Capital Markets

A Citi Situation

The mother of all write-downs is unlikely to mark a turning-point.
Economist StaffJanuary 21, 2008

It has a fearful symmetry to it. A year ago Wall Street banks were taking turns to chalk up record profits. Now they are sheepishly making history writing down curdled mortgage investments. Citigroup, the world’s biggest bank by assets, if no longer by market value, plumbed new depths this week, reporting a $9.8 billion fourth-quarter loss. It cut the value of collateralised-debt obligations (CDOs) and other nasties, already marked down heavily, by a further $18.1 billion.

Citi’s newish boss, Vikram Pandit, has a plan: a $14.5 billion capital infusion from sovereign-wealth funds and others (including Citi’s éminence grise, Sandy Weill), a dividend cut, and the jettisoning of “non-core” businesses and people. Bold stuff, but it was not enough to reverse the recent decline of bank shares or the overall stockmarket, which is growing increasingly alarmed about the prospect of a recession.

The good news is that fresh equity is available for capital-strapped banks. (Merrill Lynch, which was expected to announce a big write-down after The Economist went to press, also secured a large dollop this week.) They have also been cheered by the return of interbank lending rates to more normal levels, thanks to liquidity injections by central banks.

The first piece of bad news is that banks’ prospects are just as murky as they were in August. Perhaps the most depressing aspect of Citi’s results was the tone of remarks by its chief financial officer, Gary Crittenden. Valuing CDOs and the like “all gets extremely complex”, he told analysts, and “it is very difficult to forecast exactly where all this is going.” It does not help that there is no uniformity of valuation methods across the industry. Some banks rely heavily on the ABX index, which references mortgage-backed securities, as a benchmark. Others, including Citi, stick to their own models.

Worse, it is no longer just mortgages that plague banks. Credit cards and other retail-finance businesses are fading with the American consumer. Citi reported a rise of $4.1 billion in credit costs in its American retail business, the source of 30-40% of its profits in recent years. Other results this week from JPMorgan Chase and Wells Fargo told a similar story. Analysts at CreditSights, a research firm, think the picture will keep getting worse until late this year, though they do not expect credit-card and car-loan defaults to break records.

Provisions for bad loans are likely to grow fast as the extent of the contagion becomes clear—and as those banks that have squirreled away the least, such as Washington Mutual, catch up. Recent changes in accounting rules will amplify this, because it has become harder for banks to spread the building of reserves over the cycle. They must now wait to identify specific weak loans. As a result, provisions have become more pro-cyclical, says CreditSights, rising more sharply from low levels when markets turn.

Europeans should temper any Schadenfreude at the tales of woe across the Atlantic. American banks’ write-downs may be bigger (Switzerland’s UBS being the dishonourable exception) but analysts complain that standards of disclosure are worse in Europe. Hypo Real Estate, a German lender, shocked investors on January 15th by revealing a charge of €390m ($570m) on its holdings of CDOs. The bank’s share price fell by a third.

More bodies will doubtless be uncovered when European banks start reporting their year-end results in a couple of weeks. The economic headwinds are gentler than in America, but there are some familiar-sounding worries: unwinding housing booms, falling commercial-property prices and rising defaults. And Wall Street banks are not the only ones hunting for cash. Capital needs, on some measures, are greater in Europe than in America; so is dependence on the wholesale markets for funding. On January 14th Crédit Agricole, a French bank, said it would sell its 2.1% stake in Suez, a utility, to help shore up its balance sheet. That more will follow is one of the few safe bets around.