Financial services firm Citigroup Inc. has the dubious distinction of joining the unflattering group of companies that have been quasi-nationalized—companies with large government stakes and for whom the market has voted that equity holders will be left with nothing.
Vikram Pandit, the Indian-born chief of Citigroup, came to the helm of the embattled company in December 2007 with a lot of fanfare, at least in India. Since then the stock has slipped from $33 (Rs1,706 today) to $1, equity holders have lost about $160 billion of value, the bank has posted $27 billion in losses and received extensive help from the US government by way of capital and asset guarantees. Is Pandit to blame?
To best gauge what Pandit got himself into when he took the Citi job, it’s helpful to compare Citigroup with Bank of America Corp., the bank that the market suspects is next in line for a government equity stake. There’s no question that Pandit inherited a riskier balance sheet than Bank of America’s—the large international exposure, the second lien mortgages, the exposure to collateralized debt obligations (CDOs).
Second lien debts are subordinate to the rights of other, more senior debts issued against the same collateral, or a portion of the same collateral. If a borrower defaults, second lien debts stand behind higher lien debts in terms of rights to collect proceeds from the debt’s underlying collateral. CDOs are investment-grade securities backed by a pool of bonds, loans and other assets, and are often non-mortgage loans or bonds.
The flurry of activity when Pandit came to the helm, which included, among other things, bringing Citi’s exposure to structured investment vehicles (SIVs) on to its balance sheet, led us to believe that Pandit would quickly get to work and shrink Citi’s behemoth balance sheet. SIVs are funds that use money borrowed under short-term agreements—typically commercial paper—to buy longer-term, higher yielding debt investments, which have included subprime mortgage-related assets. Let’s not forget this was still early 2008, Bear Stearns Companies Inc. hadn’t collapsed as yet and the credit market, although convulsing, was still functional.
But Pandit preferred to play the wait and watch game, perhaps believing that classic banks can earn their way out of trouble model or perhaps not wanting to shrink his fiefdom. Asset sales became a reality only when capital was so dear that Citi had to do away with its financial supermarket model and dispose of its crown jewel—the Smith Barney wealth management division. A look at Bank of America, however, makes Pandit’s lack of action seem less criminal. Ken Lewis at Bank of America had the luxury of a stronger balance sheet before he started steadily chipping away at shareholder value. After absorbing the less than pristine balance sheet of Countrywide Financial Corp., Lewis decided to devour Merrill Lynch and Co. Inc. This was a classic case of mine’s bigger than yours, aptly pointed out by an angry shareholder who accused Lewis of not thinking with his brain when he decided to acquire Merrill!
Who’s to blame? Citigroup chief executive officer Vikram Pandit at Capitol Hill on 11 February. Manuel Balce Ceneta / AP
When Lewis eventually did a flip-flop over his decision to acquire Merrill, the US Federal Reserve’s thinly veiled threats of pushing management out at a later date evidently made up Lewis’ mind about consummating the deal.
A close shave towards a big misstep for Pandit was Citi’s planned acquisition of failed bank Wachovia Corp. The deal was facilitated by the banking regulators and Citi was offered guarantees on $312 billion of Wachovia’s assets, on which Citi’s losses would have been capped at $42 billion. Citi was going to pay a nominal amount in stock for the deal; at the last moment, banking competitor Wells Fargo and Co. took Wachovia from under Citi’s nose.
At the time of the deal it was widely expected to be accretive for Citi and provide a further stable deposit base. As asset quality has continued to worsen, we doubt this acquisition would have been anything but a further headache for Citi. The chief executives of the large banks were recently dragged before the US House financial services committee and asked to explain their various business decisions. Our observation from the testimonies was that the only CEO who was willingly answering questions and did not seem completely miffed at being there was Pandit. As a matter of casual conversation, we had opined that Pandit, at that point, knew his only saviour was going to be the US government—and of course the government obliged.
Interestingly enough, just a couple of days ago, amid the rising rancour of protectionism, Bank of America joined the ranks of the so-called loyalists by rescinding job offers made to foreign MBA students—a gesture that will most definitely appease politicians. Should we be drawing a parallel to Citi’s actions?
As we write this piece, the news that’s driving the markets is that Citi has been profitable for the first two months of the year, which has caused Citi’s stock to bounce 38%, or a princely amount of 40 cents! We wouldn’t fault Pandit for putting this piece of news out—he direly needs every bit of PR he can get—but we doubt that credit quality is getting better soon or that profitability can be sustained without the help of cheap government funding.
We’d expect the government’s ownership in Citigroup is going to increase significantly; Pandit probably hadn’t bargained working for the US government when he took up this job.
Rajeshree Varangaonkar and Bharat Indurkar have day jobs with US-based hedge funds. They write every other Thursday. Send your comments to firstname.lastname@example.org