I have gotten a ton of mail regarding my recent article "When Whitney Attacks" mainly from a rabid assortment of her supporters.
I do apologize to Ms. Whitney as it does turn out that CIBC divested her division to Oppenheimer so she is now an Oppenheimer analyst who only used to work (as of last November) for CIBC. It may not sound like a big deal to you but it seems to be vitally important to others (like Toronto's Globe and Mail) that this fact be ironed out lest my entire defense of the financial sector be deemed invalid.
Perhaps they are touchy about the fact that I pointed out that foreign banks, in addition to the usual suspects, stand to benefit from CitiGroup's troubles, last I heard they did all compete in the international markets and CitiGroup was, and still is at the moment, the 800-pound gorilla of the financial industry.
Rather than allow this to degenerate into a war with the Whitney camp, I'm just going to make a simple case for CitiGroup (most data from Yahoo Finance and Investools) as an example of how this bank bashing has gone too far:
CitiGroup has $2.1 Trillion in assets and some of those assets are in the dreaded "sub-prime" category. The company wrote down $1.56Bn in Q3 '07 in CDOs and an additional $1.35Bn of "leveraged finance commitments." This dropped Q3 net income to "just" $2.2Bn on $43.2Bn in sales vs. $5.5Bn earned in Q3 '06. In November, CEO Chuck Prince resigned and was replaced by Vikram Pandit and I predicted at the time that they would throw the kitchen sink into Q4 so they could put it all behind them and the bank indeed came through, writing down $18Bn worth of debt, turning Q4 into a $9.8Bn loss.
At the time, CitiGroup said their total exposure to sub-prime was $55Bn, INCLUDING $43Bn of CDOs. Remember this is out of $2,100 Billion in total assets! While all this was going on, Citi's business was going gangbusters, with 5% growth in overall revenues, led by a 29% growth in International revenues – beating out competition like… oh, let's say CIBC.
As a rapidly expanding bank, Citi finds themselves vulnerable to the old Mr. Potter attack strategy of fomenting panic in the markets as the bank has a very high, but usually manageable lone/deposit ratio:
Since a large portion of their money is lent out, it is very damaging to C if, suddenly, a lot of people ask for their money back. A lot of this is payback for Citi's aggressive marketing that has driven internal revenues up 30% in 2007 and they finished the year, despite of $20Bn in write-offs, with a profit of $3.6Bn on $159Bn in revenues. In order to shore up their reserves the bank sought and quickly recieved $12.5Bn in capital in exchange for convertible preferred shares and also sold $7.5Bn worth of stock to Abu Dhabi. The company also cut their $10Bn dividend by 40% and announced plans to lay off 4,200 out of 374,000 employees.
It must be nice to be able to snap your fingers and get $20Bn dropped into the vault! After writing off $25Bn of the $55Bn of total questionable debt (which, of course, gives them a pass on taxes for quite some time) the bank was "only" down 50% and at this time (January) the attacks stepped up significantly and, without going into it all here, let's just concede that ALL $55Bn of sub-prime and CDO assets turn bad – how bad will it be?
Remember we're taking about $2,100,000,000,000 in assets with $55,000,000,000 being written off, that's 2.6% of the assets which will ultimately become a tax benefit against the bank's net income of $20Bn a year. They've already written off half of it and the knock on Citi is that they didn't write the whole thing down yet it does seem reasonable to assume that the bank will ultimately be able to sell the homes for 50% of their loan value, it's just that other banks have written down more aggressively by comparison.
It is unclear how Ms Whitney sees a writedown of another $18Bn of paper assets will impact the $39Bn of cash flow from operations generated by CitiGroup last year, even with the $25Bn in write downs in Q4 and the $10.8Bn dividend payout the company generated $11.7Bn in free cash flow in 2007 but Ms. Whitney states: "We estimate that Citigroup will actually earn $1.43 per share shy of its dividend payment this year. In other words, C will pay out $1.43 per share more than it earns this year. How anyone, let alone C's management and the board, can believe that its dividend is safe given this earnings scenario is beyond our comprehension."
That revenue estimate is miles below the $1.73 average estimate AFTER DIVIDENDS that are expected by the other 16 analysts who follow the stock and have an average price target of $27.64. Oppenheimer has one of the two sell ratings on the stock so they are either ahead of the pack or out on a limb with this one.
The premise for Whitney's super-bear attitude is that the ratings agencies may write down more structured bonds (haven't we heard all this before with ABK and MBI?) causing the banks to hold more capital reserves and crimping revenues – remember that C was the most agressive lender by a mile and may stand the most to lose. Based on the same premise (double dipping) it then follows that the banks will be forced to write down these assets too, leading to another round of losses.
However, it should be noted that Citi has been acting aggressively to address its precarious capital position. According to its annual earnings report filed this February, it has raised $30 billion in qualified Tier 1 capital since last November (which is the same amount Whitney said back in October that Citi would need).
At this point it looks like the bank is marginally OVERcapitalized. As it points out in its annual report, "To be 'well capitalized' under federal bank regulatory agency definitions, a bank holding company must have a Tier 1 Capital Ratio of at least 6%, a Total Capital Ratio of at least 10%, and a Leverage Ratio of at least 3%." According to that report, it has a Tier 1 ratio of 7.12%, a total capital ratio of 10.7%, and a leverage ratio of 4.03%.
So let's say Citi does only earn $1.49 per share and can't pay their dividend and let's say that their losses are so severe that they don't recover until 2010 and, even then, earnings don't get past $2 per share. How much should we pay for $2 per share forward earnings? The average p/e in the Banking sector is 12.7, even at $1.49 that's $18.92 in Meredith's worst case scenario. Citi is trading down to $20.83 today, close enough for us to have piled in on leaps and shorter calls (iust on the very slight off-chance that Ms. Whitney is wrong).
Maybe it's just me but I see a bank with $2.1 Trillion in assets and 200M depositors in 50 countries with 4,700 locations and 120M credit card clients, more than MA, who are valued at $28Bn just for that segment, selling for a total of just $108Bn after earning $24Bn in '05, $21Bn in '06 and $3.6Bn in '07. That is AFTER paying out $10Bn in dividends and $10Bn in taxes.
So no thanks bears, I think I'll take my chances that the entire financial system won't go down the toilet. Yes you have BSC to point to but that too was an engineered failure brought on by panicked investors causing a liquidity crisis in an investment house that was already having troubles. BSC was beholden to a fairly small group of wealthy investors and you can organize (oh sorry, I promised to call it a coincidence) withdrawals that can cripple the firm but no matter how many TV shows you go on, I don't think you can take down a diversified financial the size of C. Either way, it's going to be an interesting couple of weeks until earnings.
