Citigroup, Pandit & The $49B SIV Assets

Yesterday's big financial sector news was that Citigroup, newly headed by CEO Vikram Pandit, to reverse course and take $47B of SIV assets onto its balance sheet.



Shortly after Thanksgiving, last month, I wrote this post about these SIV assets. In contrast to my earlier belief that a bank couldn't legally, without exposure to shareholder lawsuits, assume the liabilities and, thus, the assets of its SIVs, I determined, on the basis of the then-new information, that Citigroup effectively owned its SIVs.



Yesterday's move confirms my contention. Due to the bank's agreement, in the SIV formation, to be the buyer of last recourse if the SIVs' notes were unsalable in the market, Citigroup has, indeed, become the owner of much of the debt obligations of its SIVs and, thus, its assets, as well.



This led to more downgrades of Citigroup, both in its debt, and as an equity investment. As the nearby Yahoo-sourced one-year chart of Citigroup's and the S&P500 Index's stock prices reveals, the large bank has really been punished by the equity markets beginning in mid-year.

Several things come to mind as I have read the recent Friday and weekend editions of the Wall Street Journals, both containing prominent pieces related to Citigroup and Pandit.

First, given how badly Citigroup's stock price has collapsed since June, one should expect that sometime in the next two years, Pandit will receive credit for when the inevitable snap-back from this huge drop occurs. It could have been anybody, really. At some point, when bad news stops hitting the bank, some institutional investors will probably buy in at the bottom, and send the stock soaring from its depressed values.

So, no matter who would lead Citi right now, it's almost certain that sometime in the next 18-24 months, some Wall Street Journal article will crow about how great the CEO is at having 'turned Citi around,' despite the fact that it will have only been a reactionary pop in the stock price due to the cessation of bad news.

The matter of the $49B in SIV assets coming onto the Citigroup balance sheet probably will be seen as confirming the precedent set by HSBC recently. For all practical purposes, I suspect the charade of these being arms-lengths creations is over for good. Which may result in some added downgrades for affected commercial and investment banks.

Friday's article concerning Pandit's options at Citigroup went into considerable detail about various breakup options, and their drawbacks. Primarily, the alleged constraints involve regulatory opinions, capital adequacy, and taxes on gains of sales of units.

I'm of two minds about these sort of analyses.

From my own experiences at Chase Manhattan Bank, I know that these can become serious impediments to the sort of strategic maneuvering in which a bank CEO may engage. Allocating losses in retained earnings such that some units would have to take those hits upon dissolution of parts of Citigroup is no theoretical issue. Neither are taxes on gains of units having some original purchase value.

On the latter point, by the way, a spinoff to shareholders would, I believe, be tax-free. Then, the putative CEO of the spun-off unit could simply agree to merge with another entity.

However, to the larger point, I would say that this really puts Citigroup shareholders, both present and prospective, in a major bind. It effectively forces them to choose between a slimmed-down, manageable bank with regulatory challenges on the road there, or the dismal prospect of being constrained to continue operating a discordant collection of businesses in a mediocre manner which, in total, stand almost no chance of ever consistently offering shareholders better returns than those of the S&P500 Index.

To tell shareholders that muddling through with the current stew of businesses is the least bad of various unpleasant options is to invite a gradual bleeding of market value from Citigroup, until it simply becomes too irresistible for someone to acquire, then split up.

Pandit had better hope he's not constrained from any business disposals at Citi, or he's in for a very sobering and unhappy tenure at the helm. I will forecast that the bank, in its current incarnation, won't reach the point, as Goldman has, of becoming a consistently superior total return performer, relative to the market. Without the freedom to simplify Citigroup's cumbersome and ineffective business mix, Pandit's virtually guaranteed to preside over more bitter years for shareholders.