Will Citibank Survive?

Mar 22, 2008 - 05:03 AM
By: James_Turk
The center of focus this past week on Wall Street – and indeed, much of the financial world – was whether or not Bear Stearns will go belly-up. As questions arose about the quality of its $395 billion of assets that were carried on only $12 billion of equity, its customers and other brokers became unwilling to accept the counterparty risk that arises from transacting with Bear, while its lenders began worrying about repayment. Being leveraged to that extent, even a small decline in the value of its assets can significantly erode the firm's equity base. But given that Bear is no more than the fifth largest broker in the US , it is a relatively small fish in the financial world....

The question therefore becomes, what are Citi's assets worth? As explained above, we can't accurately answer that question, but here is some information to ponder.

(1) Citi has $133.4 billion of Level 3 assets. Here's how MarketWatch recently described this category when reporting Citi's Level 3 assets: “Level 3 assets are holdings that are so illiquid, or trade so infrequently, that they have no reliable price, so their valuations are based on management's best guess.” In an analysis of Bear Stearns, Barron's prudently observes: “Of particular concern are Bear's so-called Level Three assets, which stood at $28 billion as of November and by definition are illiquid and valued on the basis only of the firm's own estimates.

Any buyer might be worried about the need to mark down the value of these assets, and the value of Bear's large book of financial derivatives.” What's more, Bear's so-called “large book” of derivatives pales in comparison to the size of Citi's book. According to the Comptroller of the Currency, Citi is counterparty to financial derivatives with a notional value of $34.0 trillion (sic). We should keep in mind Warren Buffett's warning from 2002: “Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

(2) Last week JP Morgan warned that the Street is facing a “ systemic margin call ” on subprime mortgages that alone might deplete $325 billion of capital. Citibank alone has about 10% of total bank capital in the US , so if it were to incur 10% of that loss projected by JP Morgan or $32.5 billion, only $17.2 billion of tangible equity would remain. Note that Morgan's analysis ignored all of the other paper now being called into question, which could mean even bigger losses for the banks. For example, on February 29 th Bloomberg reported: “Citigroup Inc. helped create at least $6.9 billion of securities insured by Ambac Financial Group Inc. that have tumbled in value and may require the insurer to pay claims...

The problem is leverage. Too much debt has been extended on too little capital, so even a small decline in the value of a bank's assets can significantly erode its capital and make it insolvent.

In any case, it looks like the financial crisis already upon us will get worse before it gets better, and I am not alone in that thinking. David Rubenstein, co-founder of the Carlyle Group told The Wall Street Journal last week: “This is the tip of the iceberg. People are looking at our situation and saying, ‘There but for the grace of God go I. ' There are others out there hanging on by their fingernails...

He should know. His group managed Carlyle Capital, which recently defaulted on its loans to Citi and other banks, and whose stock price is shown in the above chart.”