The Wall Street Journal-20080116-For Financial Stocks- Is It Another False Bottom-- Big Cash Infusion Fails To Prop Up Citigroup- Keeping Powder Dry
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For Financial Stocks, Is It Another False Bottom?; Big Cash Infusion Fails To Prop Up Citigroup; Keeping Powder Dry
Like little kids stuck in the backseat of a car, investors keep whining that the ride through the financial crisis never ends. Each new multibillion-dollar write-down holds out the promise that it could finally be over -- until a new set of losses eclipses the last.
Citigroup's latest announcement has proved to be no different. The bank yesterday said it took an $18 billion write-down in the fourth quarter on securities linked to subprime mortgages. Although Citigroup had raised $7.5 billion in new capital less than three months ago, the fresh losses prompted it to seek at least $14.5 billion in additional funding, cut its dividend by 40% and sell noncore assets.
Citigroup now holds the distinction of sustaining the biggest hit of any bank or broker related to the mortgage mess and ensuing credit crunch, easily topping write-downs of $10 billion at UBS AG and $9.4 billion at Morgan Stanley.
But bears say there is more bad news to come, meaning it is still too early to go bargain hunting among many financial stocks. Citigroup itself practically said so, these investors add, by going out and raising more capital than would be needed if the crisis were passing.
"The financials aren't out of the woods yet," says Thomas Vandeventer, a portfolio manager at Tocqueville Asset Management, which has about $7 billion in assets. "Other than brief bear-market rallies, it doesn't look like there's a compelling reason to buy these stocks now."
On the bank's conference call with investors, Chief Financial Officer Gary Crittenden acknowledged that the capital being raised will allow the bank to weather more bad news, if needed. He also spelled out a host of risks still facing the bank, and by extension other financial stocks, including the potential for further losses on subprime-linked securities, rising delinquencies among holders of credit cards and the risk that some bond and mortgage insurers might not be able to make good on their commitments.
But the additional capital raised by Citigroup also will put the bank in a good spot if the outlook brightens. "It is the correct way to position the company going forward to take advantage of opportunities or to guard against the risk of a downturn," Mr. Crittenden said on the call.
That said, markets sided with the more downbeat assessment. While most analysts initially expected Citigroup shares to rally on its capital-raising plans, the stock fell 7.3%, or $2.12, to $26.94 in 4 p.m. New York Stock Exchange composite trading.
The gloom extended throughout the financial sector, which had taken some cheer late last week on the announcement that Bank of America Corp. would acquire battered mortgage lender Countrywide Financial Corp. in a $4 billion, all-stock deal. Following Citigroup's move, the KBW Bank share index fell more than 4%, touching levels last seen in 2003.
Merrill Lynch & Co., which also is expected to announce big mortgage-linked write-downs when it reports results tomorrow, saw its stock fall 5.3%, or $2.96, to $53.01 after announcing that it would raise $6.6 billion in new money. Merrill in late December had raised $6.2 billion through a discounted share sale after taking a $7.9 billion write-down.
Not all investors are giving up on a rebound, and some think markets have baked too much bad news into financial stocks. "Who cares if there's another write-down?" Richard Pzena, head of Pzena Investment Management Inc., says about Citigroup. He believes the firm's long- term earnings potential remains at about $5 a share annually, given the bank's strong franchise and access to funding, but that the market is currently pricing the stock as if profits will be forever degraded. Mr. Pzena's firm has bet heavily on the financial sector.
"The company has remarkable access to the capital markets, and it's now one of the best-capitalized banks in the country," Mr. Pzena says. He adds that the new capital will dilute Citigroup shareholders by about 10% but that this is a figure he can live with.
In addition, history may show that for banks and brokers, it is indeed darkest before the proverbial dawn. Financial companies usually bottom several quarters before their performance improves, as investors anticipate a turnaround. And banks usually bottom out four months before the economy starts to improve, according to a study of the past 38 years by Birinyi Associates Inc., a Westport, Conn., investment firm.
Still, divining the shape of financial companies isn't an easy task, given the unprecedented level of uncertainty in markets. It also isn't clear whether the write-downs now being taken by banks and brokers reflect past losses or are anticipating further weakness.
Since there isn't a market for many instruments that Citigroup is writing down, valuation becomes more art than science -- and that is a concern.
After examining Citigroup's write-downs of collateralized debt obligations, Janet Tavakoli, president of Tavakoli Structured Finance Inc., says the bank might have needed to take an additional $3.3 billion haircut. She believes that markets would price in lower values for pieces of CDOs that Citigroup holds that are thought to be super- safe.
"The Citi write-downs do not appear to reflect current market prices," Ms. Tavakoli says. Such increased write-downs would have pushed Citigroup's overall write-down to about $21 billion, eating further into its capital.
In response to similar criticisms on the bank's conference call from analysts, Mr. Crittenden said that Citigroup had "taken the reductions that we think are appropriate." He added that Citigroup used extensive models to value the securities, taking into account projected losses of 6.5% to 7% this year and next on housing owned by subprime-mortgage holders, as well as regional housing-market differences. The bank also cross-checked prices against indexes that track subprime-backed securities, he added.
While additional subprime losses are an immediate concern, there is also a growing worry that Citigroup and other banks will have to book more and more losses as consumers fail to pay credit-card and auto loans, even as more mortgages go bad. Underlining such concerns, Citigroup made a provision for potential loan losses of $7.4 billion during the fourth quarter.
All this has left investors feeling wary. "We're looking very actively, but instead of hoping to capture the upside, we're tying to focus on the downside, and pencil in exactly what it may be -- but we haven't been able to do that," says Charles Lahr, portfolio manager of Mutual Financial Services Fund, part of the Mutual Series value- oriented lineup of funds. "So, we're keeping our powder dry."
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Gregory Zuckerman contributed to this article.
(See related article: "Lax Lending Standards Could End Up Fueling Sudden Acceleration in Auto-Loan Delinquencies" -- WSJ Jan. 16, 2008)
