Citigroup’s Corbat Gets Housing Rebound Pandit Missed: Mortgages

Citigroup's Corbat Inheriting Housing Rebound Pandit Missed: Mor
Citigroup Inc.'s new head Michael Corbat is inheriting leadership of a bank that's still mistrusted by investors five years after bets on mortgages crippled the firm. Source: Citigroup Inc. via Bloomberg

Citigroup Inc.’s newly appointed Chief Executive Officer Michael Corbat has one big advantage over his predecessor Vikram Pandit -- a housing rebound that’s accelerating enough to help the lender deal with its most troubled investments.

Corbat, 52, is taking over a bank with $171 billion of distressed or unwanted assets within its Citi Holdings unit, including $95 billion of U.S. mortgages. The division, which is losing almost $4 billion a year and ties up a quarter of the company’s capital, is weighing on the lender, Goldman Sachs Group Inc. analysts said in a report last month, saying it could spin off the loans into a new company to increase returns.

The new CEO, who has run Citi Holdings since 2009, is gaining flexibility as U.S. housing starts surged 15 percent in September to the highest level in four years. Prices rose 4.6 percent in August from a year earlier, the biggest increase since July 2006, according to CoreLogic Inc., a Santa Ana, California-based mortgage data firm, and late mortgage payments have declined. Citigroup, the third-biggest U.S. bank by assets, sold $750 million of delinquent loans last quarter.

“The worst is over for Citigroup,” said Gerard Cassidy, an analyst with RBC Capital Markets. “A stronger than expected housing recovery would benefit the assets that are tied to housing such as mortgages. You will have fewer defaults because as the market recovers prices will rise and people on the edge of default may pull back and values of distressed assets that have been written down will stabilize and may even improve.”

No Change

Corbat said on an Oct. 16 call with analysts that he doesn’t currently plan to change strategy for Citi Holdings. Shannon Bell, a spokeswoman for Citigroup, declined to comment.

Executives from Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. have said in the past week the market is recovering after a six-year slump as the central bank pushes down borrowing costs to record lows and federal incentive programs encourage homeowners to refinance.

That’s drawing in firms from Cerberus Capital Management LP to Goldman Sachs to raise money for new funds targeting mortgage bonds that aren’t backed by the government, driving a rally in the debt. This includes subprime mortgages, which fed the housing boom that peaked in 2006 before triggering the worst financial crisis since the 1930s and causing billions of dollars of losses at Citigroup.

Corner Turning

“This is the best housing’s felt in some time,” Bank of America’s Chief Financial Officer Bruce Thompson said on a conference call yesterday with reporters. “We’ve clearly begun to turn a corner.”

Corbat is now in line to benefit from the recovery after Pandit was ousted by the banks’ directors. They concluded his mismanagement of operations caused setbacks with regulators and damaged credibility with investors, a person with knowledge of the discussions said this week.

Analysts including Todd Hagerman of Sterne, Agee & Leach Inc. had said that investors were “increasingly frustrated with the seemingly slow pace” of mortgage sales in Citi Holdings under Pandit. On a conference call on Monday, the day before Pandit was ousted, CLSA Ltd.’s Mike Mayo asked why the bank hadn’t accelerated sales.

The Federal Reserve in March blocked Pandit’s proposal to increase payouts to shareholders, who rejected his compensation plan in a non-binding vote a month later. Moody’s Investors Service cut Citigroup’s credit rating by two grades in June, and last month the bank took a $4.73 billion pretax writedown on the value of its stake in a brokerage venture with Morgan Stanley.

Citigroup Rises

While Citigroup has risen 46 percent this year, it has declined about 88 percent since Pandit took over as CEO on Dec. 11 2007.

The lender has had to contend with litigation costs to defend against demands by buyers of its loans, including Fannie Mae and Freddie Mac, that it repurchase defective loans.

Corbat, Pandit’s replacement, previously led Citigroup’s business in Europe, the Middle East and Africa. He was assigned by Pandit in 2009 to divest $573 billion of assets as permanent head of the Citi Holdings unit, which was set up to contain unwanted businesses including private-equity stakes, auto loans, a life insurer, a student-loan firm and a fund-of-hedge-funds business, along with mortgages and corporate bonds.

By the end of last year, when Corbat was transferred to become the bank’s European regional chief, the assets had been cut 61 percent to $225 billion.

Mayo Reverses

CLSA’s Mayo, who has spent the past five years telling investors to sell Citigroup stock, reversed his stance after the board led by Chairman Michael O’Neill replaced Pandit.

“Corbat is an operator,” Mayo told Bloomberg TV yesterday. “Now you have the operator who has already disposed of assets working for a chairman who has disposed of assets at a company where they need to dispose of more.”

Citigroup should be aggressive and creative in disposing of unwanted assets, especially in an improving housing market, Mayo said.

Corbat may need to be. Even as investor appetite for home loans increases, Citi Holdings held about $95 billion of mortgages at the end of September. While that’s reduced from $111 billion a year earlier, the portfolio is still bigger than assets at regional lenders KeyCorp and M&T Bank Corp. The mortgages include more than $35 billion of home-equity loans, and there’s no market for such debts after they sour, according to the company.

Tighter Guidelines

About $8.3 billion, or 8.7 percent, of mortgage debt is more than 30 days overdue, according to a quarterly filing.

The lender wrote off about $635 million last quarter to comply with tighter guidelines from the Office of the Comptroller of the Currency. About $454 million was tied to home-equity loans, the bank said in a presentation. The “vast majority” of the loans it wrote off weren’t delinquent, said Chief Financial Officer John Gerspach.

The unit contains other assets that the lender has failed to sell, such as $28 billion in a special pool including corporate bonds, subprime mortgage debt, collateralized loan obligations and auction-rate securities.

Citi Holdings is still losing close to $4 billion a year and is tying up more than 25 percent of firm-wide capital, Goldman Sachs analysts led by Richard Ramsden wrote in a Sept. 10 report.

The bank could boost profit and improve its share price by spinning off bad mortgages from the unit into a new company, the analysts said. The most efficient way to boost returns is to eliminate assets with the largest losses and largest capital requirements, according to the report.

Sufficient Capital

“While we recognize the challenges for Citigroup given the size and complexity of the portfolio, the North America mortgage book within Citi Holdings fits the bill for both,” they wrote.

While Citigroup has set aside sufficient capital to cover loan losses, the analysts said, the bank would likely have to accept a steep discount if it tried to sell such a large portfolio. The bank could avoid that issue by creating the new entity, while allowing it to lower capital requirements.

Citigroup executives don’t share the same level of optimism towards the housing recovery as some of their rivals.

“We continue to watch the mortgage market closely,” Gerspach said in a conference call this week with investors.

“While we have noted signs that the housing market may have stabilized, we would like more clarity on economic trends in the U.S. before we can conclude that the housing recovery is sustainable.”

Stumbling Block

The bank also laid out the challenges of selling the mortgage portfolio.

“There just aren’t a great deal of big national buyers in the market right now,” Gerspach said. “The biggest stumbling block I think that we’ve got right now from a buyers’ point of view would be liquidity.”

Citigroup has risen 4.8 percent since the lender announced Pandit’s resignation, a signal investors are pleased with the board’s decision to replace him, said John Mack, the former chairman and CEO of Morgan Stanley.

The cost of protecting its debt from default has also dropped to the lowest in more than a year.

Credit-default swaps tied to Citigroup fell 11.1 basis points to 135.8 basis points yesterday, the lowest since July 2011, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

Investors will want to see Corbat dispose of more businesses and reduce its stake in Citi Holdings further, RBC’s Cassidy said.

“Investors have indicated the number one reason they don’t own Citigroup stock is because of Citi Holdings,” Cassidy said. “You have to take a harder look at selling than holding on.”

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