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.
