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.