Citibank Eight Months Later

November 24, 2009 – I last wrote about Citibank eight months ago in an article entitled “Will Citibank Survive?” That article is still posted on the Internet and can be read at the following website: www.financialsense.com

To be precise, I should actually be saying “Citigroup” as the bank is only one part of this financial services behemoth. But I guess habits die hard. When I began my business career by joining a major New York City bank nearly forty years ago, banks were just that – banks. They were not the hodgepodge of businesses that many of them have become in their attempt to serve up a smorgasbord of financial services that are not necessarily interrelated.

Perhaps this head-long plunge into extra-banking activity explains why I focus on Citi, to use its popular name, and not other banks. I don’t mean to pick on Citi, but for decades it had been the bellwether among all banks and stood head-and-shoulders above its rivals.

From that preeminent position, Citi has devolved to become the poster child of bad banking practices. These are marked by the reckless financial engineering foolishness and irresponsible credit excesses that have turned staid and conservative banks into the out of control casinos they have become.

Banks – or to be precise here, the bankers who run them – in recent decades have focused on quarterly results and management bonuses. Gone is the caution that should be prudently and routinely exercised in their role as guardians of the depositories of other people’s money.

I suppose though this outcome was inevitable. When the government proclaims that you are “too big to fail”, that implied backstop will unsurprisingly encourage management to throw caution to the wind, and so they have. But we are now seeing the results of this misguided policy and the bad banking practices that result from it. This reach to generate outsize returns for shareholders comes with enormous risk.

In our book, The Coming Collapse of the Dollar, published in December 2004, John Rubino and I identified Citi, then trading around $49, as a short sale candidate. When working a year ago on the paperback version, The Collapse of the Dollar, John and I re-confirmed Citi as a short sale candidate even though it had fallen by then to $31. When my article written eight months ago questioned Citi’s solvency, its stock was trading at $21.57. Citi closed this past Friday at $3.77. On the accompanying chart we can see that the price of Citi’s stock has literally fallen off a cliff.

This chart is answering my question from eight months ago with a resounding “no”. This chart is saying that Citi will not survive. There are other reasons to reach this same conclusion.

While Citi has reduced assets and increased capital in recent months, Citi’s tangible equity as a percentage of tangible assets in its latest quarterly report on September 30^th remains a paltry 3.2%, meaning it is still leveraged at a towering 31-to-1 and well above prudent levels.

That high leverage is bad enough, but a more disturbing trend has emerged in recent months. Citi’s deposit base is eroding.

Deposits have dropped 6.1% from a peak of $831 billion as of March 31^st to $780 billion six months later, a decline of $51 billion. Some $46 billion of this decline (after accounting for the sale of its retail banking operation in Germany) occurred in interest-bearing deposits in Citi’s offices outside the U.S. Most of these deposits are not insured. Thus, it is clear that Citi is losing the confidence of depositors outside the U.S., which means that companies, other banks and individuals are pulling deposits from Citi to move them to safer alternatives.

We can only speculate as to whether deposits have eroded further since the end of the quarter because hard numbers are not available. But given the bad publicity it is receiving from the huge losses it has taken in each of the past four quarters and in response to the way Citi’s stock price has cratered, it is reasonable to assume that uninsured depositors in particular must be pulling deposits out of the bank. After the collapse of Lehman, no one is taking chances anymore with their money.

It has been my experience that it is the nature of bear markets to smash the darlings of the previous bull market. Citi clearly held that exalted position in the 1980s and 1990s bull market, but the tide has turned. Stocks are in a bear market, and Citi is suffering the consequences of bad management, the bad policies they implemented and the bad results they produced.

Citi is now trading with a market cap of $21 billion, about 22% of its reported book capital as of September 30^th. Clearly, the market is anticipating more big losses from Citi in the months ahead which will further reduce its capital base.

It’s not difficult to see what the market is thinking by giving Citi’s share price this big haircut. The recession has barely started, and typically, the bad news for banks from loan losses and defaults does not occur until the recession nears an end. And given the ongoing decline in economic activity, it looks like we are nowhere close to that point. So the big markdown in Citi’s stock price looks reasonable.

Citi is not likely to remain for long in its present form and with its current management. I expect more bad news that will likely drive its stock lower in the weeks and months ahead. Nevertheless, the opportunity to make big money by selling Citi short has now passed. So if you have also viewed Citi as a short sale candidate, I would therefore use this present decline in its stock price to cover the short sales. I then recommend putting the profits into something safe, namely, physical gold.