sold a chunk of its most complex mortgage-backed securities at a steep discount Monday, investors should be prepared for the possibility of more writedowns at
this quarter, warns one analyst.
Deutsche Bank analyst Mike Mayo predicts that Citi will take third-quarter writedowns of roughly $8 billion on its collateralized debt obligations, according to a note published early Tuesday. He also says that Citi may have to raise capital sooner rather than later as a result of the writedowns.
Citi still has $22.5 billion of net CDO exposure as of the end of June. It "could have another $7 billion of writedowns," Mayo writes. "In addition, we estimate a $1 billion loss on its remaining $2 billion exposure with monoline insurers."
Mayo cut his estimates by $1 and now predicts Citi to post a third-quarter loss of 59 cents a share. For the full year, Mayo expects Citi to post a loss of 80 cents a share.
Merrill is selling the loans for about 22 cents on the dollar, vs. current markets at Citi of 53 cents on the dollar, Mayo says.
"Citi should still be able to absorb much of these charges and credit costs in general given estimated $20 billion of
second half 2008 pre-tax provision, pre-tax earnings and the sale of its German retail business," Mayo writes. "
But the decision about raising new capital could be closer than we previously thought."
Mayo's note follows Merrill's announcement after the market close Monday that it
$30.6 billion of U.S. super senior ABS collateralized debt obligations to an affiliate of Lone Star Funds for $6.7 billion. The sale of the troubled loans, which reduces Merrill's exposure to the risky securities by $11.1 billion, will result in writedowns totaling $5.7 billion in the third quarter.
Among U.S. banks, Citi and Merrill Lynch have been at the forefront of the credit crisis, which began little more than a year ago, because of their large exposure to CDOs. Both financial titans ousted their CEOs last fall and have had to raise billions in capital.
Merrill also plans to raise $8.5 billion in capital through the issuance of common stock, among other things. Temasek Holdings, which has already provided capital for Merrill, has agreed to purchase $3.4 billion in the offering, the firm said.
In the second quarter, Citi posted its third consecutive loss of $2.5 billion, or 54 cents a share. The loss was driven by $6.7 billion in writedowns related to the bank's exposure to subprime, downgraded bond insurers, commercial real estate and alt-A mortgages.
Merrill posted its fourth loss in a row of $4.7 billion, or $4.97 a share, two weeks ago, amid $9.4 billion in writedowns and impairment charges.
Shares of Citi were most recently down 1%, while Merrill shares fell 5%.