Citi's Investors Never Sleep Either

In comparison to the multiple billions in earnings and market cap that Citi has parted ways with in the disastrous last couple of years, a $7.6 billion loss is chump change. But still, with all of the bravado coming from the banking industry, you'd think Citi could rub together a bit more than a loss of 33 cents a share. Yes, most of the loss was related to paying back the government, but then maybe that's just a sign that it should've waited to be profitable before rushing to pay the government back just because it had to pay its employees "competitively?" (i.e. so they wouldn't all run away to work for Goldman. As if Goldman would ever stoop so low. I mean, the folks at Goldman only hire "real talent.")

But no worries, Citi plans to earn its way out of the hole it dug for itself when it decided to pile full throttle into the booming CDO market (as well as every other over-priced asset in the credit boom.) Maybe one of those bullish analysts can explain how you earn your way out of a hole by continuing to post losses.

Financial Headlines 12/17/2009

• Yesterday's Fed decision yielded little unexpected news. Chairman Bernanke and his cronies basically said that the economy was a bit better, but not enough for them to actually do anything to stop the potential for a massive bubble reflation. The fed funds target will remain stuck between zero and .25%, so please, won't you please, keep buying the long bond cause we're going to need to sell ALOT more of those. But don't worry about agencies and MBS, we plan to buy another $150 billion or so of those. Oh, and by the by, you should expect some volatility in Feb after we let most of the artificial liquidity supports expire.
• Citi completed its $20 billion offering. The sale was considered a bit of a bummer, as the shares wound up being priced at around a 20% discount. Furthermore, the government backed out of its plans to sell up to $5 billion in Citi's shares that was intended to lower its stake from 34% to 30%. According to the FT, the government backed out because it would have suffered a loss on its investment. Frankly, that's a fairly stupid reason to back out of selling stock. I know the government wants to keep crowing about what a great money manager it turned out to be and how much money it has made on the TARP so far. You know, because Paulson and Geithner were smart enough to buy preferred stock in GS with a 5% dividend when Buffett got his with a 10% dividend? While the rest of the market was pricing in insolvency and the government could've and should've received a 25% dividend? Yeah, they're a bunch of geniuses. In any event, they're probably going to wait until the stock hits $2 and then try to offer it out at $3.
• In the cheery world of commercial real estate, Morgan Stanley handed over 5 more office buildings in downtown San Francisco to lenders. In yet another example of why we don't want these "savvy" investors, who don't lend to small businesses or consumers, playing with money that carries an implied government guarantee, the buildings have lost around 50% of their value since the purchase. The buildings were part of a $2.5 billion deal where MS purchased 10 buildings from Blackstone Group in May 2007. Blackstone had just purchased the buildings in its $39 billion buyout of Equity Office Properties and then flipped them for a nice profit. It's still hard to fathom how nobody recognized a bubble back in 2007 when office building flipping was a major financial activity.
• Bank of America finally found a new CEO. The job went to Brian T. Moynihan, a longtime B of A employee. In a sign that big transformative changes will be afoot as a result of hiring an insider, Mr. Moynihan said that he doesn't foresee any "big changes," nor does he plan to exit any of the companies current businesses. So yeah, his hiring will make a really big difference.

Abu Dhabi Wants Its $7.5 Billion Back

Back in the day when it seemed like a great idea to pay over $30 a share for Citigroup, Abu Dhabi struck a deal with the bloated investment bank to pump billions of dollars into the bank. At the time, Citi needed the cash, and Abu Dhabi was looking for a sure thing. The sovereign wealth fund invested in Citi in November 2007, in return for an 11% dividend until March of 2010. Doesn't sound like a horrible investment so far, right? Alas, part of the deal was for Abu Dhabi to begin buying $7.5 billion in Citi shares at $31.83 each. I'm certain I don't have to remind readers of the sad fact that Citi's shares are currently trading at around $3 and change. The good news is that this makes the folks at Citi look like maybe they weren't the biggest bunch of bumbling idiots in the sea of financial idiocy of the past couple of years. The bad news is that Abu Dhabi is pissed and no longer wants to honor the contract. You see, the thing is, it has to fork over $10 billion or so to prop up Dubai World, so it kind of needs the cash.

Abu Dhabi is insisting that Citigroup scrap the deal entirely, or pay $4 billion in damages if the deal is upheld on account of some "fraudulent misrepresentations" it claims Citi made. I'm not sure exactly what those representations were. Mismarking assets? Accounting fraud? Who knows? But I'm fairly certain than anyone who paid over $30 for Citi in 2007 suffered from the same misrepresentations. Maybe some enterprising lawyer can pick up Abu Dhabi's case and turn it into a class action lawsuit.

Citi, Dubai, and Other News

Equity futures are higher on some bullish headlines:

• Dubai received $10 billion from Abu Dhabi, which will pay part of the debt held by Dubai World and its property unit Nakheel. $4.1 billion of the bailout will be used to repay Nakheel's bonds that mature today. The rest of the money will be used to finance Dubai World's needs up until the end of April 2010. So, if you were confused about whether Dubai World was going to get a bailout, (and why wouldn't you be? What part of "investors understand nothing!" did you not understand?) this should help clear things up. At least until the end of April.
• Citigroup has finally negotiated its partial exit from the TARP. However, the government is requiring that the bank raise $20.5 billion in equity to replace the $20 billion in TARP funds its wishes to repay. Additionally, the US Treasury will sell up to $5 billion of the common stock it holds in a secondary offering at the same time. The rest of the government's 34% stake will be sold "in an orderly fashion," or in a frenzied panic, whatever the case may be. Here's hoping Citi's efforts to escape the claws of the government is worth all the dilution shareholders will suffer.
• Speaking of dilution, Exxon Mobil will spend $31 billion in stock to acquire XTO Energy in a bid to boost its presence in the natural-gas industry. The bid represented a 25% premium to Friday's closing price. The market still loves a good M&A deal, particularly on Monday morning. You know, because all of those huge M&A deals are always such value creating opportunities. Like all of those big bank mergers from the past ten years, not to mention AOL-Time Warner. That one worked out really well...for the investment bankers.

Headlines 12/8/2009

• Both Fitch and Moody's out stating the obvious today, with massive downgrades of both Greece and Dubai. The Dubai downgrade is patently ridiculous. If there is anyone left out there that doesn't know that Dubai World defaulted on its debt and the Dubai government refused to step in to bail it out, Moody's is here to educate and protect those investors about to make a foolish decision. Maybe word hasn't reached those sitting in debtor's prison in Dubai? Who knows? Oh, and also, in a completely shocking development, Nakheel, Dubai World's real estate development subsidiary that owns all those half-built buildings on man-made palm shaped islands, lost a boatload of money, $3.65 billion in the first half of 2009 to be exact. As for the Greek downgrade? Rumors abound about the country's troubled finances. But don't worry. The Dubai crisis, much like the subprime crisis, is contained.
• US consumer credit shrank for the ninth month in a row, by 1.7% in October. A couple of interesting highlights from the WSJ article: In 2005, over six billion credit-card offers were sent out to consumers. This year just 1.4 billion have been sent out. Also, Visa reported earlier this year that people for the first time were using their debit cards more than credit cards. The trend lower is likely to continue for some time in order to reverse the absolute explosion in consumer credit over the past few decades. What's shrinking along with consumer credit? The probability of a strong V-shaped recovery. Good chart at Calculated Risk.
• Citigroup and Wells Fargo are getting in on the "We wanna pay back the TARP" action, according to the WSJ. The banks are wrestling with the US government over how much capital they need to raise to exit from the program so they too can "compete" with all the other large banks that have managed to negotiate an exit. The problem is that issuing more stock is expensive. Of course, with the strong market rally looking like its finally petering out, they'd better pick up the pace before it gets even more expensive. I'm all for paying back the TARP. Get on with it. Just as long as everyone agrees that there is no next time if you were wrong about your balance sheet being strong.
• As if you needed yet more evidence that the government employees in charge of protecting our TARP dollars are a bunch of spineless twinkies, the Pay Czar actually caved in to AIG's general counsel's demands for no pay cuts for her and her cronies. It seems that the five employees who threatened to quit so they could collect a fat severance package will get to keep their over-$500,000 salaries. That's right, because without the right general counsel, there's no way that AIG will ever crawl out of that $100 billion hole.

Citi Finally Does Something Right

No, I'm not talking about getting high marks for its managers from some bogus consulting firm that the board hired to conduct a government-mandated review. Although, according to the WSJ, Citi passed the preposterous test, which involved asking managers such tough questions such as "how effective are your colleagues?" No wonder the FDIC is skeptical about the rigors of the review.

What I'm giving Citigroup high marks for is offloading its Phibro unit to Occidental. Ever since the furor erupted over Andrew Hall's $100 million pay package, I have been advocating that the bank get rid of the unit. It's not that I don't think Mr. Hall deserves to get paid a boatload of money when he generates sizable profits. It's that I don't think anyone working for a firm that essentially went bankrupt and only has a pulse due to government assistance should be paying out those sums to anyone, no matter how profitable their individual unit was. Rather than deal with the political backlash of having to defend Mr. Hall's pay, it's just easier to get rid of the unit so the firm can concentrate on the more important business of managing its multi-trillion dollar balance sheet. Oh sure, Mr. Hall's unit made some money for the bank over the years, but it was a drop in the bucket compared to Citi's enormous losses. Furthermore, it is a proprietary trading business, which means the unit could easily misfire and lose a bunch of money too. Most importantly, the idea of bailing out Citi was to protect depositors and avoid the catastrophic consequences of the disappearance of a large lender to consumers and businesses. It was not to protect large pay packages to employees and support a commodities casino business. No, that was merely the government's intention when it bailed out Merrill...

Pay Czar Gets Tough Assignment: What to Do About $100 Million?

Kenneth Feinberg, the man with the enviable position of Pay Czar, has his work cut out for him. He is tasked with reviewing and approving the executive compensation packages that were crafted before, and in some cases during, the great banking sector blow-out of 2008. According to the WSJ, Mr. Feinberg is not allowed to rip up previously agreed-to legal agreements. He can reduce salaries to compensate for overly generous bonuses and reduce future earnings. Reducing future earnings will, of course, lead to "top producers" leaving their posts. If your contract says you are owed $10 million and you get paid $10 million today, but are told you'll get a big fat donut next year, why bother coming in to work tomorrow? I wonder, can the Pay Czar cut the salaries enough so that salaries go negative? Isn't that a handy way for the government to defer the cost of supporting these insolvent institutions?

Reports over the weekend about a Citi trader's $100 million pay package are bound to put pressure on Mr. Feinberg to make some "tough" decisions about pay. Believe it or not, Citigroup actually has a group that makes money. You've probably never heard of it because it is a "highly secretive" energy trading group named Phibro run out of a barn in Connecticut by a man named Andrew J. Hall. Apparently, Citigroup only likes to publicize its divisions that are bleeding cash. In any event, Mr. Hall is due $100 million in compensation according to his contract and Citi finds itself in a pickle. It's tough to dole out $100 million to one man when the rest of the firm is still losing money and on $45 billion worth of government life support without inciting the pitchforks again from the masses. Sure the guy made hundreds of millions of dollars for Citi and wasn't responsible for the banks losses, but who cares?

Once upon a time, before government intervention in the private sector, there was a very easy way to deal with busting employment contracts at suffering firms. It was called bankruptcy. Nobody got riled up over Enron employees getting fat paychecks after the firm imploded because the employees were screwed along with Enron's investors. So it seems preposterous that a discussion over whether anyone working at Citi should get $100 million is even taking place. If Mr. Hall was such a savvy trader, he should have negotiated his lucrative deal at a bank that would actually remain solvent. Winding up at Citi was just a poor bet from a man who is supposedly good at taking risk. If the group is really that savvy and capable of generating huge risk free profits, then Citi should just spin it off for billions of dollars and pay the government back. But handing over $100 million to one man seems out of the question. Mr. Feinberg should choose wisely.

Investors in Citi's Alternatives Search For Alternatives

If you ignore the issues with subprime mortgages, SIVs, auction-rate securities, leveraged lending and commercial real estate (just to name a few), the rest of Citi's businesses are doing well, right? Right?? Well, not exactly. The WSJ has an article this morning detailing the problems surrounding Citi's alternatives business. One only has to look at assets under management, which have shrunk from $54 billion to $14 billion in the past year to know that something isn't really sitting right with investors. The article doesn't detail how much of the shrinkage was from investor withdrawals and how much was from investment losses but one can assume it was a healthy a combination of the two.

Citi plans to scale back its approach to alternative investments by pulling back from peddling the investments to retail clients and instead focusing on private-banking and institutional customers. As if the rich and institutions are more interested in poorly managed alternative investments with terrible returns than retail clients. Nevertheless, this is Citi's new strategy and I wish them luck. However, it seems like clients are perhaps not going to go for it. I offer exhibit A as evidence: clients of a private-equity fund that amassed $3.4 billion in airport, road, and other infrastructure projects last month voted to bar it from making new investments after its co-head quit and several high-profile deals collapsed. A second, smaller fund geared towards sustainable development failed to attract clients and was shelved. It's not a very high vote of confidence when your clients tell you to stop making investments and no longer wish to invest in your brilliant new fund ideas. The funds were the brainchild of Michael Froman, former operations chief of Citigroup Alternative Investments, who was apparently so bullish on the alternatives group's prospects that he left to go work for the Obama administration in January. Another co-head of the group has also recently left. But, no hard feelings from those who remain at Citi slugging it out. After all, with the government taking a stake in Citi, they too are working for the Obama administration. Citigroup's Vice Chairman praised Mr. Froman for doing "an outstanding job" at Citigroup. Other executives agree that he assembled a strong team of managers and that his funds "were hurt by market forces beyond his control." You know, market forces such as deciding to invest in leveraged illiquid infrastructure projects at the peak of a credit bubble. Because really, you can't control market forces like that.

Comic Relief: Citigroup Posits AIG Equity Worthless

A Citigroup analyst wrote a research report claiming that there is a 70% chance that AIG's equity is worthless. Investors may be shocked that such a bold and decisive investment proclamation could emerge that is such a deviation from the usual "neutral" and "hold"-type crap emanating from most Wall Street analysts. What could've possessed this analyst to finally put his foot down and proclaim now, a year after the company has lost 99% of its market value, not to mention puked over $100 billion in actual earnings, and received a massive government infusion, that the final $2 billion in market cap is in danger? What type of secret insight can this analyst possibly have that the AIG stock-buying diehards are missing? Well, he does work at Citigroup. Really, does anyone know worthless equity better than Citigroup?

A few weeks ago, I looked up at my stock screen and was astonished to discover that AIG was a $20 stock again. After rubbing my eyes a few times and conducting a small amount of due diligence, I discovered the company has executed a 20-1 reverse split. The move was done presumably to keep the company's stock listed and to entice investors into buying the stock again? I'm not entirely sure. What it means to me is that I get yet another opportunity to short this stock into the dust. I don't consider this move to be un-American, merely a hedge against all of my taxpayer dollars that are being wasted keeping this unwieldy beast of a company afloat.

Bank Capital Raising Frenzy Continues

On the heels of its $8 billion capital raise last month, Morgan Stanley, perhaps stunned by how high its stock price has remained, is raising another $2.2 billion in equity. Gotta pay back that TARP so it can return to paying bonuses at the expense of shareholders. Interesting that shareholders are still willing to buy into that philosophy. Yesterday afternoon, JP Morgan and American Express both announced plans to raise more capital. This is the first time to the trough for JP Morgan, which is raising $5 billion. Meanwhile, AmEx raised a more modest $500 million yesterday.

If you don’t believe that paying back the TARP is primarily a compensation issue, then just check out Citi’s announcement today. The beleaguered bank is halting severance payments to five former executives that left last year. According to the WSJ article, Citi had promised roughly $100 million in payouts to these executives, and has already made roughly half of the payments but is halting the rest. The bank is betting that the executives will be too embarrassed to file lawsuits, as evidenced by the outrage caused by the AIG payouts. For evidence that Wall Street’s ideas about paying “talent” ridiculous sums of money for seemingly no reason, I present you with exhibit A: Michael Klein. Mr. Klein, a 23 year veteran of Citigroup, was the head of investment banking. He RESIGNED in last July. Funny thing is, I have resigned from a few jobs in my time, and I’ve never been granted severance. Severance is for people who are laid off, not those who resign. Despite this, Citi offered to pay Mr. Klein a “severance” of $42 million in return for not poaching any of the bank’s investment bankers. I know that Citi is on a huge cost cutting scheme, reducing the amount of money it spends on paper clips and copies, etc. But $42 million buys a lot of paper clips. Why on earth the bank, which is suffering from some serious financial problems, felt obligated to pay someone this kind of money when he was leaving the firm and would no longer contribute one iota of value to Citi, shows a complete and total lack of economic prioritizing. Citi knows that this kind of wanton flushing of money down the toilet no longer flies as it has no shot in paying back the government any time soon. The rest of the 19 banks don’t want to be subject to the same constraints next time they feel like paying someone $42 million for no good reason.

As I’ve noted before, I want the banks to pay back the TARP. I don’t think taxpayer money should be funding risk-taking. I don’t care what banks pay their employees, but I don’t think the government should subsidize outrageous Wall Street style compensation, especially when the unemployment rate is 9%. But my conditions for TARP repayment are the following: You pay back the TARP, and this whole government-backing-the -banks scheme is over. Going forward, no more TARP, no more FDIC guarantees, and no more pledging any collateral other than treasuries to the Fed for loans. No more Too Big To Fail. The government shouldn’t be bailing out risk takers.

Citi, B of A Argue Stress Test Results

Citi and Bank of America are not happy with the results of the government-mandated stress tests, which will force them to raise significant amounts of new capital. According to the FT, Citi needs $10 billion more, while B of A needs “well in excess of $10 billion.” The banks are furiously arguing their case, claiming the stress test results were too pessimistic. PNC and Wells are also mentioned as regional lenders that would be required to raise capital, unless they manage to convince the Feds otherwise.

In the event that the government prevails, Citi is rooting around for more securities it has issued that can be converted into equity. The good news, for Citigroup at least but not so much for investors that were hoping to continue to collect interest on their trust preferreds, is that Citi has around $15 billion in trust preferred securities lying around that it can convert. No word yet on how B of A plans to fill its hole.

Stress test results have been delayed and will be released on Thursday, May 7th giving the market plenty of time to continue rallying for no good reason. Somebody wake me up if anything interesting happens before then.

Citigroup: The $1 Stock That Can't Stay Out of Headlines

It used to be that after a particular stock dropped into the single digits, investors just stopped caring.  The company was delisted from its corresponding exchange and relegated to the indignity of trading on the pink sheets.  Then, maybe seven years later, some headline declaring the company's bankruptcy would hit, you'd scratch your head and say "Hmmm.  Didn't that stock used to trade at $70?  I can't believe it took them this long to go bankrupt." (i.e. Lucent)  So why is it that I pick up the paper every day and have to continue to read about AIG and Citi?   Haven't they done enough damage already to investors and taxpayers' wallets?  The answer, of course, is "yes", but unfortunately the fate of capitalism itself lies in their hands.

The Wall Street Journal brings news of yet another "contingency plan" for Citi, as if three bailouts, the most recent merely a week ago, weren't enough.  According to the Journal, regulators are merely trying to ensure that they are prepared if Citi takes a sudden turn for the worse, which, by the way, they aren't expecting, but, you know, just in case.  Apparently, regulators including the Treasury, the Office of the Comptroller of the Currency, the Federal Reserve, the FDIC and the Post Office (ok, not really, but I hear the Postmaster General was pissed he wasn't included) were involved in discussions with Citi executives over the weekend.  Regulators say that the planning should be seen as a normal function of government during a financial crisis.  Talks of a "bad bank" to take distressed assets resurfaced yet again, as if we hadn't beaten this dead horse to a pulp enough times, but officials were considering other approaches (aka they have no idea what to do other than spout the words "bad bank" every couple of days.)

Citi's beleaguered CEO Vikram Pandit leaked news of actual profitability at Citi for the first two months of the year.  According to the Journal, Citi is having its best quarter in a year and a half, which honestly isn't saying much as the company has puked $40 billion? $50 billion?  Does anyone even keep track anymore?  Apparently, the bank posted revenue - excluding asset write-downs - of $19 billion in January and February.  For the full quarter, earnings before taxes and set-asides for problem loans are $8.3 billion.  Given how many write-downs and set asides for problem loans Citi continues to take, I'm fairly certain that these "profits" are somewhat meaningless.  Honestly, credit spreads are at record wide levels and the bank can finance everything at 0%, so yeah, they're obviously making money financing their inventory.  But who cares if they have $100 billion more in write-downs coming?  That's the only number that matters.  If Citi can have one quarter, just one, where earnings are actually positive DESPITE write-downs and set asides, that $1 stock might start to look pretty tasty.  Otherwise, get back in your $1 hole and stay out of my newspaper. 

Citi and Car Makers in the Headlines, Again

So many big problems, so little time.  Although the banking sector is supposedly getting a rigorous stress test, Citi seems to be running out of time and is jumping the gun.  How about bolstering its tangible common equity before the stress test by swapping the government's preferred shares into common stock equal to a 40% stake?  This is the latest rumor floating around and reported in the Financial Times and the Wall Street Journal.  The market seems to like this news, as equity futures reversed a decline last night after the Journal reported the "talks."  Really, I have a better idea though.  What if the government just forked over an additional $10 billion (because really, what's another $10 billion at this point?) and bought 100% of Citigroup?  After all, this is the current market cap of the bank.  So really, why settle for a 40% stake?  It seems as if the administration is attempting to avoid the appearance of out-right nationalization at all cost.  Whether this strategy will work or is just an attempt to keep markets trading until the stress tests are under way on Wednesday, giving the government a little time to think of a better idea, remains to be seen.

Meanwhile, outside advisors to the US Treasury have begun lining up the largest bankruptcy loan ever to the car makers with banks and other lenders.  The financing package would amount to at least $40 billion for GM and Chrysler.  You know, "just in case."  It sort of makes you wonder why Congress didn't bring in the automakers and the bank CEOs at the same time to testify.  Then the awkward conversations before Congress could've been combined into the following snippet: 

Congressman: (to Rick Wagoner)  Why did you fly here on your private jet? You fat cat!

Wagoner:  (with head bowed) Can we borrow $40 billion?

Pandit:  We sold our jet, Mr. Congressman!  And I'm only accepting $1 in pay this year.  Did you hear that?  I'm only getting paid $1.  

Congressman:  Shut up!  You're a fat cat too!  Now since the taxpayers own you, I demand that you lend money!  Lend Lend!  Give the car companies a $40 billion loan.

Pandit:  Yes, of course, absolutely!  Whatever you say.

Congressman:  So then you will do it?

Pandit:  Yes, but there's a small matter of, um.

Congressman: Speak!

Pandit:  Can we borrow $40 billion?

See, wasn't that so much more efficient than the three days of painful testimony we were subjected to?  In any event, every option for the car makers is still on the table, even Chapter 11.  Again, the somewhat amusing part is that government officials are trying to browbeat the biggest banks, whom they accuse of not lending to consumers, aka Citi and JP Morgan, to use their capital to participate in the largest DIP financing of all time.  The government is looking at ways the Treasury could "prime" other banks making DIP loans so the government could be paid back before the private creditors.  Naturally, the banks are crying foul, while GM and Chrysler both insist they can avoid bankruptcy.  Certainly they can avoid bankruptcy, if the they can just get another $24 billion or so from the government.  But this is the last time.  No really, they mean it.  In any event, it should be understandable, given the questions of solvency of our banking and manufacturing sectors, that the market has taken it on the chin lately.  A tidy resolution to the whole mess would be welcome.  But really, that would be asking too much. 

   

    

Executives at Citi Follow Other Banks' Lead in Declining Bonuses to Head Off Furor

Pity the poor Citigroup executive who must forego his bonus purely to ward off near-certain flogging by the media and angry taxpayers footing the bill for its bailout.  The Citi chiefs recognized that paying themselves bonuses in a year where they flushed billions of dollars down the toilet and required two bailouts from the government would be political suicide.  The New York Times article quotes Vikram Pandit with: "The harsh realities of 2008, primarily our earnings results, mean that our bonus pool is dramatically lower than last year."    The article goes on to say that bonuses at the top will be down at least 40% for 10 members of its senior leadership team.  Call me crazy, but somehow "at least 40%" doesn't cut the mustard for me.  I would like to recommend "at least 77%" instead, for that is precisely how much Citi's stock was down in 2008.  Or how about "at least 95%?"  For this is the indignity that Wachovia employees were handed for coming in to work in 2008.  Despite Wells Fargo rescuing the Wachovians from their fate as future employees of Citigroup (or more likely just members of the unemployed) after an FDIC seizure, according to the New York Times story, the California bank is refusing to cough up retention packages and bonuses to Wachovia's employees to compensate for Wachovia's stinginess.  A top Wells Fargo executive is quoted with announcing to a group of Wachovia's bankers the following "I know that's very painful to hear, but that's the reality.  It just would have been irresponsible to the company's shareholders to do anything else."  The New York Times managed to find an embittered Wachovia third-year Vice President, who at least had the presence of mind not to identify himself, to make the audacious claim that the bank's decision was putting its employees in "financial extremis" and in some cases, at risk of not making their mortgage payments.  While it is certainly true that if you spent every cent of your bonus money during the biggest boom Wall Street has ever witnessed, and assumed that your bonus was guaranteed ad infinitum, then yes, you are definitely up the creek now that you can't make the mortgage payment on your $(insert a number) million house.  The thing is, that's not really your employer's problem, nor should it be.  

For years, private equity and hedge funds fed the finance compensation boom by poaching already highly paid Wall Street employees and offering them a bigger piece of their profits.  While alternative asset managers rewarded very richly to the upside, they can't pay when they lose money, as 20% of 0% (and more likely negative returns) is still a big fat donut.  After a brutal year for hedge fund and private equity returns, coupled with record redemptions, the competition that was willing to pay up for "talent" is gone.  It seems that several boom years on Wall Street corrupted some executives and employees into thinking that they should get a bonus every year no matter what, even if their employer lost, for example, $22 billion in a quarter (i.e. Wachovia,) was seized by the FDIC, and more than likely would not have been saved by another bank if it weren't for the government's largesse.  

While my thoughts go out to the naive third-year Vice President quoted anonymously in the New York Times article who now finds himself in "financial extremis," I'd like to offer some unsolicited words of wisdom:  First of all, congratulations, you still have a job.  Second, suck it up, downsize, kiss some ass, and keep your thoughts to yourself at work as well as dinner parties, particularly if you happen to go to dinner parties with people who don't have six-figure salaries or are unemployed during a major economic downturn.  And last, never forget that third-year Vice President = Very Expendable.  

US Government Bails Out Citi, Who's Next?

After much see-sawing and several leaks to the press on Sunday, the government finally reached an agreement to bailout Citigroup.  The terms of the deal include splitting the bank's assets into a "good-bank/bad-bank" format.  Alas, the government will be guaranteeing the assets in the "bad bank" as well as administering spankings when appropriate.  The outline of the terms of the deal can be found here, but here are a few highlights:

$306 billion in bad assets will be "ring-fenced" in the bad bank.  Citigroup will absorb all losses up to $29 billion in addition to existing reserves.  Beyond $29 billion, the losses will be split, with the government taking 90% and Citigroup absorbing 10%.  For anyone who actually cares which of the institutions will be bearing the loss, the government has broken this out as well.  Although ultimately it is all coming from the same kitty, the breakdown matters because investors need to know how much is left in the TARP for other beleaguered institutions.  The US Treasury will absorb the first $5 billion, followed by the FDIC with $10 billion, with the Fed on the hook for the balance as it will be financing the debacle with a non-recourse loan at a rate of OIS plus 300 basis points.

What is the government getting in return for assuming all of this risk?  Citi will issue $7 billion in preferred stock with an 8% dividend rate.  However, Citi will retain the income stream from the guaranteed assets insuring that the government's investment has little upside and enormous downside.  Citi will be prohibited from paying common stock dividends for three years and, of course, compensation of executives will need to be approved by the government.

Frankly, this is a fantastic deal for Citigroup and a really lousy one for the government.  The maximum downside to the government on this deal is $209 billion.  Certainly that is if the assets go to zero, and nobody measures risk that way, blah blah blah.  But a failure of risk managers to consider catastrophic losses as a possibility is what got Citi in this mess to begin with.  The original purpose of the TARP, to purchase toxic assets from banks, has been revived, but apparently only for Citigroup.  I suspect that the market is going to continue punishing the stocks of all the banks, until the government agrees to do the same with any institution it deems as holding too many crappy assets.  Does this sound like a crazy conspiracy where the banking industry attempts to cannibalize itself in order to force the type of government bailout it wants?  Absolutely.  But a front page story in the WSJ detailing how traders at Merrill, Citi, Deutsche and UBS attacked Morgan Stanley in late September by purchasing credit default swaps in what may have been a coordinated attempt, points out how willing Wall Streeters are to punish each other.  Somehow, they don't seem to understand that forcing Morgan Stanley into collapse may pose irreparable damage for their own business.  Or perhaps they understand the business is doomed and only the government can save them now?  They want the TARP back and the governments seems only too willing to comply.        

Are Citi and Goldman Finally Facing the Music?

Citigroup's CEO Vikram Pandit held a town hall meeting intended to boost morale, and then announced that the bank will be eliminating more than 50,000 jobs or about 14% of its workforce.  I'm not sure how that town hall meeting was supposed to bring anyone back from the ledge, but at least the bank is getting realistic.  Citigroup announced that the company was planning to reduce expenses by 20%, targeting 2009 expenses of $50 to $52 billion.  The reports do not mention whether Citi plans to cuts the rest of its dividend.  But at some point it should sink in that paying a government-sponsored dividend in these times is flat-out moronic, not to mention politically unwise.

Meanwhile, in a masterful public relations move, top executives at Goldman Sachs have decided to forgo their 2008 bonuses.  Although Goldman has (so far) had a reasonably profitable year in what has been a disaster for other banking institutions, senior management has figured out that it is far less painful to give up a bonus than try to explain their compensation to Henry Waxman.  It is hard to make a case that your executives "deserve" millions in pay when the investment bank is surely being kept afloat by the Fed through its numerous new toxic-asset financing facilities.  Furthermore, partners at Goldman make $600,000 in salary and have all been showered with millions in compensation for the past several years.  Nobody at the senior ranks of Goldman is going to starve without a bonus this year.  Employees of Goldman Sachs are no doubt nervous about this announcement as it has implications for their own end-of-year compensation.

It is widely known that securities industry professionals are an extremely well-compensated lot.  The industry is clearly shrinking and many who were accustomed to getting paid hundreds of thousands and even millions a year are now facing the prospects of living off of their salaries or being unemployed for a very very long period of time.  The interesting follow-up question remains:  How will the contraction of the securities industry affect other sectors of the economy that thrived off of the Wall Street boom of the last few years?  It is widely known that investment banks were leveraged 35-to-1 during the boom.  But how leveraged were the bank's employees?  While it is certainly probable that some percentage of securities industries professionals lived within or even beneath their means, it seems more likely that a large percentage expected to collect huge bonuses every year to maintain their extravagant lifestyles.  How many of those shiny new Manhattan luxury condos are going to come on the market within the next two months?  What will this do to other luxury goods retailers?  Villa rentals in the Caribbean?  Prices on contemporary art?  Ferrari dealerships?  Secondary home prices in the Hamptons and Nantucket?  The list goes on and on.  But I suspect that if you're in the market for a slightly used Rolex, you're probably going to get a great deal. 

Merrill, Citi, UBS: What a Debacle!

Merrill Lynch, the investment bank which slyly sold itself to Bank of America the weekend Lehman went kaput, has proven to the world that it is consistently capable of losing $5 billion a quarter.  The former investment banking powerhouse posted a $5.2 billion loss on, um everything.  Merrill had a total of $9.5 billion related to, CDO's, leveraged loans, paying Temesek back for diluting the funds original investment, you name it.  $3.8 billion was specifically labeled as "write-downs tied to GSE's and other investment banks which were either taken over or failed during the month."  The company declined to offer more details on those investments only to say "yes, we really are that bad at managing risk."

In other horrible bank earnings news, the financial disaster powerhouse that is Citigroup lost $2.8 billion in the third quarter on more than $13.2 billion in charges bringing the total credit losses taken by the bank to an eye-popping $64 billion.  I now know for certain where Citigroup came up with the idea to sue Wells Fargo for $60 billion for stealing Wachovia.

Just as a small reassurance to the US taxpayer who may be reading this news with horror, rest assured that the US investment banking industry remains highly competitive with the rest of the world.  Even the Swiss, those conservative, secretive, banking geniuses, are getting bailouts from the Swiss government.  UBS announced that it is selling $60 billion in garbage to the Swiss government which will be taking a 9% stake in the firm.  Credit Suisse has opted not to take a government handout, but will be raising capital in order to shore up its adequacy ratios.

Needless to say, the global banking industry is in shambles.  But you already knew that because governments around the world have been bailing out their banking institutions.  

What all of this proves, using Merrill as an example, who has now given back all profits since 2001, is that the practice of paying out 50% of revenues in bonuses at investment banks was a complete and total joke.  I wrote a piece on August 4th claiming that the Fed's dramatic financing of illiquid assets of investment banks amounted to a subsidy for investment banking bonuses.  I used the example of Thomas Montag who was awarded a $40 million signing bonus to run Merrill's sales operation in early August.  In light of Merrill's $5 billion loss, Mr. Montag has obviously not been worth the $40 million that Merrill punted on his hire.  My post was viewed by some as controversial, because yet again, the claim was made that all of that great "talent" at banks would flee if it wasn't getting paid.  Maybe now we can return to a more normal world where the neighborhood urologist makes more money than the guy who's mispricing default risk on a CDO.   

Weekend Bailout/Merger/Banking Alert

Germany's Hypo Real will receive a new 50 billion euro "rescue package" after a bailout package negotiated last weekend failed to materialize.  The German government and the Bundesbank have claimed that Germany's second-biggest property lender is too big to fail.  Meanwhile, BNP Paribas will buy 75% of Fortis Bank Belgium from the government for 8.25 billion euros in stock and purchase the Belgian insurance operations.  BNP Paribas will also acquire 66 percent of Fortis's bank in Luxembourg.  

In the US, Citigroup and Wells Fargo spent the weekend in court battling over Wachovia, the US bank that was ordered to merge last weekend with a bank, any bank, just merge before the opening bell on Monday.  The FDIC threatened to seize Wachovia if a merger was not forthcoming.  If you missed the action, here's a quick summary:  Citi bid $2 billion for parts of Wachovia on Monday.  Wells Fargo offered to pay nearly 7x Citi's bid on Friday for the entire bank.  This really pissed off Vikram Pandit so much that he filed suit against Wells Fargo.  He even called the Wall Street Journal and told them to replace the stock photo of him grinning like a loon with one where he looks angry, because he's not fooling around.  It appeared as if Citi won a victory in court on Saturday when it persuaded a New York state trial-court judge to extend the exclusivity agreement between Wachovia and Citigroup until Friday.  However, Sunday a state appeals-court judge overturned the extension of the exclusivity agreement.  Meanwhile, the Fed has jumped into the fray and asked the battling banks to make nice and work out a deal.  According to the Wall Street Journal, Citi and Wells are being asked to carve up Wachovia along geographic lines.  I would bet that a carving up of the bank will not pan out despite the Fed's best efforts and Wells will more than likely wind up owning Wachovia.

As an aside, I must note how amazed I am at how quickly the court system in America works when something "very important" is on the docket.  I spent six weeks serving as a juror on a very brutal murder trial this summer.  The murder happened in 2002 and it took six years to come to trial.  The prosecution had ample evidence for a conviction and the jury found the defendant guilty.  During the six weeks of my service, the court never met on a Friday, much less the weekend.  So I have to ask, how did Wells Fargo and Citigroup get to argue their case over the weekend in two different court rooms?    

A weekend's worth of more bailout negotiations by banks and governments around the globe have only served to intensify fears over the soundness of the banking sector.  Markets that have opened are already falling again this Monday, while S&P futures point to a lower open in the US after a brutal week for equities last week.  The good news in all of this?  The short-sale ban expires on Wednesday, so investors can line up their orders for Thursday morning.  Longs have three more days to sell their stocks which makes me wonder if the market will go down more at the beginning of the week as longs try to front-run the shorts.  Furthermore, with hedge funds having their worst September ever, is there anyone left who can still afford to short?  

Wells Fargo Snags Wachovia From Citi's Clutches

In a surprise move, Wells Fargo bested Citigroup's bid and snatched Wachovia as its prize. Wells Fargo agreed to pay $15.1 billion in stock for Wachovia, or roughly $7 a share, a significant improvement over Citi's $1 a share bid. Better yet, the Wells Fargo bid does not include any government guarantees. While Citi's bid included a promise from the FDIC to take a maximum of $270 billion in losses after Citi took the first $42 billion, Wells Fargo has indicated it has the stomach to swallow any potential future losses from Wachovia's ailing mortgage portfolio. This is proof that the market has the ability to find value in the banking sector without any need for a government bailout. Some might say that Wells Fargo waited to pounce on Wachovia until it was relatively assured of a bailout package passing in Congress. But then, it should've waited until the unpredictable House actually passed the legislation. Furthermore, Wells plans to issue $20 billion in additional equity to help finance the deal. With the stock near 52-week highs, issuing stock while the SEC short-sale ban in still in effect is brilliant and entirely predicatable. Any bank that doesn't take advantage of this window of opportunity to raise equity while the shorts are banished from trading should be immediately shorted when the ban expires.

Citigroup Acquires Wachovia Banking Operations, Profit-Sharing With FDIC

Citigroup will acquire the banking operations of Wachovia and enter into a profit-sharing (or rather loss-sharing) agreement with the FDIC on the future performance of $312 billion in loans on Wachovia's books. Citigroup has agreed to assume the first $42 billion in losses on the loans with the FDIC responsible for the rest. In return the FDIC is getting $12 billion in preferred shares in Citi to compensate the federal agency for assuming the risk. Frankly, I'm not sure $12 billion in crappy Citi preferred is worth assuming $270 billion in downside risk on a portfolio of mortgage-related assets but I'm not going to knock the FDIC. I'm still impressed with Sheila Blair for making $1.9 billion on the WaMu seize-and-flip to JP Morgan. Maybe we should put her in charge of the Bailout Fund. In any event, bondholders are happy as Citi has assumed Wachovia's senior and sub debt. Equity holders appear to be wiped out. Now that the Wachovia issue is resolved, we move on to the next question: Who's going to bail out Citigroup?