Dan Wilchins & Joseph A Giannone
NEW YORK (Reuters) – Citigroup Inc inched closer to selling a stake in its Smith Barney retail brokerage to Morgan Stanley, but its shares fell on concerns about the bank's balance sheet and its fourth-quarter results.
Citigroup shares closed down $1.15, or 17 percent, to $5.60 on the New York Stock Exchange, bringing the company's market value down to $30.5 billion. The shares hit their lowest level since November 24, a day after the company received a $20 billion capital infusion from the U.S. government.
JPMorgan Chase & Co and Bank of America Corp shares also dropped on concerns about their credit problems.
Governments worldwide have been infusing cash into major banks and taking stakes in them as battered banks look to shore up capital. Citi's move to sell a stake in one of its prized assets is the latest sign that the global financial sector is still enmeshed in a widening credit crisis that started in 2007.
Citigroup and Morgan Stanley have agreed on major terms, and are expected to announce a deal by mid-week, a person familiar with the matter said.
Morgan Stanley would combine Citigroup's Smith Barney unit with its own retail business to create the world's largest network of brokers, according to sources.
Citigroup, the third-largest U.S. bank by assets, would retain a 49 percent stake in the joint venture, and receive a payment in excess of $2.5 billion and would write up the value of its brokerage business, boosting capital.
Morgan Stanley would expect over time to buy the whole of Smith Barney.
A joint venture could give Citigroup an additional $5 billion to $6 billion of tangible common equity, a boon for a bank under U.S. government pressure to shore up a balance sheet battered by more than $20 billion of net losses over the four quarters ended September 30, 2008.
The company may record a fourth-quarter operating loss in excess of $10 billion, The Wall Street Journal reported on Monday, underscoring the depth of its difficulties.
"They're selling one of the crown jewels, which you only do if you really have to," said Bill Fitzpatrick, an analyst at Optique Capital Management in Milwaukee, which does not own Citigroup shares.
Citigroup has received $45 billion of capital under the government's Troubled Asset Relief Program, including the $20 billion in November and $25 billion in October. That extensive support from the government has come at a price: the U.S. is exerting more pressure on the bank to improve its balance sheet.
Regulators are also pressing for the bank to replace its chairman, Sir Win Bischoff, the New York Times reported on Monday.
Richard Parsons, former chairman of Time Warner Inc, appears to be at the top of the short list of successors, and an announcement could come as soon as this week, the newspaper reported.
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Citigroup is not the only bank to be receiving government support. The British government bought 17 billion pounds ($25.6 billion) of shares of Lloyds TSB and its takeover target HBOS after private investors shunned a rights offering.
"Whether it's the U.S. government with Citi, the Swiss with UBS or the UK with Royal Bank of Scotland, governments are going to say, 'You are very big institutions to be bailed out, and it would be good if you were a degree smaller and much more manageable'," said Simon Maughan, analyst at MF Global in London.
Britain will get a 43.4 percent stake in Lloyds Banking Group, the enlarged bank to be formed this week, adding to the 58 percent holding it took in RBS last month.
The U.S. subprime mortgage crisis has widened into a broader credit crunch. Banks, reeling from losses, are making it harder to borrow, which reduces spending and hurts banks even more.
Keith Horowitz, a stock analyst at Citigroup, said in a research note that Bank of America could have $165 billion of credit losses embedded in its balance sheet, about a third of which have already appeared through loan loss provisions and purchase accounting related to Countrywide Financial Corp.
These concerns helped pull Bank of America's shares down 12 percent on Monday to $11.43. JPMorgan's shares, down 4.1 percent during the trading session, edged higher after hours, when the company said it was reporting its fourth quarter results later this week, six days earlier than planned. A bank spokesman declined to comment on whether the acceleration means the results will be better or worse than expected.
Citigroup's upcoming deal with Morgan Stanley would be fraught with risks, analysts said. Integrating businesses takes time, and can require increased investments in areas like technology.
"It will take three years to successfully merge these operations together," Bernstein Research analyst Brad Hintz told clients on Monday. "In the meantime, the retail business will face a severe downturn."
And the brokerage business could be weak as falling market prices shrink assets under management and nervous investors generate fewer commissions.
Clients also may leave the combined brokerage, analysts said.
Brokerage deals often trigger an exodus of financial advisers to competitors, taking clients and their assets with them. The risk of an exodus may be mitigated by the fact that there are few better alternatives for brokers looking for jobs.
"My sense is, there's turmoil right now wherever you go," said Tony Riotto, a recruiter for brokers and private bankers. "There are a lot of people in this business who are just happy to have jobs."
The deal is structured to give Citigroup cash and capital upfront, with the opportunity to benefit as the business improves in the future.
Morgan Stanley would expect to buy more of the joint venture later, but at a price to be determined in the future rather than now, according to a person familiar with the deal.
Being able to benefit from any market recovery was important to Citigroup, a person close to the matter said. That ruled out selling the business to JPMorgan Chase & Co, whose chief executive, Jamie Dimon, has long been interested in buying a brokerage, but which could not have done a joint venture.
Citigroup would be entitled to revenue from the venture for at least another three years under the deal, the source said.
Citigroup has recorded more than $50 billion of credit losses and writedowns since the middle of 2007. Its market value has shrunk to around $30 billion, less than rivals with just a fraction of its assets.
But the economy does not appear to be getting better, and loan losses typically take time to ratchet higher as the economy slows, said Ray Soifer, a bank consultant.
"The worst may be ahead," Soifer said.
(Editing by Jeffrey Benkoe and Bernard Orr)