Sandy Weill’s “Mea Maxima Culpa”

Sandy Weill, the man who almost single-handedly did more to obliterate Glass-Steagall now admits that he made a most grievous mistake. Those watching him on CNBC on the morning of July 25, 2012 were treated to a rare peak inside a confessional booth as the architect of today’s Citigroup admitted his folly. He now realizes that what he did was wrong and needs to be reversed.

Weill now believes that banks need to return to pure banking, whereby they accept deposits and make loans. Brokerage firms need to return to executing trades on behalf of customers, positioning securities to facilitate those trades, and taking risk positions within the boundary of reasonable leverage ratios.

It is time to begin the process of dismantling these financial behemoths. Citibank, Bank of America, JP Morgan, Wells Fargo, and others can dispose of their nonbank enterprises by simply issuing shares in those nonbank entities to existing shareholders. At the same these financial shopping centers need to reduce or eliminate the use of derivatives that have cast a giant cloud over their financial statements. While the institutions adhere to the belief that their long and short derivative exposures should be can be netted out, the stock market strongly suggests that market participants favor focusing on gross exposures since the counterparties are of questionable financial strength.

Forgive me father for I have sins - as a commercial banker, I discovered a loophole in the law that allowed me to be the first person to establish a brokerage firm as an operating subsidiary of a bank holding company in 1979. My application, regrettably, provided a pathway for others to follow. The loophole allowed limited brokerage services; however, in the 1990s those powers expanded geometrically thanks to favorable legislation and rulings.

People who were not trained as commercial bankers became CEOs of the nation’s largest banks, and they proceeded to transform those entities into unmanageable financial organizations or financial supermarkets. Sandy Weill was the poster child for that era and when he retired he left a crippled organization as his legacy. If the banking industry had a Hall of Shame, he would be a leading candidate to be the first person installed. Too bad it took him so long to get religion and see the truth!

Citigroups Stress Test Blunder

Citigroups ability to transform the latest Fed stress test into a disaster is further evidence of the incompetence of its management. It adds weight to the following tale.

An extremely wealthy man had triplet sons – Jim, John and Joseph, who were born in that order. When they were born he promised his wife that the boys could have anything they wanted when they turned 21.

On their 21st birthday he and his wife invited the boys into the living room to honor his promise. Jim was first born and entitled to make the first choice. When asked what he wanted Jim said he had always liked professional football and wanted to own his favorite team, the New England Patriots. His father immediately called Robert Kraft and made an outrageous offer that Kraft accepted.

The second son, John, was then asked what he wanted. He said that he had always liked professional baseball and wanted to own his favorite team, which was the New York Yankees. His father immediately called Hal Steinbrenner and made an offer that was accepted.

The third son, Joseph, was then asked what he wanted. Joseph said that he had always liked the circus, particularly the clowns, and dreamed of one day owning his own circus. After thinking for a minute, the father called Richard Parsons and offered to buy Citigroup!

Citigroup Exposure To Federal Housing Finance Agency Lawsuit Is Modest

Citigroup once again was on the receiving end of bad press when it was named as one of the 17 organizations sued by the U.S. government over losses in subprime mortgage bonds. The negative publicity was out of proportion to Citigroup’s exposure, which was $3.5 billion. Of the 17 organizations named in the lawsuits only four others were sued for less.

The lawsuits were filed by the Federal Housing Finance Agency (FHFA), which is the government entity that oversees Fannie Mae and Freddie Mac. The lawsuits allege the named organizations sold bonds backed by mortgages that should have never been packaged into securities. The lawsuits cover a total of $196.165 billion in securities.

In contrast to Citigroup, Bank of America was sued for a total of $57.453 billion (BAC $6 billion, Countrywide $26.6 billion, Merrill Lynch $24.853 billion) and JPMorgan Chase was sued for $33 billion.

The following is a listing of the 17 named in the lawsuits and the dollar amount (in billions) of securities in question.
• Ally Financial $6
• Bank of America $6
• Countrywide (unit of BofA) $26.6
• Merrill Lynch (unit of BofA) $24.853
• Barclays Plc $4.9
• Citigroup $3.5
• Credit Suisse $14.1
• Deutsche Bank AG $14.2
• First Horizon National Corp. $0.883
• General Electric Co. $0.549
• Goldman Sachs Group $11.1
• HSBC $6.2
• JPMorgan Chase & Co. $33
• Morgan Stanley $10.58
• Nomura Holdings Inc. $2
• Royal Bank of Scotland $30.4
• Societe Generale $1.3
• Total: $196.165

Disclosure: I am long Citigroup

Citigroup’s Technical Pattern Indicates Upside Potential

A review of Citigroup’s (C) closing stock prices for the past 24 months reveals an interesting pattern. In a two month period from 12/17/2009 through 2/12/2010 Citigroup tested a floor price of $31.49 five times. Closing prices were $31.99 on 12/17/2009, $31.49 on 1/26/2010, $31.79 on 2/4/2010, $31.49 on 2/8/2010, and $31.79 on 2/12/2010. Within three months of its fifth test of its low closing price, Citigroup rose to $49.49 on 4/20/2010.

The stock then nosedived and within a month it had fallen to a low of $36.29 on 5/20/2010. That closing low would then be tested four times which were on 6/7/2010 at $36.39, on 6/29/2010 at $37.29, on 8/26/2010 at $36.59, and on 6/8/2011 at $36.81. Like during the earlier period, Citigroup has withstood five tests of its most recent low.

If Citigroup responds to this fifth test of its low as it did the last time then investors can expect C to challenge the $50 price level within the next several months. On four occasions during the past two years Citigroup has approached or exceeded that price. On 8/28/2009 it closed at $52.29, on 10/14/2009 it reached $49.99, on 4/20/2010 it hit $49.69, and on 1/14/2011 it closed at $51.29.

This data strongly suggests that Citigroup’s current stock price offers much more upside potential than downside risk.

Disclosure: I am long Citigroup common stock

Citigroup (C) Declines After Earnings

Before the stock market opened on July 15 Citigroup (C) reported a 21% earnings per share increase in second quarter above the comparable 2010 quarter . Its stock surged $1.37 or 3.5% at the opening to $40.39 . This rise in price was accompanied by heavy volume and seemed to offer a glimmer of hope to long suffering shareholders. By noon, however, Citigroup (C) had lost all its gains. During the afternoon (C) fell as low as $38.12 before ultimately finishing the day off $0.64 or 1.64% at $38.38.

The dispiriting price action for Citigroup was accompanied by price declines in JP Morgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC). The percentage decline at (C) was greater than at these other large banks.

It seems clear that in the current environment market participants will always be able to find something disturbing with bank financials that will outweigh any improvements cited by management. In the case of Citi the decline in net interest margin (NIM) to 2.82% in the second quarter of 2011 from 2.88% the previous quarter was particulary unwelcome news. During the second quarter of 2010 Citi had reported a NIM of 3.15%; therefore, NIM declined by 33 basis points or 10.5% in one year. Wall Street hates declines in margins and has a long history of punishing companies and/or industries that experience such declines.

An examination of the decline in net interest margin at Citi reveals it was largely attributable to a very pronounced decline in the yield on its investment portfolio. The yield on that portfolio was 2.79% during the quarter just ended, while it was 3.17% during the first quarter of 2011 and 3.89% during the second quarter of 2010. This is a remarkable and worrisome decline in yield on an investment portfolio that averaged $318 billion during the second quarter of 2011, $320 billion in the prior quarter and $311 billion during the second quarter of 2010.

Adding further selling pressure to (C) was the fact that Citigroup increased its staff by 2% or 3,000 people during the second quarter. The fact that it increased staff while margins were under pressure is a source of concern even though its total staff is the same as it was the year before. Investors generally expect payroll reductions, not additions, when margins are under pressure.

On a positive note it should be mentioned that loans outstanding rose slightly in the second quarter versus the prior quarter and the average loan yield rose 13 basis points to 7.93%. Loans outstanding still remain well below the level of the prior year.

The positive impact that would result from redeploying funds from investments yielding 2.79% and deposits with other banks yielding 1.06% into quality loans yielding 7.93% is obvious. Citi needs to accelerate its lending if it expects to meaningfully increase its income by reversing the decline in its net interest margin, and it must do so without compromising credit quality. If its lending staff cannot generate quality loans then Citi will have to start acquiring fixed and floating rate corporate obligations with the ample funds it currently has available.

Disclosure: I am long C

CitiFinancial Sale Weighs on Citigroup

For several months, Citigroup has been seeking a buyer for CitiFinancial, which is the largest consumer finance company in the US. CitiFinancial is reported to have a book value of about $2 billion and some $13 billion in assets. The delay in getting this transaction done is weighing on Citigroup’s stock.

This unit of Citigroup is one of the many trophies Sandy Weill acquired as CEO when he paid $31 billion in Citi stock for Associates First Capital, CitiFinancial’s predecessor. In 2010 Citigroup closed more than 300 CitiFinancial branches, stopped making loans at another 184 and rebranded the remaining 1,500 outlets OneMain Financial.

Four groups had been rumored to be among the interested bidders. One group was comprised of private equity firms Warburg Pincus LLC WP.UL and KKR & Co LP. It was supposedly aligned with Spain's Banco Santander and BlackRock Inc.

A second group of rumored bidders included Brysam Global Partners, Blackstone Group LP, Carlyle Group CYL.UL, Thomas H. Lee Partners THL.UL and Wilbur Ross' WL Ross & Co. Brysam is run by former Citigroup executives, including former COO Robert Willumstad and former Global Consumer Group CEO Marjorie Magner, who know CitiFinancial well.

Other rumored bidding groups had included Apollo Management APOLO.UL and J.C. Flowers; and Clayton Dubilier & Rice and Onex Corp.

Disposition of this troubled consumer-lending unit has dragged on to the point where it appears to be getting shop worn. Terms keep changing as Citigroup attempts to avoid a significant loss on any sale, while at the same time it unloads troubled loans.

On May 4 the New York Post, citing people close to the transaction, reported that the Brysam Group and the Apollo Group have both dropped out of the bidding.

The Revenue Growth Fixation

Financial analysts have been focusing their attention on revenue growth because of a general belief that companies need such growth to fuel earnings at this stage of the business cycle. While this focus certainly has merit for most businesses, it is far less applicable to financial firms.

Revenue at the major commercial banks is a mixture of interest income and noninterest income and is not identical to sales figures reported by nonfinancial firms. The former is determined by the level of interest rates and the volume of earning assets. Increases in rates and volume of earning assets will be accompanied by revenue growth.

Analysts were quick to point out that gross revenue at Citigroup was down 22% in the first quarter of 2011 versus the first quarter of 2010. Few, however, mentioned that the decline in assets at Citi Holdings was a prime contributing factor.

Citi Holdings is effectively the “bad bank” Citigroup created to house its worst assets during its near death experience. The assets in Citi Holdings fell by $166 billion or 33% from the end of the first quarter of 2010 to the end on the first quarter in 2011. Concurrently, revenue declined 50% to $3.3 billion and that accounted for 57.9% of the decline in Citigroup’s total revenues.

As of March 31, 2011 Citi Holdings had total assets of $337 billion, which is down from a peak of $827 billion reached during the first quarter of 2008. Citigroup management has clearly stated it considers the businesses and assets contained in Citi Holdings to be nonessential to its core business going forward. The remaining assets are to be liquidated through business divestitures, portfolio run-offs and asset sales.

A continued reduction in Citi Holdings assets will weigh on Citigroup’s gross revenues; however, it should continue to lower Citigroup’s risk profile. Citi Holdings reported losses of $36.5 billion in fiscal 2008, $8.8 billion in 2009, $4.0 billion in 2010 and $0.6 billion during the first quarter of 2011.

Disclosure: I am long Citigroup (C)