Buy Like Buffett

I was thinking recently about the failed Citigroup Wachovia deal. As a Wells Fargo stockholder, I was in favor of the Wachovia deal because of the large deposit base that Wells is picking up. The merger will give Wells Fargo a major presence on the East Coast and should increase earnings in the future. But I can’t help thinking, what would have happened if Citigroup had gotten Wachovia? 

Citigroup’s merger with Wachovia would have given Citi a deposit base of 600 billion dollars. Citigroup would have only had to assume the first 42 billion dollars in losses with the government backstopping any additional losses. But I still am not sure if this would have been enough for Citi to stand alone without additional capital injections. Citigroup still has over 1 trillion dollars in off balance sheet assets that have not yet been written down.  I think that the government would have had to pay substantially more to backstop the losses of a Cit Wachovia deal.

Wells probably has the strongest balance sheet of all of the major banks. Their balance sheet should be strong enough to absorb additional losses from Wachovia’s Golden West mortgage portfolio. I am not sure that Citigroup could have handled any losses related to Wachovia’s shaky mortgage portfolio.  I think that this is only the beginning of Citi going to the government for fresh capital. This will only further dilute shareholders. I can only wonder if a merger with Wachovia would have kept Citi from its freefall or accelerated the process.

Citigroup announced that they would be laying off 53,000 workers yesterday.  Citigroup has already laid off 23,000 employees earlier this year. Citi has lost 20 billion dollars over the past year and has had four straight quarterly earning losses. Citigroup is on its third CEO in the last year. Citigroup has watched its stock price decline to $8.00 per share and its market cap has shrank to 43 billion. Citigroup is also facing mounting losses from its mortgage, credit card portfolio and will likely need to raise additional capital. Citigroup is trying to return to profitability by selling off assets and implementing a number of cost cutting initiatives. This strategy will help Citigroup in the near term. But it does not solve the long term issues that plague Citigroup.

Beginning with the ill fated acquisition of the Travelers Group, Citigroup has struggled since the late 90’s to find its niche in the banking industry. Citigroup grew to prominence by making large acquisitions and through aggressive cost cutting. These tactics allowed Citigroup to flourish in the 90’s. The problem with relying on these methods to fuel growth is that eventually you run out of major acquisitions to make and costs can only be reduced for so long. This is the problem for Citigroup. They don’t seem to be exactly sure what kind of business they are. They have been trying to redefine their business model for the past 10 years. Is Citigroup’s main business consumer banking, investment banking, insurance or as a credit card issuer? Is Citi more focused on international growth or increasing their domestic presence in US banking?  Can Citigroup be a smaller player and still survive among the banking giants?

Citigroup is now trying to find its place in the new financial landscape. Citigroup faces a much more challenging environment with Bank of America, JP Morgan, Wells Fargo and US Bancorp all aiming to become larger players in the diversified financial services industry. The failed merger with Wachovia would have helped Citigroup by significantly increasing their number of branches in the US. It would have also given them a foothold in the southeast region of the US. However, it would not have addressed the larger problem at Citigroup of no organic growth.  Citigroup’s main focus should be on increasing profitability through organic growth and not acquisitions. Citigroup needs to maximize the earnings in the businesses that they already own.

Citigroup currently pays a dividend of 64 cents per share which amounts to a 6.7% yield. The dividend does not appear sustainable based upon the company’s weak balance sheet and deteriorating loan portfolio. Will Citigroup survive? Definitely. Citigroup is a company that has been deemed too big to fail. The Federal Government’s 25 billion dollar cash injection makes that a certainty. Citigroup will survive but the days of Citigroup as a thriving company in the financial services industry may be a distant memory.