The Case Against a Citi Breakup

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Before readers start throwing brickbats, let me set forth some general views:

1. I have never thought the financial supermarket was a good idea and have said so for at least 15 years

2. I was opposed to the sale of Salomon to Travelers

3. I was opposed to the merger of Citibank and Travelers

4. I have been saying for over 15 years that that the idea that bigger is better in banking is a head fake that serves only the top executives (bank CEO pay is correlated with the size of the balance sheet). Just about every study ever done of the banking industry finds, contrary to popular image, that the industry has a slightly increasing cost curve once a certain size threshold has been surpassed (the level varies by study, but trust me, it’s low). That means that bigger banks, despite the supposed economies of scale, are actually LESS efficient. I can give you my pet theories if you care to hear them.

So how can I possibly be opposed to a breakup of Citi, a behemoth that is barely able to raise capital fast enough to offset the seemingly neverending writedowns? (Other banks are able to play the game of announcing losses and similar sized fundraisings with a tad more dignity ).

Shareholders have every reason to be angry (but really, you should have voted with your feet a long time ago). The frustration at the continued hemorrhaging is a big part of the impetus for the calls for a breakup.

Having worked in M&A and as a management consultant with very large financial institutions (Citi was a client in the 1980s), less is to be gained and more stands to be lost by a breakup (defined as hiving off core business units, such as retail banking or perhaps the credit card operations, to create businesses with much narrower product offerings) at this juncture. One of the dirty secrets of M&A is it’s all about timing. Deals make sense when valuations are favorable. This isn’t one of those moments.

Mind you, Ciit may still have to do that at a time not of its choosing. But as we will see, it’s unlikely to be to its advantage. Consider:

1. Citi’s big problem is that (like every large Western financial institution, but more so) it is undercapitalized. Yes, they managed to maintain the fiction of having adequate regulatory capital. But let’s face it, banks wouldn’t be hoarding cash, clamping down on lending, and going to the Middle East on bended knee if they really thought the credit crisis was over. We may escape further brushes with systemic meltdowns, but (per the post by Satyajit Das on nuclear de-leveraging), more writedowns are in the offing, and more assets will be involuntarily coming on their balance sheets, increasing the need for capital in the absence of business growth.

So the only way a break-up makes sense (in terms of helping Citi through its tsuris) is if you can sell the businesses and show a gain on its book value of those units, or at least come out whole. But who is a buyer of bank assets now? Private equity firms might buy operational units, but for the most part, they don’t like regulated entities (with good reason) and have little experience with financial institutions. The possible acquirers of its credit card business are other big credit card players; that raises anti-trust issues and most either are in nearly as bad shape as Citi or, like BofA and JP Morgan, are otherwise occupied. HSBC might have been a buyer, but the chatter today about its latest earnings announcement says that it is in vastly worse shape than the official release indicates. The Japanese and Chinese have the dough, but this isn’t a strategic fit (and the issues raised re the credit card ops apply to trying to sell the entire retail business). So who does that leave? Chris Flowers, and he isn’t known for overpaying.

The proof of this assessment? The absence of a breakup plan. When a company allegedly has value that can be unlocked via a restructuring or split-up, plenty of people start putting pencils to paper. Someone, say financial analysts, shareholder activists, investment bankers trying to tee up a deal, will publish a breakup analysis. I’ve seen no evidence that one exists, and any reader that knows of one (a real one, with valuations of the parts versus the whole) is encouraged to speak up.

2. More important, if you believe Citi is a deep dodoo (and I do), you can’t simultaneously stabilize the patient and do major surgery. These entities have combined overheads; Pandit’s recent move to segregate the credit card business says that even t is fairly well integrated into the retail bank from a managerial and cost perspective.

Breaking up Ciit would a full employment act for a hoard of consultants, accountants, and bankers. I guarantee just producing the financials would be a huge exercise, and the drill would fully consume senior management and prevent them from taking needed action within the businesses.

And where do you get the management talent for these independent entities (if you assume spin outs)? The fact that Pandit has the CEO job says Citi is thin in talent at the top ranks.

Thus, Pandit’s plan to offload 20% of the bank’s assets isn’t as self serving as it might appear. He’s hiving off units that (presumably) are sufficiently discrete that they aren’t (from an operational and transaction standpoint) ungodly difficult to be rid of them. While Michael Shedlock may assert that this is tantamount to a breakup, disposing of small to middling units and portfolios, even if they adds up to a lot of value in aggregate, is a very different task than separating core units.

Now in the end, Pandit’s plan may all come to naught. Oppenheimer analyst Meredith Whitney, who has been spot on in her calls so far on Citi, says that Citi is too broken to fix:

Citigroup Inc. Chief Executive Officer Vikram Pandit faces an “impossible feat” in turning around the biggest U.S. bank as it faces “seismic” costs to restructure, Oppenheimer & Co. analyst Meredith Whitney said….

“I think it’s an impossible feat,” Whitney said. “They don’t have the revenue power, they don’t have the earnings power in so many of their businesses. Even Stephen Hawking could not pull this off,” she said, referring to the British physicist.

Whitney said she expects Citigroup, which lost a record $10 billion in the fourth quarter, to post “de minimis” profit during the next three to five years. She repeated her prediction that Pandit would be forced to lower the dividend again, and didn’t give an estimate for restructuring costs. She estimated a loss this year of 45 cents a share.

While Citi’s situation may be as dire as Whitney says (and note that some other analysts disagree), Citi is not going to be permitted to fail. Ironically, if it is as big a garbage barge as she claims, its size and systems issues will keep anyone from taking it on (many an otherwise enticing banking deal has been scuttled due to systems issues; it’s a very serious consideration in financial services mergers. The multiplicity of systems would be very troubling for a potential partner, even if one assumed there weren’t compatibility issues. After all, Citi is stuck with its mess; anyone else would be electing to take it on).

Thus Citi could continue to be a significant value destroying event for equity holders, yet limp on through this period.

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  1. Independent Accountant

    Brickbats? I’ll throw hand grenades. Bust up Citi. Now! My guess is that the only thing Citi makes money at is consumer loans. Citi is TBTF. So I say break it up into 50 smaller pieces if need be, each of which is not TBTF and will lack the political clout to have the Fed protect it. Oh yes, and damn the economists’ and apologists’ torpedoes, full speed ahead.
    Properly costed, I believe the majority of businesses Citi is in, should not exist.

  2. Anonymous

    If it does a Bear, it’ll be far too big for JPM to swallow up. The breakup plan needs to be there for a liquidation. Hopefully the taxpayer would only have to back the derivatives book, not the whole damn bank, but they may be too intertwined. Peel off Travellers, regional and local banks, SSB if that is still a distinguishable entity, using the system boundaries as guidelines. Flog them to whoever will take them at the price – locals, management, whatever. Keep going – sell more banks, unwind CDOs and VIEs – until you just have a miserably undercapitalised OTC derivatives exchange with 20% of its contracts unworkable and another 15% unconfirmed. That bit can be nationalised and run off, or perhaps actually turned into a real exchange if there are enough lawyers around to sort out the mess. Awful thought: there may not be enough lawyers already.

    Fred Goodwin may be looking for a job soon. Sounds right up his alley – he cut his teeth on BCCI.

    49 1/2

  3. Lune

    I think your argument is muddied somewhat by mixing in different players and their respective interests. The real question is, “Is a Citi breakup beneficial to X”. Replace X with 1) Citi’s management; 2) Citi’s shareholders; 3) The financial services industry; or 4) the government / taxpayer and you’ll get very different answers. So here’s my speculation:

    1) Management. Undoubtedly bad. As you’ve mentioned, CEO pay is based on how big your company is, not necessarily how well it performs. So management has every incentive to keep the ship together, regardless of which parts are rotting.

    2) Shareholders. I don’t think it makes a difference: they’re screwed either way. At this point, even kept together, Citi might sink anyway. And even if keeping it together means it’s TBTF, the govt will likely wipe out shareholder equity before bailing it out. OTOH, you’re absolutely right that trying to sell off parts in this market means you’ll get lousy prices. Which one will ultimately pay a higher price: the federal govt when it rides to the rescue, or the private vultures picking over citi’s carcass? Not sure…

    3) Finance industry. Probably bad. As you state, anyone picking up a piece of Citi will face significant regulatory and systems issues as they try to assimilate it. More importantly, a sale of assets on the open market at distressed levels will provide lower mark-to-market price points for other companies and their units. After all, if Citi ends up selling their credit card business for pennies on the dollar, what does that say for Chase’s valuation?

    4) govt/public. Unadulterated good. IMHO, there has never been any public interest served by having enormous banks. In addition to the reduced efficiency that you mention, big banks are bad in numerous other aspects. The too-big-to-fail syndrome is already well known. As is their lobbying power for favorable regulations. But big banks also stop engaging in the boring and less profitable sections of banking like investing in neighborhood housing and businesses, and providing financial services for local needs, and concentrate more on making money through playing on Wall St. or international markets and big corporate deals. Indeed, many of the home loans that are now defaulting were made by large corporations making loans in distant locations that they had no local knowledge of, with their full focus on making profits through the eventual CMOs and MBSs. I suspect that neighborhood banks that know the local market better and have less ability to securitize away their risks probably made better loans.

    Maybe I’ve seen “It’s a Wonderful Life” too many times, but if there’s any shortage in the financial services industry, it’s a lack of local, regular, boring services (ever try to get a checking account in an inner city? Now you know why so many poor people use payday loans and currency exchanges for their financial services needs). One area that we truly have an excess of is the sexy, “innovative” stuff on Wall St. If breaking up Citi leaves a bunch of smaller banks, focused on their geographic and/or service niche, each of which will be allowed to fail if they mess up, then this is a pure good for the government and the public.

    So my final opinion is directly opposite yours, Yves: I say, break up Citi, and break it up now! Damn the shareholders, the CEOs and the rest of the industry. The only time the goverment gets to force a breakup is when the bank is weak. The fact that that’s when it’s most painful to the first 3 groups doesn’t matter.

    In essence, I view this question similar to the question of when to impose regulation. When banks are weak, what they usually need is a temporary break from regulations, not more rules. But if you wait until they’re stronger before you impose new regulations, your opportunity to do so is usually gone.

  4. Yves Smith


    As for your initial point, I was writing the post from the shareholder’s viewpoint because some shareholders have called for a breakup. I should have been explicit.

    I agree completely with your thoughts about community banks, and then some. My pet belief is that the reason banks show scale diseconomies when by any rational calculus you’d expect the reverse (huge economies in interbank funding vs. deposit gathering, very big economies in processing) is that despite widespread belief otherwise, lending is best done on a local basis. You have tremendous intelligence by being a member of a community (particularly as a bank lending to small businesses). You know how stable the local employers are, what longevity in jobs is like, whether doctors and the hardware store do well or badly. And I also believe that there is much to be gained by in person assessments of borrowers. Yes, there are con artists and the self-deluded who are very convincing, but most people don’t lie that well.

    However, don’t kid yourself. If Citi was broken up, its pieces would be reconsolidated (or the assets and client relationships picked clean) into larger banks. The US even with 25 years of bank consolidation still has one of the most fragmented banking systems. Canada, has five big banks, Australia 4 and one half going into four. The belief that bigger banks are more efficient is taken as gospel (and in the US, powerfully reinforced via senior level pay). Look at how every time a deal is announced, the acquirer is talking about cost reduction. No one wants to admit the incumbent could have taken those costs out on its own.

  5. Lune


    You’re right, of course. I’m dreaming if I think Citi will somehow mutate into a hundred community banks. But even on the mega-bank scale, Citi is massive. and if it’s broken up, it may give pause to some of the hyperactive M&A guys looking to patch together the next big bank.

    On a different note, part of the reason why small banks haven’t eaten big banks’ lunch despite cost efficiencies is because the regulatory environment favors big banks (in addition to the lack of local knowledge, as you correctly note). For example, Citi can base its credit card operations in S.D. to take advantage of its lax regulations, but a local community bank offering a credit card would have to either open an office (even if it’s just a shell office) in S.D. or comply with stricter regulations in its home state. Similarly, witness the intense lobbying by banks against credit unions: since banks can’t compete with credit unions offering good, cheap services, they’re instead lobbying the federal government to restrict their practices.

    If one of the byproducts of the current mess is a level regulatory playing field for large vs. small banks, then we might not need the govt. to breakup citi. It might just be killed by more nimble, smaller outfits.

  6. macndub

    Yves, I agree with your post entirely. Citi shouldn’t exist. But it doesn’t follow that it should be destroyed today.

    Your comment, “Canada, has five big banks,” is true (5 or 6, depending on your definition of big), but the equivalent number of U.S. banks of the same size is 50. The economy is 1/10 the size, so you’d need 1/10 the number of banks assuming that optimal scale is the same, no?

    Never thought I’d be defending Canadian banks, but they are so slow and stupid that they’ve avoided the worst of the credit excess, it seems. And without facing significant competition, they don’t face shareholder pressure to goose returns in the happy times. What is my alternative as a shareholder, other than to invest in exactly the same big bank across the street? And when you only have 5 or 6, they are all the same.

  7. Yves Smith


    In banking, dumb and reliable is not so bad, although it can be very frustrating if you don’t fit in their boxes. Dumb and not reliable is a nightmare, you never get problems fixed.

    I don’t have current stats, but in the late 1980s, the US had 16,000 banks. Last figures I saw were it now has north of 8,000, at best (or worst), it might now be a tad below 8,000. That’s more than an order of magnitude more than Canada, even adjusting for the difference in size of the economies.

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