Let’s get real about this. There is no way that Citigroup will be allowed to go bankrupt.The government is about to step in to “rescue” the mega-bank.
Does this mean that the panic of Citi shareholders is irrational? Of course not. If the FDIC takes over the bank, there will be nothing left for Citi’s shareholders. Equity will be wiped out. If the Treasury takes over, it will likely pull an AIG. That means shareholders will be all but wiped out, left with a small residual piece of the equity that will trade lightly and be worth less than half of what they were trading at before the “rescue.”
Is Citigroup’s market cap rational? You betcha!
Tangible assets, excluding goodwill or intangibles, are 55 times the bank’s tangible equity. Here’s how the Wall Street Journal’s David Reilly explained things:
Tangible assets rise to nearly 59 times tangible equity if Citi has to bring about $120 billion in credit-card assets back onto its books in 2010, as is likely. Citi also may have to consolidate some of the roughly $670 billion in mortgage assets currently held by off-balance-sheet vehicles.
If the bank had to consolidate just 20% of these mortgage assets, tangible assets would rise to about 63 times tangible equity. Citigroup thinks it is “highly unlikely” it will have to bring back on book much of these mortgage assets. Even so, Citi needs to take more radical action to reduce its leverage. The job cuts are simply a step in the right direction.
Translation: there is no residual value left for shareholders if Citi goes down. The bank continues to operate simply because it still has liquidity and thanks to the Federal Reserve and the Treasury Department it probably cannot run out of liquidity.
Let’s just take one little slice of Citi’s problems. Citi has $16.9 billion of commercial real estate mortgages and mortgage backed securities sitting on its trading book. There are marked at 86 cents on the dollar. Do you believe that CMBS are going to hold at that level? Neither do we. The bank’s exposure represents about 17% of tangible equity, according to Sandler O’Neill. That far outstrips JP Morgan Chase and Bank of America, each of whom has reduced their exposure to single digits.
Credit default swaps are soaring. Right now they are priced at $425,000 to protect $10 million of debt against default for five years. For reference, Bear Stearns’ CDS were priced at $730,000 on the Thursday before the Fed stepped in. But that was before we knew the government would consistently bail out creditors and counterparties.
By the way, we wouldn’t be surprised to see Citi shares bounce at the end of the day. Short sellers are going to want to cover their positions going into a weekend of uncertainty.
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