Quote of the Month
Proverbs 22:26-27 "26 Do not be a man who strikes hands in pledge or puts up security for debts; 27 If you lack the means to pay your very bed will be snatched under you"
Position of the Month
Opening Price: Above $27
Expected closing price: Below $16
Horizon: One year
Citi is unwinding leverage in the capital markets while facing a deteriorating consumer credit business.
Position of the Month:
The Citi is in trouble, and everyone knows it.
The previously largest bank by market capitalization in the world is trying to get hold of all the problems threatening the company. The unwinding of off balance sheet debt positions (think Enron) led to the ratings agencies attempting to downgrade to junk six of their seven off balance sheet companies. In the last minute before six of the seven SIV companies were downgraded to junk, the SIVs were adopted on to Citi’s balance sheet. What remains of the $100B of asset backed securities that Citi was caught holding the bag with, $43B of the securities still remain.
But that was the first issue. Citi seemed to lending to it’s citizens seems to be too lax. Citi also purchased two subprime insurers at the top of the market that continue to cause writeoffs as the loans deteriorate. In addition, Citi took positions is securities and derivatives that analyst William Tanona estimates gives the company 37B exposure to subprime mortgages. This issue will continue to haunt Citi as the market reprices homes from the top of the market.
The bottom line for Citi is that mortgage losses, credit losses, and derivative losses all draw cash away from the bank. Unhedged long term positions threaten to bring the banks capital ratios down below the capital requirement levels required. If the people of Citi think the bank cannot repay, they will be very likely to take their deposits elsewhere.
Ok things are bad, but what is next for Gotham?
From the transcript of the Citi 4th quarter conf call…
"The American consumer is losing net worth at phenomenal rate with the decrease in housing prices. The Case & Schiller index of home prices indicates we are only in the second year of five year retreat in home prices. Much of the consumer economy of the past ten years has relied on or was financed by the increase in home prices. As the prices fall companies like Citi will have larger and larger draws on it’s available cash from it’s consumer operations to fund it’s illiquid leveraged positions, managing bank capital ratios against decreasing asset values, and continuing losses from lax lending areas from auto loans to credit cards."
“Pyramid schemes and chain letters collapse because there is no more credit to feed them. As the system of modern day levered shadow finance slows to a crawl, or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question.”
Author William Gross, “Pyramids Crumbling”, Investment Outlook, January 2008
The current unwinding of financial markets is repricing risk from historically low levels. When price trends reach the end of a cycle and start retracing prices tend to overshoot, not revert to the mean. So we can expect significant increases in the cost of consumer credit over the next couple of years.
To support the point refer to the CFO of Citibank as reported in the New York Times (1)
“Mr. Crittenden, the chief financial officer of Citigroup, had a different message on Tuesday, as Citi disclosed an $18.1 billion write-down. He told analysts that Citi was raising rates on credit cards and tightening the amount of credit it would extend. Asked by an analyst whether credit card lending was an area where Citi might want to “pull back or increase pricing,” he responded, “All of the above.”
"Low Federal rates of turn of the century led to a credit boom with lax lending standards. Now that lenders are getting burned, the spigot is being turned the other way. This bodes poorly for overextended consumers.
Again the NYT reports…
“Citi is not alone. While the tighter credit market has not stopped credit-worthy individuals or companies from obtaining loans, it has made loans more expensive for many of them, and left those with the greatest need for cash far less able to obtain it.”
“They are parceling out credit with a keen eye on the balance sheet,” said John Garvey, the head of the financial services advisory group at PricewaterhouseCoopers. “There is a flight to quality and a renewed focus on risk.”
(1) “An Effort to Stem Losses at Citigroup Produces a Renewed Focus on Risk” by Floyd Norris