Thursday, March 12, 2009

Citi Never Sleeps!!

Yesterday, comments from the company’s CEO, Vikram Pandit, in an internal letter that was also filed with the Securities and Exchange Commission, set off the biggest rally in stocks since November. But there’s a lot less to the story than investors took away from the news.
Pandit boasted that the bank has conducted its own stress test ahead of regulators and, low and behold, it was confident in the bank’s capital strength even using more pessimistic assumptions than the Fed would employ. Pandit also touted that the company was profitable during the first two months of 2009 and it was having its best quarter-to-date performance since the third quarter of 2007.

It all sounded great on paper; and the media not surprisingly focused on the profit part of the picture while largely ignoring the fact that Citi’s sour assets still have to be addressed. Delving a bit deeper we were far from impressed.
In terms of its capital strength, thanks to the conversion of the government’s preferred shares into common stock (assuming 100 percent preferred conversion), Citi’s pro forma tangible common equity is $81 billion (including $29.7 billion in capital as of 12/31/08). The conversion raises the company’s tangible common equity to risk-weighted assets 8.1 percent.
If it really did have $81 billion in tangible equity, why not just buy back all of the outstanding stock? The company’s market capitalization after all is only $8 billion.
And then there were the “oh, by the way…” comments buried in the letter. For instance, Citigroup has $44 billion in deferred tax assets most of which it expects to be able to realize, even if near-term conditions deteriorate significantly. But later on in the letter Pandit says that some observers say Citi’s deferred tax assets may be at risk and may have to be deducted from its tangible equity. If true, that alone would halve the company’s tangible equity.
And here’s the real kicker: Citi has $301 billion of assets that have been “ring-fenced” under an agreement with the U.S. government. That’s a nice way of saying guaranteed by Uncle Sam. Pandit is claiming that after three government bailouts Citi is in great shape. And it is—assuming the government comes through on its guarantee of more them $300 billion of the company’s toxic assets! It’s hard for us to keep a civil tongue when we read Pandit pushing such unmitigated crap.
He takes investors to task for the “broad-based misperceptions about the company and its financial position.” Perhaps investors are misinformed, but we think the $1.45 share price (down from $20 six months ago and $55 when the financial sector started to unravel) tells the real story. Another sign the company is still in quite a lot of hot water can be seen in the sky-high cost of its credit default swaps. The cost of insuring against its bonds defaulting in the next five years is more than 5.7 percent of the face value of those bonds.
We don’t know about you but we’ll take our cue from the market over the company’s chief cheerleader any day. Nevertheless, plenty of investors bought the story as a sign that the banking sector is on the mend. To be fair, stocks were deeply oversold and looking for an excuse to rally, and they found it (a weak one at that) in Citigroup. The early buying also brought about short covering which added fuel to the rally.
Equities could rise a bit further in the coming days and weeks, but don’t get your hopes too high. The market has not displayed the classic signs of a bottom—and the financial crisis is far from resolved. Chances are the rally will falter at some point and we’ll trade back down to the recent lows and possibly go lower before an ultimate bottom is reached.

Courtesy:Stephen Leeb, Ph.D.

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