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Wall Street Thinks Pandit's New Plans Won't Fix Citigroup's Old Problems: Street Whispers

Citi's multi-billion after tax writedown related to its divestiture of a stake in a brokerage joint venture with Morgan Stanley (MS - Get Report) at only underscores the issues hampering Citigroup's stock as it languishes over 90% below pre-crisis levels.

In exiting its MSSB venture with Morgan Stanley, cut at the height of the crisis in 2009, investment bank Perella Weinberg appraised the value of the brokerage joint venture at $13.5 billion, roughly $8.5 billion less than the valuation of the unit at on Citigroup's balance sheet, as of the second quarter.

Wells Fargo analyst Matthew Burnell, calculated in a Tuesday note to clients that the loss will reduce Citi's tangible book value by 2%. Still, he estimates the MSSB exit will provide some certainty on Federal Reserve stress tests.

Other uncertainties lingering on Citigroup's balance sheet may provide a bigger hit.

In a Monday note to clients, Goldman Sachs analysts noted that CitiHoldings still absorbs roughly 25% of the firm's capital while representing less than 10% of assets. Meanwhile, the disqualification of the banks' deferred tax assets stemming from crisis-time losses will not count toward Basel III regulatory capital, signaling a $50 billion drag to Citigroup's capital, according to Goldman Sachs analyst Richard Ramsden.

"While we recognize the potential value of a realizable deferred tax asset (DTA), current valuation for Citigroup appears to apply no (and maybe even negative) value to it given the dilution it causes to return on equity," writes Ramsden in the note. Since Ramsden calculates only $10 billion of the $51 billion deferred tax asset would count under Basel III capital ratios, if Citigroup were to write off the remaining $40 billion DTA, it would cut the bank's tangible book value to $38 from $52.

It's those legacy uncertainties tucked in CitiHoldings and the bank's overall balance sheet, which color shares, even as the bank posts signs that its ongoing operations are poised for growth.

In second quarter earnings, Citigroup reported better than expected adjusted earnings of $3.1 billion, or $1 per share, on revenue of $18.6 billion. Notably, Citigroup's North America consumer banking unit saw credit quality improve sharply as net credit losses fell 29% from year ago levels. Meanwhile, the bank's core operations increased earnings 5% and maintained flat revenue, while overall operating expense of $12.1 billion was 6% lower than the prior year period.

Excluding currency adjustments, revenue grew 8% in Latin America and was flat in Asia and other emerging markets. Meanwhile, the bank said that all international regions grew deposits and loans as credit quality generally improved. Overall, Citigroup's international consumer banking credit quality improved from the prior year period even as loan portfolio's continued to grow.

Those results helped to assuage fears that Citigroup's strategy to target banking opportunities in regions with higher-than-trend gross domestic product (GDP) growth outlooks could backfire.

While the immediate negatives of prospective writedowns related to Citigroup's MSSB exit may overwhelm short term earnings, the bank may yet see a benefit from aggressively exiting CitiHoldings assets, giving investors reason to give the bank credit for a growth heavy future.

For instance, Ramdsen of Goldman Sachs argues that Citigroup's best chance at getting to a $50 a share valuation would come from a spinoff of $100 billion in real estate assets that remain at CitiHoldings.

-- Written by Antoine Gara in New York
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