Citigroup (C)

Today i received the common proxy statement from Citi -- and one of the voting options is to approve the 'reverse stock split amendment.'

Potential ratios are 1:5 -- all the way to 1:30.

Does any one ever 'recover' once they start using 'reverse splits?'

1) Citi will have considerable credit losses this quarter, and this is the big unknown. The suspension of FAS 157 will provide some cushion to this figure .

2) The major problem is that we do not know what the real earning power for Citi is. Revenuess recieved a huge boost from the “illegal” fixed-income, one-time trading of the AIG CDS, which improved the earnings by at least $2.5B in 1Q(earnings report). All banks took advantage of the easy money offered by the AIG-feds, so we do not know without that one time boost how the earnings will look like. This is directly correlated with Citis sharp fall after 1Q earnings ($4.40 down to $2.80), investors needed time to read the data and realize that the absolutely surprising profit came from one-time AIG CDS.

3) Citi is loosing talent due to the government harsh pay regulations, in addition they have reduced enormously their risk exposure which reduces any risky investments that can yield large profits. We might not see the same performance in these segments: Institutional Clients Group and Wealth Management, and these two are absolutely critical for sustained increase in the net revenue. The only way Citi can show improved earnings is by cutting expenses, obviously their revenues are not going to be the major moving factor due to the cuts, lay offs, brain drain, selling assets, etc…however the emerging markets can help a bit to the net revenue.

The banking sector increased too fast in a short amount of time, expect to see prices decrease substantially and sideways movement until September. Since the solvency issue has been removed from the US banks next focus is on global recovery. For those trading C, I would sell puts around the $3.00 range if the premium is over .75 cents. Next quarters earnings will not be anything spectacular therefore there is no reason for C to be trading above 4.

Most retail investors purchase shares in a company such as Citi on the assumption that it’s going rise in price over time. And that’s good for stock prices. Supply and demand tells us so.

Back in early March, for instance, when Citigroup Chief Executive Officer Vikram S. Pandit’s “we’ve made money” memo leaked into the mainstream press, the good news stoked investor demand for Citi’s shares - causing them to shoot up 38% in one day.

But as we all learned in Econ 101, there’s another part of this formula - supply. Even as investor demand was increasing, there’s also an incredible incentive to short the stock - in no small part due to Citi’s Feb. 27 announcement that it would exchange as much as $52.5 billion in preferred stock for common stock beginning in April at an approximate price of $3.25 per share. This all has to do with a type of trading known as “stock arbitrage,” meaning that sophisticated investors can play one value off another and profit from the difference.

In this case, the difference was between the value of Citi’s preferred shares - those that were part of the deal announced in February - and Citi’s common shares. Because there is enough money at work, the pressure from the arbitrageurs actually creates something of a reverse incentive for the banking giant’s common shares, to the effect that that the lower the price of the common shares when the conversion happens, the greater the profit traders who are in on the deal can make.

The bottom line: No matter how much the investing masses would like to see Citi’s share price increase, big money has been wagered that the bank’s stock price would fall first.

Citi is still reeling in the wake of the subprime lending fallout. CEO Chuck Prince was forced to step down after Citi announced unexpected write downs in their subprime related investments. These write downs come a few months after Citi announced it was largely protected from the turndown in the subprime sector. While new leadership may be a good thing for the beleaguered bank, the new management will still have to deal with an additional $8B-$11B in subprime writedowns expected in the fourth quarter.

Shares of Citigroup Inc. (C), once the world’s biggest bank by market value, dropped below $1 in New York trading for the first time as investors lost confidence the shares could recover after more than $37.5 billion in losses and a government rescue. Citigroup is now the 184th biggest bank by market value, behind Malaysia’s Bumiputra-Commerce Holdings Bhd, according to data compiled by Bloomberg.

The old Citicorp no longer exists. The "franchise" is ruined. Their reputation is trash. Service is poor. Management operates with a sense of entitlement. Under Sandy Weill's deal doing days he built a giant conglomerate of fragmented businesses that were never properly integrated together. The parts can’t communicate with each other and work together. The old Citicorp culture is gone and so are all the real Citicorp people. The company is now managed by second or third rate people from the lousy companies Sandy bought. Citibank will ultimately self destruct.

Citi had to chop lot of wood. It has lot of bad stuff on its Balance Sheet. If your time horizon is 4-5 years, then C and all other financial stocks are good. They have close to $100B of risky asset class. The actual risk on much of the Balance Sheet is largely unknown since historical models for predicting success rates are no longer reliable. Citigroup, and other financial stocks, are not good for short term buys, and they will continue to experience hardships in the short run.

Dramatic Changes Underway : In April 2007, Citigroup has pushed a plan to cut 17,000 jobs while shifting 9,500 jobs to lower level positions - at lower costs. It is predicted that this plan will save the company approximately $10.4B. Citigroup has also sold off parts of its businesses such as CitiCapital for $4 million, CitiStreet for $222 million, Citigroup's German Retail Banking Operation for $4B, and Citigroup's Interest in Citigroup Global Services Limited for $505 million. Yet this push to downsize won't see benefits in the short term, and the regions its investing in hold a lot risk as information and models are not as widely available nor as accurate. Thus, it will be difficult for Citi to achieve immediate gains from this plan. Stock prices will not increase rapidly or soon given the firm's scope and scale.

In late July, Merrill Lynch sold a large block of collateralized debt obligations (CDOs) to a private equity group for approximately 20 cents on the dollar of initial par value. Were Citigroup to realize a similar sale price, it would need to take $12+ billion in charges or writedowns - and even if Citi were able to avert a firesale price, Merrill was carrying its CDO assets at 35% of par prior to the deal; Citi still maintains its CDO assets at close to 65% of par on the books. If the CDO assets of the two firms are roughly comparable, Citigroup has several billion dollars of writedowns it will need to take in the third quarter (or later).

From http://collegeanalysts.com/2008/07/29/merrill-lynch-mer-throwing-in-the-towel-on-cdos

The bank closed its Old Land Partners hedge fund, which was co-founded by Citigroup CEO Vikram Pandit. It was bought for over $800 million not even a year ago. Citigroup will purchase most of the fund's assets and client redemptions will be allowed as of July 31. Previously, Citigroup said that most investors would withdraw their money while a $202 million Q1 charge was already taken. This move is consistent with last month's decision to sell off $400 billion worth of assets but taking these assets on will increase assets by $9 billion. While it appears that the change-of-heart is proof of a management blunder, consider that buying the fund was a way to secure Pandit's services. Citigroup shares are still down over 32% on the year.

Value or Growth? : In the past summer reporters noted Citigroup as being a global bank that had trouble raising its stock price in-line with its competitors. At the same time, Bank of America was being lauded as a high-growth institution that could replace Citigroup as the largest bank.

On June 1st, Citi was removed from the Dow after losing more than 90% of its share price since the beginning of 2007. Its exit from the Dow can be attributed to the uncertainty of its future after receiving more than $45 billion dollars in taxpayer bailout money.

With the government with a 35% stake in Citi, its future is unclear. Especially since Citi announced that its converting $58 billion of its preferred investments to common stock. This means paying less dividends, and paying less out in case of liquidation...

Citigroup seems to follow a similar pattern to the zombie banks of Japan during the '90s. The Banks are sustained and continue to lend out money only because of government funding. Citi has a market cap of only approximately $10B, yet it has received $40B in government loans. The vast amount of its value is sustained only by these government capital infusions - it has fundamentally no market value. Eventually, tax payer money will run dry and so will Citi.^[1]

Federal officials are discussing the possibility of converting the U.S. government’s preferred shares of Citigroup Inc. (C) to common stock in a move that would boost taxpayers’ stake in the company to 40%, The Wall Street Journal reported.

The government currently owns $45 billion in preferred Citi shares, or a 7.8% stake of the company. By converting those shares into common stock, the government would increase its stake to 40% at the expense of current shareholders, whose stock would be diluted. The move would be at no additional cost to taxpayers.

Citigroup officials would prefer the government stake be closer to 25% according to The Journal.

By converting the preferred shares into common stock, Citi would bolster its “tangible common equity,” or TCE. The TCE is a measure of what shareholders would receive if an institution were liquidated. It is expected to be one of the key components of the new financial stress tests being administered by federal regulators.

Those stress tests are scheduled to begin this week and will determine how much - if any - additional money that large financial institutions receive from the government. This additional step is being taken to address a gap in how the U.S. government - under the original Troubled Assets Relief Program (TARP) - was previously analyzing the health of big banks and other financial institutions, before injecting taxpayer-provided capital. With the stress tests, the Obama administration is aiming to have a better handle on the health of these institutions, and to lessen the odds that additional rounds of rescue money would have to be brought to bear.

Indeed, under this new plan, if the current financial situation deteriorates, the government may resort to take a majority stake in the most troubled lenders. This has raised the specter of bank nationalization, something that has been hotly debated among the country’s leading financial analysts.