Citi's good bank, bad bank solution

CitiÆs restructuring is both a change in direction and a return to simplicity, but some perceive it may be too little, too late for the current management.
In an early address to employees after taking charge in late 2007, CitiÆs CEO Vikram Pandit suggested that one way the financial behemoth could tackle the subprime crisis was to split itself into a bad bank and a good bank. According to this plan, the company would offload its distressed assets to a æbad bank', leaving the ægood bank' unhindered.

The announcement Citi made on Friday suggests that this is what is finally happening. But despite the proposal to split Citi into a core bank, Citicorp, and a non-core bank, Citi Holdings, the similarity is only cosmetic. The two banks which have been proposed are awash with problems that run deeper than the collateralised debt obligations (CDOs) portfolio which the bank is proposing to spin off.

Problems currently being faced by Citi include weakening revenues across businesses and a continued exposure to toxic assets. And its Asian business, earlier touted as a jewel in CitiÆs crown, has made its own not-insignificant contribution to the global loss.

The proposed restructuring is something of a step back in time. Citicorp will consist of a similar set of core businesses that made up the company of the same name, before it merged with Travelers in 1998.

But while the split may be a step backward, some observers are sympathetic to the plight of Citi.

ôThis is no easy fix, even for the best of managers,ö says Credit Suisse in a report issued on Friday, after the restructuring announcement made by the US bank. ôConsider the credit cycle, the cost of asset dispositions (sold revenues and earnings) and the need for infrastructure upgrades and integrationàthereÆs still more downside than upside risk to estimates.ö

On the basis of CitiÆs latest results and an expectation of higher credit costs, Credit Suisse has revised its earnings-per-share estimate to -$0.90 for 2009 and $1.00 for 2010. The Swiss bankÆs earlier prediction was -$0.55 and $2.10 respectively. It has also lowered its target price for CitiÆs shares to $6 from $10. The stock closed at $3.50 on Friday after falling 8.6% during the session.

Another significant issue for Citi is the potential for a change in business direction. As a recipient of US government financial aid, Citi could reasonably be expected to focus its activities on domestic business. And Pandit has admitted as much.

ôWe are committed to helping the financial markets recover as quickly as possible," says Pandit in the NYSE filing the bank made on Friday. "To accelerate that recovery Citi is putting the TARP capital that it has received to work to support the US economy and consumers û expanding the flow of credit to US households and businesses responsibly and on competitive terms.ö

The need to deliver goods back to the US could mean that the global reach that Citi has spent the last decade developing will suffer.

It also remains to be seen whether the sympathy extends to the management team. From the time that Pandit presided over his first analystsÆ call in January 2008, he has been questioned about his plan with respect to a divestment of businesses. Some analysts now believe that Pandit has not shown enough momentum on this front to shore up capital and refocus the core business.

Indeed, CitiÆs decision earlier this month to spin off the Smith Barney business û regarded as one of Citi's most valuable franchises even after the downturn û to a joint venture with Morgan Stanley, came at a time when Citi had its back to the wall. The deal effectively sees Citi cede control in a phased manner over five years. Some analysts have speculated that the decision was forced on Pandit, perhaps as part of the bailout package, given that the Citi CEO had commented as recently as November 2008 that he loved the Smith Barney business and would not be exiting it.

In an interesting aside, all major US banks moved their fourth quarter earnings releases forward by a week this month. JPMorgan Chase kicked off on Thursday, January 15, ahead of schedule, and was followed by both Citi and Bank of America announcing results early as well. None of the banks have stated a reason for announcing early but one conspiracy theory is that advisers to incoming US president Barack Obama preferred to have as much bad news as possible announced before he takes office on January 20 so that the week of his ascension can be focused on his plans to get the economy back on track.
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