Citi's Getting Smaller, But That's a Good Thing

Citigroup's reported near-deal to sell a portion of Smith Barney to Morgan Stanley is likely to strengthen the bank's traditional banking operations.
Publish date:

Updated from 2:58 p.m. EST


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reported discussions to sell a portion of its Smith Barney brokerage to

Morgan Stanley

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is likely to strengthen the bank's traditional banking operations and give it a much-needed cash boost.

Even as rivals like

JPMorgan Chase

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Bank of America

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Wells Fargo

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get larger through opportunistic acquisitions amid the credit crisis, Citi's potential downsizing will not make it a "second-tier player" in terms of retail and commercial banking, says Cassandra Toroian, the president and chief investment officer of Bell Rock Capital.

"Citi is a great brand and I would argue that they should have never gotten involved in all these other businesses to begin with," Toroian writes in an email to

. "They should have stuck to being a bank -- that is their brand strength." She does not own shares of Citi.

The size of the company's balance sheet will "dictate the loans they can compete for with JPMorgan Chase and Bank of America -- and that shouldn't change so much," she says. "Remember, we're talking about them reducing business lines and using the capital at the bank. That doesn't equate to them shrinking the bank and have a smaller loan limit."

Morgan Stanley is likely to pay Citi between $2 billion and $3 billion in cash for a 51% stake in Smith Barney, according to the

Associated Press

, citing sources close to the talks. In total, after accounting for the "revaluation" of Smith Barney, Citi would get a pre-tax gain of roughly $10 billion, or $5 billion to $6 billion after taxes,




was reporting on Monday that Citi is considering all options -- including those other than a deal with Morgan -- and if it goes through, the deal will be announced either Tuesday or Wednesday.

The move is yet another step in which CEO Vikram Pandit's hands have been tied by the tough banking environment and the precarious position Citi finds itself in, where it may have to part with generally profitable businesses such as Smith Barney.


has in the past expressed resistance to unloading the unit.

The company has raised some $45 billion through the $700 billion Troubled Asset Relief Program, or TARP, that Congress passed in October and the government agreed to backstop some $300 billion in risky assets. It has also had to back out of several potential deals for retail deposit-taking banks, including


, which was acquired by Wells Fargo and a smaller regional bank,

Chevy Chase

, which will be sold to

Capital One Financial

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Over the past 18 months, Citi has been struggling to navigate the souring credit cycle, with not much luck. The company has taken roughly $50 billion in writedowns, with some suggesting that the firm will take another $9 billion for the fourth quarter, according to Oppenheimer's Meredith Whitney. Ever-increasing credit costs on defaulted mortgages, increasingly so in credit cards and now some commercial loans, also weigh on the bank's balance sheet.

In the past week alone, the company announced a host of bad news, including suddenly supporting


reform to allow the courts to modify mortgage loans on bankrupt borrowers in foreclosure. The bank also announced that it would add $1.4 billion to its loan loss provision for its exposure to LyondellBasell, whose U.S. units filed for bankruptcy last week. Late Friday, senior advisor

Robert Rubin

resigned from his role and said he would not seek re-election for seat on the board of directors.

Investor calls are also mounting that


should replace its chairman Sir Win Bischoff.

Shares of the company closed down 17% to $5.60 on Monday.

The company has been repositioning itself by slashing its workforce and selling businesses that were not central to the banking model, but have recently seemed open to considering more severe changes in order to raise capital.

Citi's board and management was reportedly considering various core asset sales, but had said as recently as last month that the crown jewel -- Smith Barney -- was not on the block. The rumors of a joint venture with Morgan Stanley show the company may not have much of a choice to garner capital these days.

"It would appear that Citigroup is being returned to its roots or the old Citicorp. It may be that the financial industry, itself, is being driven in this direction," writes Richard Bove, an analyst at Ladenburg Thalmann. "Whether this is long-term positive for the company or not is unclear. What these potential developments imply most is that a new order is being put in place in the American banking industry."

The company is emerging as a slimmer version with three core business lines -- consumer credit through credit cards, retail banking and consumer finance, large corporate banking and payment systems, Bove writes.

Not all observers say selling Smith Barney will be the answer to Citi's problems. Some analysts say that the bank will have to raise even more capital.

Smith Barney has "often been touted by Citi's management as a key platform for cross selling its credit card, mortgage and investment banking products," writes John McDonald, an analyst at Sanford Bernstein.


We think this is a bad move for Citi," McDonald writes. "While the potential Smith Barney transaction could add some capital to Citi, it also does so at the longer term cost of trading away the strategic and financial benefits of owning the retail brokerage franchise, and is not a complete solution to Citi's capital issues."

Tom Hepner, an investment adviser at Ruggie Wealth Management in Tevares, Fla., says with the unloading of Smith Barney, it is possible that Citi could become a large regional player, along the likes of

PNC Financial Services

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and Southeastern bank


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"We could have a completely new landscape in terms of banking," Hepner says. "It doesn't mean they can't reassert themselves downstream,

but before the recovery is complete, they might be a second-tier institution.

The stock is almost priced like that right now. When Citi's trading under $7, in terms of quality, what kind of acquisitions can they do for stock?"

Hepner adds that the company's refocus on traditional banking services and shoring up its balance sheet is the right strategy for Citi.

"Citi is addressing the fact that they need to survive and they will do anything to survive and that may mean selling off some good businesses," he says.