Wall Street Thinks Pandit's New Plans Won't Fix Citigroup's Old Problems: Street Whispers

Antoine Gara - The Street  SEP 11, 2012 3:05 PM

For Citigroup, balance sheet issues continue to stall emerging market growth prospects.

 


Citigroup (C) chief executive Vikram Pandit likes to preach the bank's bright growth prospects in emerging markets, international business transactions and mobile payments as it recovers from the financial crisis.

Unfortunately, Wall Street investors are ignoring Pandit's growth gospel and instead are worried about balance sheet and legacy financial crisis issues still holding back the nation's third largest bank.

The divergence in Citigroup's growth outlook and lingering balance sheet uncertainties from its near 2008 collapse are highlighted in CEO Pandit's presentation at Monday's Barclays (BCS) Global Financial Services Conference. Analysts at the meeting continued to ask nagging questions around Citigroup's continued divestiture of what was $850 billion in "non-core assets" and uncertainty surrounding its balance sheet.

At the Barclays conference on Monday, a poll of investors and analysts signaled that only 36% of attendees held, or were looking to buy, the bank's stock.

A second poll done by Barclays banking analyst Jason Goldberg at the end of CEO Pandit's presentation showed that the main uncertainty investors would like resolved are legacy losses at CitiHoldings, a unit of "non-core assets" that Citigroup has been working to sell and run-off since the crisis.

Twenty nine percent of investors polled highlighted CitiHoldings as a top concern. Those fears outweighed the European debt crisis, uncertainty surrounding Citi's near $50 billion deferred tax asset, dividends, and trends in its ongoing investment banking and emerging market operations.

In between the polls, Pandit made a forceful case to investors that Citigroup has moved past the crisis, selling off roughly $600 billion in CitiHoldings assets, while reinvesting in emerging market lending, transaction services and mobile payments growth opportunities, among others.

"As a result of the changes we've made over the past four years, Citigroup today is a simpler, smaller, safer, stronger organization than it was when I became CEO in December 2007 and we believe we're firmly positioned for a sustainable earnings and responsible growth," said Pandit at the conference. He highlighted Citigroup's exposure to emerging markets as highlights, while pointing out legacy CitiHoldings mortgage losses and legal costs have fallen sharply.

"[Citicorp] in 2011 looked much, much like the Citicorp of 1997 premerger with a comparable mix of consumer institutional banking businesses and a diversified global footprint," noted Pandit, of the bank's asset sales and withdrawal from a financial supermarket model that was seen as a key reason for its near failure in 2008.

The problem for Pandit is while he may be right about Citigroup's growth prospects and has been steadfast in the dissolution of CitiHoldings, the bank still carries a giant legacy of uncertainty from the crisis. Those burdens, mainly capital and balance sheet issues, are also highlighted in Tuesday's appraisal of Citigroup's stake in Morgan Stanley Smith Barney (MSSB) at $8.5 billion below Citi's valuation.

As a result of the valuation, Citigroup said in a filing with the Securities and Exchange Commission it will take a $2.9 billion after-tax loss related to MSSB in third quarter earnings. That loss will provide a small hit to Citigroup's Basel I capital ratios but boost Basell III ratios slightly, the bank said.

Citi's multi-billion after tax writedown related to its divestiture of a stake in a brokerage joint venture with Morgan Stanley (MS) at only underscores the issues hampering Citigroup's stock as it languishes over 90% below pre-crisis levels.

In exiting its MSSB venture with Morgan Stanley, cut at the height of the crisis in 2009, investment bank Perella Weinberg appraised the value of the brokerage joint venture at $13.5 billion, roughly $8.5 billion less than the valuation of the unit at on Citigroup's balance sheet, as of the second quarter.

Wells Fargo analyst Matthew Burnell, calculated in a Tuesday note to clients that the loss will reduce Citi's tangible book value by 2%. Still, he estimates the MSSB exit will provide some certainty on Federal Reserve stress tests.

Other uncertainties lingering on Citigroup's balance sheet may provide a bigger hit.

In a Monday note to clients, Goldman Sachs analysts noted that CitiHoldings still absorbs roughly 25% of the firm's capital while representing less than 10% of assets. Meanwhile, the disqualification of the banks' deferred tax assets stemming from crisis-time losses will not count toward Basel III regulatory capital, signaling a $50 billion drag to Citigroup's capital, according to Goldman Sachs analyst Richard Ramsden.

"While we recognize the potential value of a realizable deferred tax asset (DTA), current valuation for Citigroup appears to apply no (and maybe even negative) value to it given the dilution it causes to return on equity," writes Ramsden in the note. Since Ramsden calculates only $10 billion of the $51 billion deferred tax asset would count under Basel III capital ratios, if Citigroup were to write off the remaining $40 billion DTA, it would cut the bank's tangible book value to $38 from $52.

It's those legacy uncertainties tucked in CitiHoldings and the bank's overall balance sheet, which color shares, even as the bank posts signs that its ongoing operations are poised for growth.

In second quarter earnings, Citigroup reported better than expected adjusted earnings of $3.1 billion, or $1 per share, on revenue of $18.6 billion. Notably, Citigroup's North America consumer banking unit saw credit quality improve sharply as net credit losses fell 29% from year ago levels. Meanwhile, the bank's core operations increased earnings 5% and maintained flat revenue, while overall operating expense of $12.1 billion was 6% lower than the prior year period.

Excluding currency adjustments, revenue grew 8% in Latin America and was flat in Asia and other emerging markets. Meanwhile, the bank said that all international regions grew deposits and loans as credit quality generally improved. Overall, Citigroup's international consumer banking credit quality improved from the prior year period even as loan portfolio's continued to grow.

Those results helped to assuage fears that Citigroup's strategy to target banking opportunities in regions with higher-than-trend gross domestic product (GDP) growth outlooks could backfire.

While the immediate negatives of prospective writedowns related to Citigroup's MSSB exit may overwhelm short term earnings, the bank may yet see a benefit from aggressively exiting CitiHoldings assets, giving investors reason to give the bank credit for a growth heavy future.

For instance, Ramdsen of Goldman Sachs argues that Citigroup's best chance at getting to a $50 a share valuation would come from a spinoff of $100 billion in real estate assets that remain at CitiHoldings.