Citi's Death Bed - CDS Protection Surges

Posted by urbandigs

Sat Nov 22nd, 2008 09:03 AM

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:

citi-cds.jpg

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!

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."
A commenter replied:
"Noah Rossenblatt, Your right you don't know anything about legeraged loans and the like.
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"
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.

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.

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.
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?

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.


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