Citi Will Pre-Announce Earnings

Citigroup now plans to pre-announce its earnings this Friday instead of its original earnings release scheduled for Jan. 22, in a move to calm the waters about its potentially bad earnings results.

Fox Business reported last week that insiders are saying Citi's fourth quarter could be the "worst in the company's history," with losses potentially surmounting $10 bn.

And as Fox Business has been reporting to you since last November, top level executives now say a breakup of what was once the world's biggest bank is in the works, a breakup that would undo the financial giant created by Sandy Weill's merger of Citigroup and Travelers in 1998.

Last November, at the time when the government gave Citi a record $306 bn bailout, insiders told Fox Business that a possible break up of the bank was on the table. Citi has received $45 bn in capital injections from the government as well.

Citi, which has been hit with about $55 bn in credit-related writedowns and losses since the credit crisis began in the summer of 2007, is now moving toward a breakup of what was once the world's largest bank.

The government has also invested $45 bn in Citigroup's shares; its initial $25 bn investment fell rapidly underwater when Citigroup's market value plunged to $21 bn in late November, at the time of its massive taxpayer-backed rescue. Citi's market value is now below that of Home Depot, Kraft Foods, and UPS.

Citi's balance sheet has nearly doubled, to $2.2 tn, from 2005 to 2007--its balance sheet is twice the size of troubled insurer American International Group, which in turn got a government bailout package half the size of Citi's rescue.

But with the sale of a majority stake in its retail brokerage, Smith Barney, to Morgan Stanley, Citi's fourth quarter losses will be mitigated. Analysts now estimate Citi's losses could be in the range of $2.6 bn, but the sums could be higher.

What is happening at Citi is of a piece with what is hammering the entire financial sector. The banks do not face just a liquidity crisis, as the Federal Reserve and the US government have pumped out an estimated $8.4 tn in rescue funds through various government hydrants.

This is a solvency issue, where banks need capital now to take care of bad assets still sitting on their books--by some estimates, a total of $1.2 tn. So far, liquidity boosts have not improved asset values for things like subprime securities, built on top of bad loans.

The problem has gone clearly viral, as it has moved beyond bad mortgages and souring credit card payments, as borrowers struggle to avoid foreclosures during a deepening recession.

The banks are now being hit with bad commercial property loans, bad leveraged buyout loans and both consumer and corporate bankruptcies, among other souring credits.

The Citi Breakup

With the breakup, Citi is returning to its roots as a global commercial and retail bank while retaining units that will handle advisory, underwriting and market-making investment bank offerings sold to clients worldwide, with offerings that include loans, M&A advice, global trade services, and capital-markets services.

Despite telling Wall Street since last November that Citi had no plans to sell Smith Barney, Vikram Pandit, Citi's chief executive, said he would now sell a majority stake in the Smith Barney brokerage to Morgan Stanley. Citi will keep a small brokerage unit, operating out of Citi branches and its capital markets divisions.

The joint venture will have 20,390 financial advisers and $1.74 tn of assets, a brokerage which would be bigger than the Thundering Herd at Merrill Lynch in both the number of brokers and assets under management.

The joint venture will be run by James Gorman, a top Morgan Stanley executive who could be in line to succeed Morgan's chief executive John Mack, who is expected to retire in 2010.

Morgan will swap into the joint venture its retail, private wealth management and international private wealth management units.

Citi will put into the joint venture Smith Barney US (excluding its branch-based and institutional financial advisors), Smith Barney Australia, and Quilter, its UK investment bank. Fox Business has been reporting since last November that Citi planned to unload Quilter, among other assets.

Morgan will get a 51% stake in the joint venture and will pay Citi $2.7 bn in cash upfront, with an option to buy out entirely the new entity in five years.

Citi will book a $9.5 bn pre-tax (or $5.8 bn after-tax) gain on the deal. It will also get about $6.5 bn in tangible common equity, and add $6.4 bn to Tier 1 capital, its regulatory capital cushion, estimates Meredith Whitney, top bank analyst at Oppenheimer Equity Research.

"There is no other way to view this move, in our opinion, than as a way for Citi to raise cash prior to its 4Q [fourth quarter] earnings release," says Whitney.

A Good Move for Citi?

Citi's Smith Barney unit contributed nearly 40% of Citi's net income in 2007, one reason why Citi's stock dropped on the initial news of the joint venture deal with Morgan Stanley.

Richard Bove, a top bank analyst at Ladenburg Thalmann, says "from a pure business standpoint, this deal makes no sense for Citigroup. It will be contributing 60% of the earnings to the new company, getting 49% of the resulting profits. This shortfall may not be covered by the" $2.7 bn in cash that it gets from the sale.

Other Asset Sales at Citi

Citigroup insiders now say it is moving to separate riskier consumer finance and securities businesses from its global commercial banking operations.

Insiders say a "bad bank" structure is "not quite the approach" Citi is taking, as one top level executive puts it, where Citi would launch an entirely new "bad bank" structure that could then get direct private or public capital infusions from investors or the government.

Instead, Citi could place bad assets, including loans, securities, and entire units worth more than $600bn--less than a third of its $2 tn in assets--into a separate division to isolate them away from the parts of the company that are working and throwing off profits. Whether or not Citi would then bring this division into the market as a new offering for investment remains to be seen.

Citigroup's Pandit had said less than a year ago that Citi would move to unload potentially $500 bn in assets. The assets now under discussion have grown larger than that sum, and could include potentially a sale of its CitiFinancial consumer-lending unit, and its Tokyo-based Nikko Asset Management, among other items-all with the aim of raising quickly cash.

However, a bad bank structure for US banks could be in the works. Federal Reserve chairman Ben Bernanke suggested in a speech that creating a huge government-run "bad bank" to own the toxic assets now roiling the balance sheets of financial companies could be an option, similar to the Resolution Trust Corp. structure the government deployed to deal with the savings and loan meltdown in the early ‘90s.

Other Bank Losses

Deutsche Bank (DB), the largest bank in Germany, now expects a loss of $6.4 bn. Fox Business has already reported that Bank of America could report a $3.6 bn loss, as it digests the problematic balance sheets of Merrill Lynch and Countrywide Financial.

Lawmakers have been highly critical of the TARP, arguing that taxpayer funds haven't led to more bank lending as planned and that the Bush administration failed to use the funds as it promised it would, such as to advance programs to prevent mortgage foreclosures.

Banks' lending has been constrained because many are sitting on large losses and others are fearful that new losses could emerge. A Goldman Sachs study updated late Tuesday estimates that investors and financial institutions could lose $2.1 tn on bad loans, but that only half of those losses have been realized.