure but increasingly pivotal gauge of banks’ capital known as “tangible common equity,” or TCE.

The highly complex TCE measurement, one of several gauges of a bank’s financial strength, gives weight to common shares — thus the interest in converting perferred shares to common stock.

Details of the rescue remain in flux. Key questions, such as the price at which the government will convert its preferred stock into common shares, haven’t been resolved.

And it’s possible that other options will emerge to stabilize the company. For example, the Obama administration could decide to sit tight until the results of several new “stress tests” on major banks — broad exams of their financial health now being mandated — are known in a couple months, one official said.

Citigroup Chief Executive Vikram Pandit huddled Sunday with his senior executives to fine-tune its pitch to the Obama administration.

Citi must be desperate because this plan is very unrealistic; the Obama team wants nothing to do with pumping more money into large banks like Citi. In the article, Citi mentions Abu Dhabi as a potential white knight. If you read my recent post on Abu Dhabi, you would know that the United Arab Emirates have problems of their own.

You should also notice that Bank of America has said it is not pursuing the same type of negotiations. They know that the markets would eat them for lunch if they did.

In my view, Citigroup has just put itself in play, meaning it must either get a huge government stake, be nationalized or file for bankruptcy. It’s life as an independent company is over.

See the link at the bottom for the rest of is article.

Also see the video below for Bloomberg coverage of the Citi negotiation.

Source
U.S. Eyes Large Stake in Citi – WSJ

Related posts:

• Citigroup talks with US Government as bankruptcy looms
• My take on the latest Citigroup bailout
• Are Citi and BofA gaming the Geithner Plan already?
• Nationalized Citi Mexicana Redux
• At least six banks need more capital under stress tests

This comes from the Danish daily Berlingske Tidene. It suggests that Citibank is cutting back all international lending. Citigroup has sold its German operations to a French bank and I understand they are cutting credit lines in the UK as well. In seeing all these stories together, one gets a full view of the kind of cutbacks now ongoing at troubled banks like Citigroup.

Update: 20 Feb 2009 1552EST: I have yet to see confirmation as to whether ‘cutting’ credit lines means reducing or stopping new credit availability. It is also unclear whether this is credit under the ‘quick and easy loan’ programme or under all Citibank activities. I will update the post accordingly when that information is available.

Citibank has stopped lending

- We are not offering loans at the moment because of the economic situation.
That is the message when you call to get a Citibank Denmark ‘quick and easy loan.’

The Bank has just closed itself for what banks are best: lending money. And it is still uncertain when Citibank will start lending money again, writes Ekstra Bladet Netsite, eb.dk.

Finn Ostrup who is a professor of Finance at Copenhagen Business School, believes that Citibank Denmark’s American owner, Citigroup, is about to go bankrupt.

“Citigroup would have gone bankrupt in December, unless they had been helped by the U.S. Government.

“They are still threatened with bankruptcy, and I think that is why they will not lend more money,” says Finn Ostrup to Ekstra Bladet.

For Danish Citibank customers bankruptcy could be a hard blow.

“If Citibank terminates loans, they might not be paid back right away,” says Finn Ostrup.

“If that happens, customers may try to obtain money elsewhere. But if Citibank does not have the option of canceling loans, customers will have no problems,” he says.

Ekstra Bladet tried all day to get a comment from the responsible representatives from Citibank, but failed.

Source
Citibank har stoppet udlån – Berlingske Tidene

Related posts:

• Citibank Belgium to pay ‘duped’ savers 128mn for bad Lehman deal
• Bankrupt Danish Bank Roskilde sold
• The Roskilde Bank problem
• Denmark bails out Roskilde Bank
• Chart of the Day: Citigroup

Meredith Whitney, the well-known former Oppenheimer analyst had some interesting words to say on CNBC about the banking sector, nationalization, dividends and Citigroup.  Take a look.

Related posts:

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• Meredith Whitney seems onboard with the fake recovery
• Is Meredith Whitney bullish now?

We heard testimony before the House Banking Committee in Washington today. The CEOs of eight large financial institutions are being raked over the coals by Congress. It was a scene which reminded me of the Pecora Hearings during the Great Depression. It was also one which is being repeated in London.

The Congressmen are ludicrously indignant — after all, Congress has been complicit in the state of affairs. One member of Congress asked the men (there are no women) to raise their hand to questions on several occassions like schoolboys in a classroom — questions akin to “when did you stop beating your wife.”

I see these proceedings as more show trial to reassure the public than anything substantive. Nevertheless, they are entertaining. Below are videos of the opening statements from each of the CEOs. You might find their comments illuminating regarding their thinking now that the economy has collapsed and they have needed governement assistance.

You should also note that not all of these banks are in a precarious way. Some are better off than others.

Goldman Sachs

JPMorgan Chase

Bank

Share and Enjoy:

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Author: Edward Harrison; Tags: Bank of America, banking, Citigroup, Financial Institutions, JPMorgan, Politics
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