A Rare Win for Citigroup Shareholders

Wall Street megabank Citigroup (NYSE: C  ) is about to take another step toward resolving legacy issues remaining from the financial crisis.

At the end of last week, Citi disclosed that fellow investment bank Morgan Stanley (NYSE: MS  ) had submitted a bid to acquire an additional 14% of their jointly held brokerage unit, Morgan Stanley Smith Barney. Citi holds a 49% stake in the venture compared with Morgan Stanley's 51%.

The unit was created in 2009, when Citi transferred its retail brokerage, Smith Barney, into the newly formed entity in exchange for a minority interest and $2.7 billion, and Morgan Stanley relinquished its global wealth management business in exchange for majority control.

Although Citi's CEO, Vikram Pandit, claimed that the joint venture would create a "peerless global wealth management business and provides tremendous value for Citi," the reasons for the agreement are much more pedestrian.

For one, Citi was desperate for cash at the time, with billions of dollars in net credit losses coming down the pike. And two, around the same time, Citi had reworked its strategy and decided to move away from retail brokerage in favor of commercial and investment banking.

The big question that remains to be answered is: What's the business worth?

Citi carries its 49% stake at $11 billion on its balance sheet, giving the entire entity a valuation of roughly $22 billion. Morgan Stanley, on the other hand, places a much smaller price tag on it -- evidently, a full 60% smaller.

According to The Wall Street Journal:

Analysts previously have estimated the value of Morgan Stanley Smith Barney between $15 billion and $24 billion. Some analysts suggested the value of [the brokerage] has diminished since the joint venture was created because individual investors are still shunning equities. Others believe it's worth more because of the future profitability it will achieve when it operates fully integrated and its financial results get a lift from higher interest rates.

The responsibility to resolve the $13 billion impasse is now in the hands of an independent appraiser. Though, given the deal's structure, Citi is bound to suffer a write down on the disposition, leading the bank to note recently that it "could have a significant non-cash GAAP charge to net income in the third quarter 2012."

A step in the right direction
Paper losses aside, any investor that's followed Citi's post-financial-crisis saga knows that fully disposing of Morgan Stanley Smith Barney, which should be finished by 2014, will be a step in the right direction.

Citi's ownership interest in the unit sits sequestered in Citi Holdings, a cast-off and much maligned division under the Citigroup umbrella, which regularly reports quarterly losses in excess of $1 billion, and also contains the bank's $100 billion portfolio of potentially toxic mortgage assets.

To give you a rough idea of the toll this takes on Citi as a whole: Without Citi Holdings, the bank's return on average tangible common equity for the first half of 2012 was 15.9%. With it, that number drops to 8.8%.

Now, it's only fair to note that even the latter number is still considerably better than Citi's closest competitor, Bank of America (NYSE: BAC  ) , which reported an embarrassing return on tangible common equity of 3.94% for the same time period -- this is likely one of the reasons that shares in B of A trade for only 0.36 times book value compared to Citi's 0.42. But being "not the worst" probably isn't Pandit's idea of success.

Is it time to double down on banks?
Even though we're almost four years removed from the worst of the financial crisis, many of our largest financial institutions continue to suffer. While this is horrible news for the economy, it's music to the ears of value investors. As my colleague Matt Koppenheffer recently noted: "Not all that long ago, buying any of the major banks at [current] valuations would have seemed like a no-brainer."

The cheapest of them all, as I noted, is unquestionably Bank of America. Does it still have problems to sort out? Yes. Though, will it be able to do so? I think it will, which is why I own shares in the troubled, but dirt-cheap, bank.

Indeed, according to our recent in-depth report on the bank, "for investors who are comfortable taking the real risk of up to 100% loss of capital, today's prices are attractive and could result in a double or triple within the next five years." Discover exactly why our senior banking analyst, Anand Chokkavelu, thinks this may happen.

Fool contributor John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America and Citigroup. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On July 24, 2012, at 12:54 AM, rusfuture wrote:

    I traded BAC and C a fair bit, several years

    back. Bought 1/2 an F-150 with the BAC

    profits, and sold my (pre-split) Citigroup at 25,

    in a Starbucks parking lot, on my cellphone,

    'cause I had a sudden burst of sanity. Held

    my GM (before its bankruptcy), from 16 to 8.

    Felt like a huge fool selling it a 8, but that turned

    out to be another bullet dodged. But I am no

    expert. Took a bath on BAC later on, but my

    rigid dump-and-exit safety algo took me out

    before LEH blew up (traded that steamer also).

    Been very, very weird times for many small fry

    like me. The big risk now, is that maybe a new

    US govt decides that the big US banking

    consolidation is actually not such a great idea,

    and a push comes to break up the megabanks,

    like the big oil trusts, big phone-company

    monopolies, and (almost but not quite), IBM.

    Trust-busting is fun, is great theatre, and it

    makes the Washington fraudsters appear as

    if they are actually doing something useful

    (they aren't, don't be fooled...) So, I think

    Mr. Market is telling us something of value,

    when he suggests that pre-revsplit, C is worth

    a tad over 2 bucks, and that BAC, (with, oh

    how many billions and billions of shares

    outstanding? ) is maybe worth 6 or 7 bucks

    a unit. Ask a smart accountant what book

    value is, and he will reply "Well, what do you

    want it to be?" Very, very few of the numbers

    being vectored around cyberspace can be

    trusted anymore. Most are engineered

    deceptions at best, some are simply outright

    lies. Everyone needs to keep that in mind.

    If you want to double down, go play poker.

    (It's a fun game, though it can be expensive.)

    BAC was run by that sharpie, Ken Lewis.

    He made out all right, no? Now, some

    lawyer is in charge. A lawyer. Like bringing

    a knife to a gunfight, maybe? What do I know.

    Not much, I have learned. Except that US

    large-cap financials seem to be bent pretty

    badly. Even Dimon at JPM, (who knows how

    to run a bank), can't keep on top of what

    his own asset-liability mgmt operation is

    doing. And regardless of who wins the election,

    it will likely remain open season on banks.

    The cards are stacked against the banks, and

    may be for a long time. It is quite possible we

    will see a double in both C and BAC, within

    5 years. But it is equally possible that they

    might pull a GM, and swing thru zero first,

    just to reset their little counters. That trick

    works so good for the insiders and the

    gov't dudes, that I (sadly) expect to see a lot

    more of it being done. Why else would we

    see full-on *negative* interest rates on 2 year

    paper in 6 different countries in Europe? And

    10 year Treasuries returning *less* than the

    rate of inflation? (1.5% versus 1.7% on the

    US CPI? Its not just euro-breakup that is the

    fear driver, it is this new government-sanctioned

    restructuring model that involves zeroing out

    the equity value in modern joint-stock companies

    as part of economic repair and reset. It's bad.

    They don't do a real bankruptcy, and move the

    assets to new owners. No, they just screw the

    stockholders, and everyone goes out to dinner.

    If it worked for GM and AIG, why not the banks

    with their zombie real-estate portfolios? Just

    flush them down, let 'em take whacking great

    write-downs, and hang the shareholders out to

    dry (again). Europe will likely end up doing

    some form of this for a lot of its non-economic

    companies. Why not C and BAC? If you

    must buy a bank, buy a Canadian bank.

    Any will do. Loan-to-values are 75-25%,

    worst-case, typically, for mtg loans. A big

    "high-ratio" might be 80-20. Cap rates are

    still running 5 to 7% on a lot of commercial

    projects (or higher), and Cdn's love to pay

    bank fees. The "Big 5" just rake it in, good

    times or bad, and their Basel ratios are just

    about the highest in the world. (I think CIBC's

    is 14% or something silly..). They should

    all trade higher, but since all trades are now

    the same trade (in/out or risk-on/risk-off),

    they get hammered when the US sneezes.

    Even Bill Gross says "buy hard assets" instead

    of gov't paper. If there is no QE3, then

    we can probably expect a slow grind for the

    next few years, flatline micro-growth at best.

    But, I don't know anything, and my opinion

    should not be relied upon as investment

    advice. Oh, and Reg. FD disclosure: I have

    positions in Canadian Bank stocks, so I am

    probably just talking my position. Best luck.

    - Rus.

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