Citi's Death Bed - CDS Protection Surges
A: For all those out there trying to find the bottom in Citigroup shares, simply because its Citigroup, and Citigroup will always be Citigroup, there was an important lesson to be learned. It was NOT the short sellers that drove the stock to a trading low of $3.05, it was not the media, and it was not the lack of stimulus from the fed and treasury. It was the combination of too many businesses, a highly toxic balance on/off balance sheet, a severe credit credit crisis, deflation, deteriorating fundamentals, and a Dick Fuld like stance by Vikram Pandit to play tough and refuse to make any deal for the desirable Citi businesses to raise capital when they could have. Confidence has been lost in Citi's management, ability to raise capital, and future business prospects; and with the stock trading down 20% even as the market rallies 6.5%, this should tell you something!
Citi's balance sheet is a complete mess and their off-balance sheet contains over a trillion dollars of illiquid toxic assets. Citi was highly leveraged and a big player in the high risk/high reward game of mortgage backed securities that collapsed beneath them. They were stuck holding the biggest bag when the music stopped.
Now that the stock is trading under $4/share, a crisis of confidence begins and options available to management die out quickly. This is the exact same sequence of events that ultimately led to Lehman's failure, with one big exception. Citi can and will NOT be allowed to fail! A failure of Citi would unleash a credit event of gargantuan proportions onto the financial system, causing a disruption in global markets unlike anything we have seen thus far. A run on banks would occur, and put simply, the government won't let it happen.
Take a look at Citi's CDS (credit default swap) trades as of the past few days, courtesy of CMAVision.com:
Amazing. In April, I got into a argument with a commenter blasting my piece on Citi's leveraged loan asset sale, where I stated:
"...my interpretation of the Citigroup plans is much different; they had NO CHOICE, must raise capital, and what they sold off is only 25% of their total leveraged loan portfolio which has nothing to do with toxic mortgage backed securities still held on their books! When a bank or brokerage has to sell stock (whether it be common shares or preferred; hey WaMu how r u!), that is a BAD sign and a clear sign that the firm is in need of cash and fast!A commenter replied:This deal involved leverages loan assets, which was sold to private equity firms using, drum roll please, you guessed it....leverage! Citigroup, come on down, you are the next contestant on THE PRICE IS RIGHT! But in no way, shape, or form does this save Citigroup and in my humble opinion is a signal of the necessary capital raising efforts that will happen over the next few quarters; one could actually argue that the leveraged loan assets were the ONLY troubled assets Citi could find buyers for! Expect plenty more rounds of asset sales and fund raising efforts before the credit storm dies out; and at some point investors will realize that this is dragging along way longer than they expected."
"Noah Rossenblatt, Your right you don't know anything about legeraged loans and the like.Ahh, I love some people who cling to hope and choose to be an eternal optimist rather than put the pieces of the puzzle together and admit that there is a problem not only with the balance sheet, but with the near term environment that is deteriorating ahead of them. Citi was trading at $23.50/share on the date of that discussion. 'Write-Ups' HA! You have got to be kidding me. Go back to that post and read the responses I made to this commenter, for an idea on how ridiculous that argument was 7 months ago. Citi stock is at $3.80 today, down some 84%. Sure, there will be a time for write-ups, but that is years away.
Citi which may have had what you continue to call call toxic paper, do not understand CITI took a write down, a write down in excess of what was necessary. By taking the loss at year end 2007, They now have a loss reserve on their books of $24 billion. It now looks like they will only use 10% of the loss reserve so they will be in a position to write up $22 of profit down the road. In the meanwhile they get a check from the US treasury for the taxes paid for the last 5 years about 15 billion which they can use as cost free capital. Citi also has the support of the FEDERAL Reserve Bank behind them. Since the Fed announcement on March 17 Citi stock is up 40% and your friend is correct. Become more knowledgeable before shooting your mouth off with such grandiose bravado, might save you from idiot status. Ass"
The options, as I see it, for Citi include:
1) a government rescue similar to AIG
2) nationalization - I view this as unlikely because it would become a credit event leading to major counterparty payouts and disruptions in the financial markets, not what we need right now
3) another round of injections from the TARP, directly into Citigroup
4) using TARP to buy distressed assets from Citi's balance sheets
5) sale of parts or whole company
6) capital raising by share dilution - virtually impossible with the stock under$4/share. This is why GE raised capital when its stock was at $21 to Buffett, they did it when it was still viable to do so
7) capital raising from private markets - unlikely, who is willing to put good money on top of bad at this point without government assurances
I think #1, #3, or #4 are the most likely options as the government can't let Citi fail. Andrew Ross Sorkin had a great piece in the NYTimes yesterday, "Shares Falling, Citigroup Talks to Government":
With the sharp stock-market decline for Citigroup rapidly becoming a full-blown crisis of confidence, the company’s executives on Friday entered into talks with federal officials about how to stabilize the struggling financial giant.Other options discussed included a public endorsement from the government or a new financial lifeline, people involved in the talks said.But after a year of gaping losses and an accelerating decline in share price, Citigroup, which has $2 trillion in assets and operations in scores of countries, is running out of time, analysts said.Just so you can understand, Citi already received $25Bln from the first round of TARP injections. As of the close of trading yesterday, the market cap of the entire company was $20.54Bln. Talk about things that make you go hmmmmm. The problem with Citi is the balance sheet, and the assets both on & off; at a time when investment banking is all but extinct, the wall street business model dead, severe credit crisis, credit/housing deflation, severe deterioration in macro fundamentals, and leverage being taken down to 10/12:1 from 30/40:1. We know that Paulson decided against using TARP funds for buying distressed MBS, so the question is, what will Citi do with these toxic assets, who will buy them, who will take on the challenge, the debts, the toxicity?But with Citigroup’s troubles opening a new chapter in the long-running financial crisis, government officials said that the Treasury Department was considering whether to ask for the second half of the $700 billion rescue fund approved by Congress in September.
I'm afraid that the government is the only lender with such capacity to do so. Time will tell. With gold surging $70 in the past few days, and Citi stock floundering, I get that feeling something eery is coming for this financial conglomerate.
Comments (9)
very compelling arguments Noah!!
what happens with the FDIC -- should one pull $ out of Citi accounts, pre-empting the inevitable run on the bank?
Posted by ul | November 22, 2008 11:01 AM
Noah, you're insights are cogent, honest and appreciated.
CitGroup is going down like the Titanic, it's inevitable -- that's what gives a person the eery feeling you speak of. The gov. as you say has to bail it out in some form. It's going to take the wisdom of Solomon to figure out the best way to save jobs, insure accountability and protect taxpayer loans (hopefully) to these banks, etc.
Speaking expansively for a moment, the whole basis of free markets can be boiled down to risk and reward, ideally tempered by a measure of responsibility, prudence and restraint. Finding a balance is forever the challenge, of course.
Clearly, for the past 5-6 years the balancing forces have been largely absent -- most everywhere, including both big business/investors and individual borrowing behaviors. Seems to be an endless cycle.
On another note and with regard to other recent posts on RE prices in the city, I haven't crunched the numbers to know exactly, but I've heard a speculation that historically, at least for several decades, the average sales price of an apt in the city has been roughly 15x the median rent for a given size unit.
For example luxury 2 bed 2 bath apts in 2003 rented for about $4k, putting their median sales price (per this formula) at that time at roughly $600k. A similar higher-end one bedroom might have been a $3k rental with a sales price of about $450k.
These numbers sound about right for that period, and no indicator is perfect, at best a rough guide because many factors interweave to create supply and demand for both sales and rentals.
But it seems this might be an indication of roughly where we'll return to as regards sales prices, especially if the 15x multiplier is something close to a historically sustainable factor. If true we may be looking at price drops much greater than the 15-20% below 2007 peaks that we're seeing now. Something closer to 30% seems likely.
Thanks again for your terrific posts.
Posted by Aquarian | November 22, 2008 11:25 AM
ul - well lets not forget the govt now guarantees up to 250K in each individual account. So, chances are you are ok. If you are over this, you may want to move some funds elsewhere, spread out the funds, or open a different type of account. For me, I have most of my money at HSBC, so I spread it out between a personal account and a business account, covering me when the limits were only 100K. But today the limits are more, so I would have been safe anyway.
It is this fear though, that leads to runs on banks when many depositors go to withdraw their funds at the same time, from a fractional reserve lending institution.
I think you are ok if you are under the umbrella of 250K. I wouldnt move it. I think Citi will just be operating under a different form than of today in the next 3 months. Something will happen, no doubt, question is what and when.
Posted by Noah | November 22, 2008 11:49 AM
Acquarian: "Clearly, for the past 5-6 years the balancing forces have been largely absent -- most everywhere, including both big business/investors and individual borrowing behaviors. Seems to be an endless cycle"
Thanks, and I couldnt agree more!!
As per your Manhattan re rent/own p/e ratio of sorts, I agree again. On this basis, prices have further to fall, a significant amount further. The correction is underway as this market is very illiquid now, and that is when the initial knee jerk snap from the peak occurs. When the reports come out showing this, buyers usually take more steps back and more sellers get nervous and the cycle continues. Like other markets. Thing is, we are a wall street city and I worry about the full effect of job losses affecting the adjustment here in the next 12-18 months. Starting with wall street, then as city slows, moving to leisure, retail, restaurants, and luxury...people are in for a rude awakening if they are not at least concerned.
Posted by Noah | November 22, 2008 11:54 AM
Why is 'change management' not one of the options for Citi? The insanity of the US bankrupcy/distressed system is that the management team that got the business in trouble in the first place, is the same team that is subsequently in charge of restructuring the company. In Europe, when a company files for bankrupcy, the court appoints a trustee (in the case of a liquidation) or the trustee hires a new management team (when it's a going concern). All I can say is: OFF with Mr Pandit's head. He is, at best, a mediocre hedge fund manager who has no skills nor a track record running a major bank.
Posted by chris | November 22, 2008 12:21 PM
And to just think, a few weeks ago, Citi was in a bitter battle with Wells Fargo to buy what was left of Wachovia. If Citi does not have any money, why were they thinking of buying Wachovia? And several months ago, Citi was in talks to buy Washington Mutual before it collapsed. That makes absolutely no sense!
Posted by Donald | November 22, 2008 1:23 PM
Chris - well mgmt will change no matter what. Something is going to happen, and there will have to be a shakeup. Simply changing mgmt as is, without one of the other options will not change anything. They need money, they need to fix their balance sheet, and either getting big money or getting the toxic stuff off their books or combo of both will help.
I agree with you, Pandit will likely be gone.
Posted by Noah | November 22, 2008 3:01 PM
Donald - hey boss. Yea, citi was in position to buy anyone. I think that became apparent as time went on with the wachovia merger idea. There is a reason they didnt buy either, and that is because they couldnt. There is talk that the Wachovia idea was simply a back door entry to a govt sponsored takeover and from what I read, the treasury/fdic/fed reached out to Citi to take over Wachovia at first...
Posted by Noah | November 22, 2008 3:03 PM
Amazing..
After BSC, LEH, AIG, FNM, FRE, and the now myriad institutions that have gone the way of the dodo (IMB, DSL, BKUNA, etc..), the hubris of mgmt teams continues to shock. For those trained and paid to manage risk, the lack of urgency in addressing deteriorating balance sheets is stunning. How does Vikram Pandit possibly think he has ANY leverage in "deciding" which business units he will keep or sell. The market has chosen for him, and 50x TCE ratios are not the selection. You can bet Pandit is gone by X-mas and this stock is a zero. It's really tragic watching all this unfold, but while Chuck Prine was insisting it was still time to dance, the truth is the music stopped a long time ago. NYC real estate is not about to correct, it will crash
Posted by aj | November 22, 2008 8:28 PM