Citigroup: Cracks in the Edifice

The world's biggest bank loses its boss, and a few billion.

On reflection, it was not the best of metaphors. In an interview in August, as the first wave of subprime woe was crashing over markets, Chuck Prince explained that customers flocked to Citigroup in such trying times because “we are a pillar of strength.” Less than three months later, that depiction looks almost comically awry. A double dose of mortgage-related write-downs—the first big, the second enormous—has made a mockery of risk models and controls at the world’s largest bank. On November 4th, as the scale of the second write-down was revealed, Mr Prince took the “only honourable course” and resigned. The troubles of Citi and other big banks helped push down the Dow Jones Industrial Average to its lowest level since mid-September on November 7th.

It is no coincidence that Mr Prince’s departure came less than a week after the ignominious exit of his counterpart at Merrill Lynch, Stan O’Neal. Both banks had ploughed gleefully into collateralised-debt obligations (CDOs), which pool mortgage-backed securities and other credit instruments, becoming the top two underwriters in the business. Poorly understood (even by their creators, it seems), these are now souring at an alarming rate.

Citi’s exposure to CDOs came as a shock: it had kept $43 billion-worth on its own books. Most of this was highly rated, but so rapidly have subprime-mortgage defaults risen that even this “super-senior” paper is now being downgraded by rating agencies. In the light of this, Citi thinks it will have to take an extra hit of $8 billion-11 billion in the fourth quarter. This has filled other firms that stacked up on CDOs with trepidation.

This is not an isolated slip-up for Citi, which has already had to swallow $1.4 billion of losses stemming from over-exuberance in leveraged buy-outs. It is also heavily exposed—to the tune of more than $80 billion—to some of the so-called structured investment vehicles (SIVs) that have struggled to roll over their debt in commercial-paper markets. On November 7th Moody’s, a rating agency, put SIV debt, including Citi’s, on review for a downgrade.

These headaches, combined with $26 billion-worth of acquisitions over the past year, have deflated the bank’s capital cushion. The tier-one ratio could fall to a dangerously low 6% or less if it had to absorb and write down SIV assets, estimates CreditSights, a research firm. Citi’s shares fell by 7% in a single day last week, an extraordinary drop for a bank with $2.3 trillion in assets, on fears that it would be forced to cut its dividend.

Mr Prince was struggling to get a grip on Citi long before the housing crisis. The bank was bloated, its revenues flat. Only when calls for draconian action came last year from the largest shareholder, Saudi Arabia’s Prince Alwaleed bin Talal, did the streamlining take on urgency.

The mortgage mess will ensure that Mr Prince is remembered as a failure. But he deserves credit on other fronts. He pushed Citi into fast-growing emerging markets. He also invested heavily in branches and technology to bring colour to its anaemic American retail operations. Most importantly, says Dick Bove, a banking analyst with Punk Ziegel, an investment bank, he restored senior managers’ faith in their ability to bring about organic growth. His predecessor, Sandy Weill, supercharged the share price with a never-ending string of bold acquisitions. But in order to find the money for those deals, Mr Weill stripped operating divisions of much-needed capital. Wall Street never quite appreciated the problems this posed for his anointed successor.

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