Citi Blackout?

Citigroup is the biggest pocketbook left for investors suing Enron and WorldCom for fraud. The company also has credit risks of about $10 billion to Brazil alone, which is in real danger (again) of defaulting on its international loans. As the bellwether of the financial industry, Citigroup's seemingly avoidable problems are a big worry for more than just its investors.

Format for Printing

Format for printing

Request Reprints


By Bill Mann (TMF Otter)
September 6, 2002

Already this year, banking and insurance behemoth Citigroup (NYSE: C) has lost more than $100 billion in market capitalization.

Market cap, as readers of this column know, is a determination by the market of how much a company's discounted future cash flows are worth. Over the last few months, cash flows once considered the next best thing to guarantees are now deeply at risk. It doesn't make a lot of sense to go back and determine what took Citigroup down to its current levels. The question is: Knowing what we know now, how much more risk do Citigroup shareholders face? Deeper still, as the big company in the financial world, is a swoon at Citigroup likely to cause a massive run on other banks' stocks?

I don't expect Citigroup to go away. It's still a massive bank, with interests on all corners of the globe. But these problems make me think the pain is just beginning for Citigroup investors.

Let's start at the top. Citigroup faces a few massive problems -- exposure to credit issues, legal issues, regulatory issues, and good old business weakness. First and foremost, the company is the biggest pocketbook around, with links to the Enron and WorldCom accounting scandals, and its exposure to both is greater than "gave financing to the guy who watered the plants at corporate headquarters." Its potential liabilities in both cases are massive.

Let's start with Enron. Everybody now knows Enron had deals with clever names like Chewco, Jedi, and LJM that kept billions of dollars of risk and debt off the company's balance sheets. Well, as it turns out, these things were improperly structured, so they were illegal. Citigroup, along with a few other companies, helped structure the deals, and, in some cases, was a capital partner in them. Citigroup marketed these same structures to other corporations as a nifty way to keep leverage off corporate balance sheets. So, Enron is in bankruptcy. Arthur Andersen basically no longer exists. And a large group of shareholders are out significant sums of money and looking to collect for the deception, as are a host of other creditors. Maybe even the guy who watered the plants. Later this month, Judge Melinda Harmon of the Southern District Court of Texas will rule whether to dismiss Enron-related lawsuits against Citigroup. Since the suits allege fraud, the potential liability to Citigroup far transcends the actual financial losses of the aggrieved.

Joint and several liability laws apply here. In other words, victims of Enron's fraud can simply go down the list of perpetrators until they come to one with money. The primary two are gone. Some individual Enron executives are at risk, then the law firm, and then the big pockets at Citigroup. Ouch.

Dirty analysts?
Were that the only problem.... Next comes a host of issues relating to Citigroup subsidiary Salomon Smith Barney's telecommunications analysts. The most visible is former analyst Jack Grubman, accused of hyping WorldCom and other telecommunications stocks in exchange for lucrative investment-banking business. Both Congress and the New York attorney general are looking into what more-senior Salomon executives knew about this apparent quid pro quo.

Further, it seems that certain clients, most notably former WorldCom executive Bernie Ebbers, may have been allocated shares from hot initial public offerings, potentially with a nod toward garnering even more banking business from WorldCom. This accusation, if true, (and duh, it's true -- even if it doesn't turn out to be actionable) is yet another sign of the slimy relationship between investment banking, research, and brokering at large banks.

Those big legal issues may be enough to scare the pants off of potential investors. But they're not all Citigroup has in its way. There's the possibility of several new rounds of corporate defaults, as the economy continues to struggle; plus, enormous loans to borrowers in countries with severe economic problems. Case in point, Brazil. American banks have about $25.6 billion in outstanding loans to Brazilian borrowers, of which Citigroup has about 40%, or about $10 billion. That's right -- $10 billion in exposure to a nation with a horrible tendency to default on its debts. The architect of this wonderful financial piece of strategy? Robert Rubin, former secretary of the treasury.

Bad loans to bad places
Brazil has been under International Monetary Fund (IMF) austerity measures for years. The Brazilians are now tired of living under these strictures, and will likely elect a president in October who's campaigning to get rid of IMF bean counters. Not so good for banks on the hook for loans to Brazil. Once that happens, the only thing left to do is wait for the collapse, and then figure out who's going to pay for the mess. Certainly, Citigroup shareholders won't enjoy their company's exposure, but remember this: Rubin's still a golden child in Washington. Don't be surprised if the U.S. government bails America's largest bank out of some pretty stupid loans by offering more emergency loans to Brazil -- paid for by you, the taxpayer.

Bad disclosure in a bad market
This just in today: Citigroup agreed to pay a $200 million fine to the Federal Trade Commission to settle charges of predatory lending. Again, not a big deal from a top- and bottom-line standpoint, but one has to wonder: What sort of tomfoolery has Citigroup engaged in to deliver its growth rates over the past several years? It's tough to say. Citigroup's disclosure of its exposure to tough businesses, such as emerging markets and subprime lending, aren't revealing. We don't have enough information about its loan-loss reserving. Decreasing credit quality and higher loan-loss reserves among subprime accounts have massacred Providian (NYSE: PVN) and Household International (NYSE: HI). What's the exposure for Citigroup? Dunno, because they don't say.

Again, I'm not saying Citigroup is going the way of the dodo bird. But there are plenty of signs of poor corporate governance from the top reaches of this company and certain definite threats to its balance sheet in the form of massive lawsuit liabilities. Some are saying superstar CEO Sandy Weill may be stepping down as a result of the problems surfacing on his watch over the last year. No question -- any uncertainties that hit Citigroup will have a devastating effect across the financial industry. Are the problems at Citigroup more than $100 billion? Outside investors have little way of knowing, and that, in and of itself, is terrifying.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Bill Mann's efforts to get some Brazilian exposure were quashed by the evil bean counters. He holds none of the stocks mentioned in this article. Please view the Fool's disclosure policy.