Death Knell for Citigroup's 'Supermarket' Model

By: AP
By: AP

NEW YORK – The original financial supermarket is dead. Citigroup signaled the end of a decade-long experiment to create one-stop shopping for financial services — everything from consumer loans to investment banking — with Tuesday's announcement that it was merging its Smith Barney brokerage into a joint venture with Morgan Stanley.

The deal, which will give Citigroup $2.7 billion in badly needed cash as it gives up control of Smith Barney, comes as the company still struggles in the aftermath of the mortgage and credit crisis. There is speculation that CEO Vikram Pandit, who for months supported Citigroup as a "universal bank," will be taking further steps to simplify and streamline the company.

Citi could soon shrink itself by one-third, according to a Wall Street Journal report Wednesday. The Journal says Citi is likely to announce plans next week to shed two consumer-finance units, the bank's private-label credit card business and cut back on trading it does on its own behalf.

And many people on Wall Street believe Citigroup could be headed for an even larger-scale dismantling if the federal government — which now has a stake in Citi thanks to its recent bailout — has its way.

"I think within 12 months, Citigroup no longer exists," said William Smith at Smith Asset Management, who owns Citigroup shares. He has been calling for a breakup of Citigroup for years, and believes the government will force that fate in piecemeal fashion over the coming year.

Citigroup was the quintessential financial supermarket, cobbled together over decades by Sandy Weill — the former CEO who is both lauded for bringing Citigroup its biggest profits ever and criticized for creating an unsustainably massive, impossible-to-manage conglomerate.

The idea behind the supermarket is that the average person can do all his saving, borrowing and investing with one company. Citigroup had it all, the retail and business banking operations, the investment banking business, the brokerage, even Travelers insurance. Whether that one company does it better than a number of specialized companies does, though, has been the big question facing shareholders since the deregulation of the banking industry in the 1990s. And Citi's announcement Tuesday further undermines the idea that one company can handle such diverse businesses at once.

To be sure, JPMorgan Chase & Co.'s model is essentially a supermarket, too, but it does not have as large an international presence as Citigroup has had. Bank of America Corp. has many disparate businesses, too — including the recent government-brokered acquisition of Merrill Lynch, the world's largest brokerage — but it maintains a strong focus on its U.S. operations. Perhaps more importantly, analysts argue that these banking giants were managed and integrated much better over the years than Citigroup was.

"The problem with Citi is the model, the execution, the management," Smith said. "How do you go a decade without integrating?"

Bank of America and JPMorgan Chase also took fewer risks than Citi took when it came to the now-failed investments in mortgage-backed securities, and so their losses were much less than the big financial supermarket suffered.

Weill, helped by the force of his personality, made the concept work during his years at the helm, although he presided over the spinoff and sale of the Travelers businesses starting in 2002. The company, whose stock price is now only about a tenth of what it was just two years ago, has struggled since Weill retired in 2006.

In late November, Pandit called the universal banking model "the right model," and that Citigroup's strategy is "to be the world's truly global universal bank." Days later, the government lent the embattled bank $45 billion — more than other big banks have received — and agreed to absorb the losses on a huge pool of mortgages and other assets.

Citigroup and Morgan Stanley plan to combine Citi's brokerage, Smith Barney, with Morgan Stanley's wealth management business.

The deal was announced after the close of stock trading. Citigroup rose 30 cents, or 5.4 percent, to $5.90, while Morgan Stanley rose 7 cents to $18.86.

The capital from the Morgan Stanley deal, however, is likely not enough to make up for upcoming losses. And if the government decides it does not want to continue propping up banks like Citigroup, its dismantling could accelerate.

The new administration could "come to the realization that the whole economy does not hinge on the banks," said Octavio Marenzi, head of financial consultancy Celent. "Banking is important. The banks themselves are not."

President-elect Barack Obama has said he might rethink the way the remaining $350 billion of the financial bailout will be used.

This is a huge underlying concern as banks release their fourth-quarter earnings in the coming weeks. While other banks don't appear to be in as much disarray as Citigroup — which is expected to post its fifth straight quarterly loss next week — the industry is still clearly troubled.

Wall Street will get an earlier-than-expected reading on the financial sector this week when JPMorgan Chase & Co. reports earnings on Thursday, nearly a week ahead of schedule.

"They've done so well so far through the credit crisis. If you see real weakness there, it bodes badly for the rest of the industry," Celent's Marenzi said of JPMorgan Chase.

Though investors largely expect banks to issue bleak fourth-quarter and full-year reports, the concern is that their credit problems are growing — and spreading to loan portfolios that up until this point had been relatively stable — setting up 2009 to be another year of multibillion dollar losses.

As the housing market tanked and defaults on mortgages spiked, nearly all banks were forced to set aside huge amounts of cash to cover losses in their mortgage portfolios last year. What will be different about the fourth quarter, and subsequently this year, is that problems in other portfolios, like credit cards and auto loans, are likely to be more pronounced than in previous periods, reflecting the deepening recession.

While Citigroup's troubles have been exacerbated by its sheer size and the scope of its global business empire — which includes everything from retail banking to credit cards to corporate lending — analysts see other banks struggling to maintain sufficient capital this year.

"We consider the financial services industry significantly undercapitalized," wrote Friedman, Billings, Ramsey & Co. analyst Paul Miller in a recent research note. "Current capital levels, which should be considered inadequate in even the best of times, pose an even greater risk entering 2009, a year that will remain challenging for financials."

Specifically, Miller is cautious about Bank of America and Wells Fargo & Co., noting their thin common equity. Both banks made sizable acquisitions last year, and therefore are likely to feel some strain as they integrate operations.

In the past year, Bank of America scooped up Countrywide Financial Corp. and Merrill Lynch & Co.; Wells Fargo bought Wachovia Corp.; and JPMorgan Chase acquired failed Bear Stearns Cos. and Washington Mutual Inc. Most analysts agree that it's too soon for these banks to have reaped any substantial benefits from the acquisitions in the fourth quarter.


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