Citigroup Shares Keep Sinking

The bank's board meets as Wall Street wonders whether CEO Pandit can withstand the pressure, or if he'll be forced into a deal or U.S. rescue

By Mara Der Hovanesian

Citigroup's shares continued their breathtaking decline on Friday, Nov. 21, despite a broader market rally, indicating that time is quickly running out for Chief Executive Officer Vikram Pandit.

Pandit continues to fight mightily to restore confidence in the market. He pronounced that he has no intention to break up the global bank and that he has enough capital to withstand a tough consumer recession. But with the stock finishing down another 20%, to 3.77, from its 4.71 close on Nov. 20, speculation continued to mount that he will have little choice but to cede the bank to government control.

A dwindling market cap means Citi (C) faces extreme difficulty in either its ability to raise capital or to market itself in a sale. "When you have a decline in the share prices of this magnitude and depth, it is a signal that the company is going under," says Martin Weiss, founder of Weiss Research. "The share price is providing the clearest canary in the coal mine."

Weiss says it is now up to the Treasury Dept. and the Federal Reserve to figure out if they want to nationalize Citigroup, à la Fannie Mae and Freddie Mac. "Someone is going to have to step up and say 'enough.'"

If Citi were to require a government rescue, it would be by far the largest bank failure in history. Citi has $2 trillion in assets, or approximately six times more than Washington Mutual's and three times more than Wachovia's.

Derivatives Drama

Moreover, the prospect of a failure by Citi poses far greater challenges to regulators, due to its massive derivatives holdings. Those derivatives are essentially side bets on interest rates, currencies, and other markets, as well as bets on the probability of defaults by other large corporations (credit default swaps). At midyear—June 30, 2008—the Office of the Comptroller of the Currency says, Citi's primary banking unit, Citibank NA, held $37.1 trillion in total notional value derivatives, including $3.6 trillion in credit default swaps. Those swaps in recent months have proven to be the most dangerous category. In contrast, Wachovia bank, bought out by JPMorgan Chase (JPM) in a deal brokered by the regulators, had only $4.4 trillion in total notional value derivatives, among which $404 billion were in credit default swaps.

Although the notional value overstates the true market risk of derivatives, another oft-underestimated risk is a bank's exposure to the possibility that some of its trading partners might default on their side of the transaction. For each dollar of risk-based capital, Citibank was exposed to $2.58 in such credit risk on June 30, according to the OCC. In contrast, Wachovia's exposure was 52.7¢ on the dollar, or only about one-fifth of Citi's in proportion to capital.

Not everyone has given up hope. Mike Mayo, bank analyst at Deutsche Bank (DB), issued a note early on Nov. 21 saying there is still fundamental value at Citigroup that justifies a $9 price target. He estimates that Citi has $100 billion of cushion to cover an estimated $50 billion on losses.

In a town hall meeting on Nov. 17, Pandit warned the market that losses in the bank's consumer loan portfolio could rise between $1 billion and $2 billion each quarter from now through the first half of next year—far less than Mayo's figure. But the market was struck more by what Pandit did not say: The bank classified some $80 billion of distressed assets into "held for investment," a subjective accounting category that allows the bank to set aside risky and hard-to-value assets in hopes for a recovery.

Eleventh-Hour Partner?

Many doubt those assets will recover and assume they will eventually be another hit to the bank's balance sheet. Stuart Plesser, an equity analyst with Standard & Poor's, says investors "looked suspiciously at those assets [and figured] they were not priced sufficiently."

Some Wall Street analysts are still floating the idea that Citi may find an 11th-hour business partner. Goldman Sachs (GS), Morgan Stanley (MS), and even American Express (AXP)—Citi founder Sanford Weill's dream acquisition in the old days—have been raised as potential suitors. Still others are circumspect about the timing: "I don't believe there is any other financial institution in the world today that has the capital or is crazy enough to take on Citigroup," says Weiss.

Pandit, the board, and other Citi executives were huddled in meetings since early Friday morning. But with the headwinds of the market, their choices are dwindling.

"This is a different ball game we're in; this is moving into a lack-of-confidence game," says Plesser. "We're talking about the fear of institutional trading partners taking deposits and wealth management clients fleeing, which would remove the value of that business. If that is occurring, we have to have a plan to sell before it loses its value. At these levels, it's out of their hands."

This is a transcript of the Market Update: Close video report.