Tuesday, November 6, 2007

Citigroup's Problems Continue; Start to Infect the Whole Sector

From the WSJ:

One day after the departure of Chief Executive Charles Prince, Citigroup Inc. officials said it will take the bank until the middle of next year to clean up its problems caused by credit-market turmoil.

Let's stop right there are acknowledge the obvious. Citigroup is publicly stating the turmoil in the financial sector is not a one-time event, but instead the beginning of a rather long process that will take at least until the end of June 2008 -- 8 months from now. That makes a hell of a lot more sense given that no one really knows how much further damage is possible. Anyone who says this is a one time event or this won't cause damage beyond the end of the year is lying through their teeth.

Citigroup's new woes underscored for many investors that the fallout from credit-market turmoil will likely continue for longer than many expected. Counting Citigroup's potential new losses, banks and investment houses will have racked up combined losses of more than $30 billion because of mortgage- and debt-market problems [in the latest quarter]. Many worry that Citigroup's predicament is a signal that more losses could be in store for other financial players.

The third quarter has demonstrated two very important points. First, the problem is widespread. I can't think of a major financial player who hasn't announced some type of portfolio writedown this quarter. Secondly, the problem is big. So far this quarter we've seen $30 billion in writedowns. That's a significant amount of capital that is vanishing into thin air. And Citi's tacit acknowledgment that further writedowns are possible indicates this won't be the last time we see the phrase "writedown" in a financial company's earnings release.

The magnitude of Citi's writedowns are starting to negatively impact trader's and analyst's perception of the sector:

For followers of banking stocks, the scary part isn't that Citigroup (C) might write down as much as $11 billion in subprime mortgage losses this quarter.

The scary part is that Citi and other leading banks might still be lowballing their losses in hopes that things won't get any worse.

Citi on Sunday said it expects to write down $8 billion to $11 billion before taxes for its $55 billion of exposure to U.S. subprime mortgages.

Last quarter, the banking giant swallowed $6.5 billion related to subprime mortgages, loan losses and other debt. Those losses trimmed its third-quarter profit by 3 cents a share.

Sunday's announcement came less than a month after Citigroup told investors it had a "good, sustainable strategic plan" for managing the subprime mess.

Boasts like that might have calmed some nerves during the early stages of the subprime crisis. But with the bad news continuing to repeat itself, Wall Street is having a harder time seeing the glass as half full.

Skepticism is so high that many analysts are already questioning whether Citigroup went far enough with its latest write-down.

"Maybe they could have taken off $10 billion to $15 billion," said Kris Niswander, senior banking analyst at SNL Financial. "Whether or not that was aggressive enough is yet to be seen."

(Back to the WSJ article)

Chief Financial Officer Gary Crittenden, on a conference call with analysts yesterday, acknowledged that the $8 billion to $11 billion in losses flagged by the bank are an estimate of write-downs that may be needed. The bank "can't give any assurance" that the loss won't grow as the quarter progresses, he added.

Further writedowns should surprise no one at this point given the breadth and depth of the problems we've seen so far. But public acknowledgment of the problem is important.

Citigroup is getting hammered right now because it is one of the largest financial firms in the world. But it is hardly alone right now -- every major financial player is going though similar problems. Note the following action on Monday:

Fitch Ratings on Monday called into question the capital reserves at financial guarantors such as Ambac (ABK - Cramer's Take - Stockpickr - Rating), MBIA (MBI - Cramer's Take - Stockpickr - Rating) and Security Capital Assurance (SCA - Cramer's Take - Stockpickr - Rating), along with closely held Financial Guaranty Insurance and CIFG Guaranty.

Fitch's review is due to take four to six weeks. If it cascades into full blown ratings downgrades, it could create another wave of forced selling in the credit markets -- this time in the $14 trillion municipal bond market.

"It's starting to feel a lot like summer," says Sid Bakst, senior portfolio manager at Weiss Peck & Greer Investments, and he's not referring to the weather.

Short version: this ain't over by a long shot.