Citi Still Needs More Capital

As FOX Business first reported Friday, Citigroup (C) is poised to report much deeper losses for its coming fourth quarter on January 22nd than both the company and analysts had anticipated, "the worst quarter in the company's history," insiders say, with quarterly losses estimated to surpass $10 bn, despite the sale of its German retail banking unit.

A breakup of what was once the world's largest bank could be in the cards, employees say. In a stunning reversal, Citi is selling its once-prized jewel and profit machine, Smith Barney, to Morgan Stanley (MS), despite repeatedly telling Wall Street it had no plans to sell the brokerage unit.

Meanwhile, insiders at Merrill Lynch speculate that Merrill's top broker, the leader of its brokerage unit, the widely respected Robert McCann, could be wooed to Morgan Stanley to help run the combined Smith Barney-Morgan brokerage operation, as insiders at both firms say McCann would be a logical fit.

Morgan Stanley co-president James Gorman, considered to be a brilliant, effective executive, is expected to become chairman of the joint venture. Gorman, respected as an expert in branding and marketing, ran Merrill Lynch's corporate acquisitions and private client businesses before Morgan wooed him away in 2005.

A combined Smith Barney-Morgan Stanley brokerage operation with more than 22,000 brokers and a total of $1.8 tn in retail client assets would easily challenge the Thundering Herd's brokerage business at Merrill Lynch and Bank of America (BAC), with 16,000 brokers and $1.5 tn in assets.

However, McCann, who recently quit, is said to have signed a six month, non-compete clause with Merrill. Top executives say Morgan and McCann have not discussed his joining the firm. McCann could not be reached for comment. Merrill Lynch did not return a call for comment; Morgan Stanley did not return a call for comment.

Meanwhile, Meredith Whitney, Wall Street's top bank analyst at Oppenheimer Equity Research, says Citi's sale of a stake in Smith Barney to Morgan Stanley and its government backstop will not be enough to stabilize what was once the world's biggest bank, whose market cap at $33 bn has fallen below the market value of Home Depot, Kraft Foods, and UPS.

Now the number five bank in the world, Citi may need to raise more capital this year. Indeed, the way the government has structured its $306 bn bailout of Citi, the bank faces potentially $56.7 bn in writedowns in coming quarters, with the government taking on the remaining $249.3 bn in bad assets.

Also, new accounting rules could force Citi to put back onto its balance sheet later this year huge slugs of its $1.2 tn in assets now sitting off its balance sheet, forcing Citi to raise even more capital to increase its regulatory capital cushion.

All of these problems could leave Citi no choice but to do massive asset sales or break up the bank.

Bad Profit Results

Citi's bad profit results prompted management to reverse itself and try to split off its Smith Barney brokerage unit. Citi's board could vote on the deal to sell a 51% stake in Smith Barney to rival Morgan Stanley today as early as today.

Citi is also unloading its retail operation in Mexico, Banamex, with insiders saying these combined moves potentially herald the beginning of the breakup of what was once the world's largest bank.

The sale to Morgan Stanley is a painful choice for Citi, as the Smith Barney brokerage provided 40% of the bank's 2007 profits.

The sale also marks a come-uppance for bank executives promulgating the "universal" banking model, whereby Citi believed it could cross sell consumer loans and credit cards to Smith's high-end clients. A universal banking model that now spells a costly "too big to fail" approach as U.S. taxpayers have had to pay for Citi's bad bet.

The news came on the heels of Citigroup's announcement last Friday that its "senior counselor" and former head of the board's executive committee, Robert Rubin, was stepping down under fire, after getting paid tens of millions of dollars in exchange for a post where he demanded no operational responsibilities or oversight, despite advising the bank to take on more risk during the credit bubble and helping to cause the bank to wade deeper into risky credit problems.

Since the third quarter of 2007, Citi has booked $45 bn in writedowns. Its eroding capital forced Citigroup to negotiate a massive $306 bn government backstop on bad loans and securities, with Citi taking the first $56.7 bn in losses and the government taking the rest, $249.3 bn.

Citi also has received a total of $45 bn in taxpayer-backed capital injections from the government in the fourth quarter, with the government potentially investing $7 bn more on the way.

The taxpayer rescue has forced Citi to back new, controversial Congressional legislation that would let bankruptcy judges force mortgage lenders to cut the mortgage principal and interest payments owed on foreclosed houses in bankruptcy.

The government's November rescue of Citigroup came after the bank's stock fell to $3.77 a share and its market value plummeted to $21 bn (down from its 2006 peak of $274 bn), putting the government's initial $25 bn capital injection under water. Citi has $2 tn in assets and $2 tn in liabilities teetering atop a net worth of just around $130 bn.

Citi's balance sheet size, with $2 tn in assets and $2 tn in liabilities, far surpasses the total $1.95 tn in assets and liabilities at troubled insurer American International Group (AIG), which was rescued by the government and has received more than $150 bn in taxpayer aid.

Pandit Under Fire

But the board remains firmly behind chief executive Vikram Pandit, although insiders say his position is becoming shakier by the day. On a November 21 company-wide conference call, Pandit had told employees that he had no plans to break up the company, pointedly noting that he wanted to keep Smith Barney.

Citi is already overseeing massive asset divestitures that could effectively have the same result as a breakup of the bank.

Already, Citi has sold its German retail banking operations, its CitiStreet benefits servicing business, its Citi Technology Services Unit, as well as its business outsourcing arm, Citigroup Global Services, four key divestitures with likely more on the way.

Richard Bove, a top banking analyst at Ladenburg Thalmann, says Citi "will have to rid itself" of two other units besides Smith Barney that came with the bank's merger with the Travelers Group--its insurance underwriting business and its money management business, besides the brokerage operation.

Pandit also is overseeing an estimated 72,000 in layoffs at the bank, which employs more than 370,000 workers. While Pandit's job seems safe, the rest of the board may not be.

Federal banking regulators are pressing Citigroup to shake up its board and replace its chairman, Win Bischoff. Richard D. Parsons, the chairman of Time Warner and a Citigroup director, has emerged as the leading candidate to succeed Mr. Bischoff as Citigroup's chairman.

Citi's joint venture with Morgan Stanley, where it would combine Smith Barney with Morgan's brokerage business, carries a combined deal value that would veer toward $20 bn.

Citi would get an upfront cash payment in the Smith Barney deal of $2.7 bn from Morgan Stanley for a 51% stake, and could book anywhere from $5 bn to $6 bn in tangible common equity. Morgan could expand its ownership stake to 80% after three years, with Citi getting a put option to buy the rest, 20%, after five years.

Deal May Not Be Enough

But the deal may not be enough to fix Citi's capital problems, and Citi may have to return to the capital markets to raise more money, says Meredith Whitney, Wall Street's top banking analyst at Oppenheimer Equity Research.

For its part, Morgan Stanley has booked $20 bn in writedowns since the third quarter of 2007, and has raised $19 bn in capital, including $10 bn from TARP, Whitney notes.

Whitney Still Negative

However, Whitney, who still rates Citi underperform, and estimates that it will report a total of $3.02 in losses for fiscal 2008 and steeper loses of $3.25 this year. Whitney has kept her earnings estimates for Morgan Stanley of $1.95 for 2008 and 2009.

An Exodus of Merrill Lynch Talent

Merrill Lynch insiders say one of John Thain's biggest mistakes was to not only cede too much control of what was once Wall Street's top brokerage to Bank of America, but also to not do enough to keep the widely respected executives at the firm.

They include McCann, Merrill's top broker and a firm leader, Greg Fleming, head of investment banking, also held in high regard firmwide at Merrill for being a shrewd, intelligent leader, as well as Rosemary Berkery, Merrill's vice chairman and general counsel, also widely respected at Merrill Lynch as a gifted, brilliant executive.

None of the three got their bonuses for the last two fiscal years, receiving only their base salary.

Meanwhile, Thain has been wooing Goldman Sachs employees with rich pay. He got Goldman Sachs star trader Thomas Montag to join Merrill with a lucrative $40 mn stock and options compensation package, on top of a nearly $40 mn bonus it agreed previously to pay him.

The shares and options were meant to compensate Montag for his forfeited equity awards at Goldman. Merrill reported Montag's compensation in a Securities and Exchange Commission filing less than a month after reporting a $4.89 bn second quarter loss.

And former Goldman Sachs executive Peter Kraus recently quit Merrill Lynch with a rich $25 mn bonus, right after Merrill sold itself to Bank of America. And while Merrill executives were seeing their bonuses yanked, Thain didn't do enough to fight for their bonuses, but instead also fought with Merrill's board to receive his $10 mn bonus for the recent fiscal year, top executives say. Thain eventually deciding to forfeit his bonus.

The combined company is expected to lay off 35,000 workers.

Gregory Fleming, Merrill's head of investment banking who championed and brokered the merger with Bank of America, also suddenly quit last week, sending jaws dropping throughout the firm.

Thain, who now leads the combined company's global banking, securities and wealth management business, took the reins from E. Stanley O'Neal who was pushed out of Merrill after leading a disastrous foray into risky securities and lending businesses.

Thain, who ran the New York Stock Exchange, was hired at Merrill because of his expertise in mortgages garnered during a stint at Goldman Sachs but quickly ran into trouble when he touted Merrill's capital position as being strong right before the firm announced disastrous profit results.

Thain signed on for a reported $50 mn a year in compensation, which could have risen to as much as $120 mn a year.

McCann battled with Thain and was passed over for a promotion in the combined company. Indeed, the combined  management team of the BofA-Merrill operation has scant Merrill representation.

McCann, head of Merrill's financial advisory unit, has stepped down from Merrill, but has signed a non-compete clause, believed to be six months. Insiders say he could jump to Morgan Stanley if the price offered is right. Meanwhile, Bank of America is expected to post $3.6 bn in losses in its coming fourth quarter report on January 20. It may also again slash its dividend.