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Pandit may have left but the risks remain

18 October, 2012

It is somehow apt that the explanations for the sudden departure of Vikram Pandit from Citigroup this week were utterly baffling. “No strategic, regulatory or operating issue precipitated the resignation,” said Michael O’Neill, the bank’s chairman. “I had a very good conversation with Mike O’Neill,” insisted Mr Pandit.

Mr Pandit’s dash for the exit from Lexington Avenue is as confusing as the global bank that Sandy Weill built and now disowns. When Moody’s downgraded Citi in June, the rating agency complained of “a high degree of opacity of risk taking and a high velocity of risk positions”. Mr Pandit’s escape velocity was even higher.

It is fairly obvious that the no-nonsense Mr O’Neill and the intellectual, detached Mr Pandit did not get along. The chairman wanted a more hands-on leader and found one in Mike Corbat, the Citi lifer who most recently ran its European operations and was formerly in charge of selling the irrelevant and underperforming businesses left over from its merger with Mr Weill’s Travelers Group in 1998.

All but one, that is. The Citi of today looks more or less like the Citi of 1997, apart for being less valuable, worse managed and including Salomon Brothers – or what remains of the infamous investment bank. These days, it is called Citi Markets and, while a shadow of its former self, remains a problem.

Mr O’Neill believes value can be restored simply by managing the bank better – he professes no “desire to alter the strategic direction of Citi”. But he ought to have some. Mr Pandit cannot be landed with the entire blame for the flatlining of its shares over the past three years, the scepticism of rating agencies and the irritation of its regulators. People want the old Citi back.

The flaws in management and strategy at Citi are connected. Mr Pandit was never an obvious choice to run a commercial bank. A former head of the securities division at Morgan Stanley, he was acquired by Citi under an outrageous $800m deal for his hedge fund Old Lane. He was more of a brainbox than the sort of relentless and detail-oriented executive a retail bank requires to thrive.

On paper, Mr Corbat has a similar pedigree. He started out as a bond salesman at Salomon Brothers in the 1980s – the era of Michael Lewis’s Liar’s Poker – and was only brought to Citi through the Travelers merger. But his low-key determination and gritty nature please Mr O’Neill, a former retail banker.

It remains implausible that better management will be enough. Citi’s problem is that no one understands its business and investors don’t trust its senior executives to run it safely. “Citi is too big to fail, too big to regulate, too big to manage and it has operated as if it’s too big to care,” says Mike Mayo, an analyst at Crédit Agricole Securities.

Mr Pandit spent four years shoring up Citi’s capital after the 2008 crisis but it still faces downgrades. Moody’s greeted the arrival of Mr Corbat by putting the bank on negative watch. Its main concern is Citi’s “commitment to global capital markets businesses, compounded by [its] size and complexity”.

Meanwhile, the regulatory tide keeps flowing against banks that combine capital markets and lending operations and are implicitly backed by taxpayers. Daniel Tarullo, a governor of the Federal Reserve, last week proposed limiting the size of US banks by capping their wholesale funding – the way in which they finance risky trading.

The obvious response for Mr Corbat would be to shed the capital markets division and return Citi to its banking roots. Mr Weill, the man who created this mess in the first place, is an unlikely convert to the cause, telling CNBC this July that banks should be “broken up so that the taxpayer will never be at risk, the depositors won’t be at risk”.

Thomas Hoenig, a director of the Federal Deposit Insurance Corporation, has provided a blueprint for US banks that fits Citi nicely. He would like deposit-taking banks to be forced to spin off capital markets operations, proprietary trading and hedge funds, while retaining lending, underwriting, and mergers and acquisitions advice.

The reason this hasn’t happened already is that Citi still seems to make a lot of money from trading. Some $3.7bn of $18.5bn in third-quarter revenues came from “fixed income markets”, the activity formerly known as Salomon Brothers, and no board would jettison this cash lightly.

It comes with a significant drawback, however. Fixed income trading is volatile and tends not to be all that it seems, a lesson Citi learnt in 2008 when it suffered multibillion-dollar losses on mortgage securities and had to be bailed out. The long-term returns often fail to live up to the initial billing.

As a result, it no longer gains any respect from investors. Citi’s shares trade at less than a third of the multiple to book value of Wells Fargo, the retail bank that beat Mr Pandit to buying Wachoviain 2008. Wells Fargo is the sort of steady, predictable bank that makes its investors comfortable.

To become more like it, Citi needs to expand its retail bank in the US and in emerging economies where it has historic roots. Owning 4,600 branches in 40 countries is a decent start but it does not add up to many in most places. With its current low share price, it lacks much of an acquisition currency.

Mr Corbat may squeeze more from the bank he suddenly runs by managing it more vigorously and patching up strained relations with regulators. It will take more than that to transform Citi’s fortunes and prospects. A good start would be to discard the last relic of Mr Weill’s troubled creation.

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Pandit may have left but the risks remain

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