Citigroup Facing $7 Billion Hit on Dollar Gain, Peabody Says
Citigroup Inc. (C) could lose as much as $7 billion on currency swings if Charles Peabody is right, putting the analyst at odds with peers who say the stock will be the best performer among big U.S. banks in the year ahead.
Peabody, who leads research at Portales Partners LLC, is among only four analysts out of 34 tracked by Bloomberg who recommend investors sell Citigroup shares. He estimates the bank may lose $5 billion to $7 billion in regulatory capital this year if the dollar gains against the yen, euro and currencies in emerging markets, which provide about half the firm’s profit. That would be its worst translation loss in five years, exceeding the $3.5 billion deficit in 2011.
Former Chief Executive Officer Vikram Pandit expanded Citigroup’s overseas businesses to help it recover from 2008’s U.S. credit crisis. Peabody, who predicted the mortgage market’s plunge as early as January 2005, said the firm’s reliance on revenue from abroad is now driving his concern that a global economic slowdown will hurt the bank more than U.S. rivals.
“Those currency risks are worth taking if the high-growth prospects are there,” said Peabody, 57. “But if global growth falters, then those risks get magnified and growth doesn’t offset the currency risks.”
Citigroup fell 3.8 percent to $49.95 in New York trading, the most since February. The stock was today’s second-worst performer in the 82-company Standard & Poor’s 500 Financials Index, which declined 1.7 percent.
Citigroup will climb about 11 percent to $55.67 within the next year, according to the average of 26 analyst estimates compiled by Bloomberg. While Peabody doesn’t disclose his price targets, he said the shares could fall 50 percent. The lender has been the best performer in the KBW Bank Index (BKX), jumping 87 percent in the 12 months through yesterday.
The other five largest U.S. banks will collectively gain 1.7 percent, led by JPMorgan Chase & Co.’s 6.5 percent advance, according to the analysts.
“Citi appropriately hedges its regulatory capital ratios to mitigate the impact of foreign-exchange rates,” said Mark Costiglio, a spokesman for the New York-based firm, which he said expects to end 2013 with a Tier 1 common ratio of at least 10 percent under international standards. “It is worth noting that Mr. Peabody made similar predictions around this time last year which later proved to be far off the mark as Citi grew its book value and increased capital ratios in the second quarter of 2012 despite significant currency volatility in the quarter.”
Last June, Peabody said Citigroup’s currency losses could reach $3 billion to $5 billion as the Mexican peso and the Brazilian real slumped against the dollar. The bank posted a $1.6 billion currency loss instead.
“I was wrong in magnitude but not direction,” he says now.
The debate was rekindled as currencies in emerging markets tumbled against the dollar amid speculation that the U.S. economy is improving. The dollar was buoyed anew on June 7 when the U.S. reported May payrolls rose 175,000, with broad-based job gains in industries from retailing and construction to education and health services.
Federal Reserve Chairman Ben S. Bernanke has said the central bank could reduce its monthly purchases of bonds if the U.S. employment outlook shows “sustainable improvement.” Investors have speculated that would lead to higher interest rates and a stronger dollar.
The Fed’s buying held down rates and encouraged investors to seek riskier assets with higher yields, such as those in emerging markets. The potential for a shift caused investors to sell currencies such as the Mexican peso and the South Korean won, according to Benoit Anne, head of global emerging markets strategy for Societe Generale SA (GLE) in London.
The peso has declined 6 percent against the greenback since May while the won has slid 2.3 percent. The Brazilian real and the Indian rupee have both slumped more than 6 percent. The Turkish lira is down 5.7 percent while the Singaporean dollar has slid 2.1 percent.
“The pain at this point is brutal for most emerging-market currencies,” Anne said. “I wouldn’t differentiate. There are laggards and front-runners but ultimately the whole market backdrop is quite negative.”
This could also hurt Citigroup, which has operations in more than 100 countries, according to Peabody. The bank had accumulated losses on currencies of $10.6 billion at the end of March after losing $711 million in the first quarter because of swings in the peso, won, yen and British pound, according to a quarterly filing. If his prediction pans out, the lender’s cumulative losses including this year would balloon to almost $18 billion.
Because of accounting rules, currency losses don’t necessarily reduce Citigroup’s reported net income. Instead, they erode book value, a measure of the bank’s worth in a theoretical liquidation after liabilities are subtracted from assets.
The losses or gains on foreign exchange appear in “comprehensive income,” a calculation that’s usually explained in the footnotes of a company’s quarterly reports to regulators that firms often file weeks after the more publicized earnings news release.
The impact may be felt in capital levels. The lender includes gains or losses on foreign exchange in Tier 1 capital, which is a key measure for regulators of a bank’s cushion against losses. A multibillion-dollar translation loss could reduce capital buffers just as Michael Corbat, who succeeded Pandit as CEO in October, is trying to build them to comply with new rules, according to Peabody and David Knutson, a credit analyst with Legal & General Investment Management America Inc. in Chicago.
“In a period of time in which capital is dear and capital growth is vital due to new regulations and prior losses, this lowers the trajectory of their capital-build intentions,” Knutson said.
Some events could turn a currency loss into one that reduces net income, such as a devaluation or the sale of a unit overseas. In February, then-Venezuelan President Hugo Chavez ordered his government to weaken the exchange rate by 32 percent to 6.3 bolivars per dollar. Citigroup lost $100 million before taxes as a result, the bank said in a quarterly filing. That followed a $170 million loss in 2010 when Chavez, who died in March, devalued the bolivar by as much as 50 percent.
In 2012, the company lost about $1.1 billion before tax when it sold some of its stake in Turkish lender Akbank TAS. (AKBNK) The impairment resulted in part from losses tied to the Turkish lira that had previously been counted in comprehensive income, Citigroup said in a filing.
The bank lost more than $2 billion when Argentina devalued its currency in 2002. Now, 11 years later, the Argentine peso threatens to become the world’s worst-performing currency this year, according to analysts surveyed by Bloomberg.
The lender’s investment in the country is subject to “substantial uncertainty,” including the possibility that President Cristina Fernandez de Kirchner could devalue the peso again, the company said in an annual filing in March.
Citigroup seeks to reduce or hedge currency losses by buying forwards and futures. These are agreements with counterparties to buy and sell assets such as currencies at a set price and date. The bank held such agreements with a notional value of $88 billion at the end of March, according to a quarterly filing.
Foreign-exchange losses are among the complexities that Corbat, 53, has inherited as CEO of Citigroup, which got about 36 percent of its $255.6 billion in revenue since 2010 from Latin America and Asia. Currencies that have had a significant impact during that period include the Mexican peso, Polish zloty, Brazilian real, Indian rupee, Russian ruble and Chilean peso, filings show.
Where his predecessors expanded, Corbat has pulled back. He announced in December that the lender would sell or scale back consumer operations in five nations including Turkey and Pakistan as part of a cost-cutting plan that will eliminate 11,000 jobs. In March, Corbat told attendees at a New York conference he might exit businesses in 21 more countries, which he didn’t identify.
Peabody’s take on Citigroup is part of a thesis he crafted late last year that asserts efforts by central banks to stimulate economic recovery will fail and that a recession is coming. The boom in fixed-income products will suffer a “grinding halt” as investors flee and revenue at many of the lender’s businesses will face pressure, he has written.
The gloomy scenario echoes another broad call he made in a note to clients on Jan. 17, 2005, days after Citigroup shares closed at the equivalent of $475.10.
“We are on the cusp of a potentially deleterious credit deterioration cycle” in housing and residential mortgages, Peabody wrote. “Lack of vigilance suggests to us that this credit cycle is likely to catch many unaware and is likely to prove to be more detrimental than currently anticipated.”
Corbat’s replacement of Pandit in October failed to persuade Peabody to change his sell rating on Citigroup, which he’s held since March 14, 2012, according to data compiled by Bloomberg. The stock has climbed 47 percent since then.
Peabody’s outlook for the dollar is more bullish than foreign-exchange analysts. The Dollar Index, which measures the greenback’s strength against six of the U.S.’s biggest trading partners, will climb about 5 percent to 86.1 by the end of the year, according to the median estimate of economists and strategists surveyed by Bloomberg. Peabody said the index, which hasn’t exceeded 90 since 2006, could rise to between 89 and 92.
He’s also an outlier in his focus on currencies. Bloomberg News asked 11 of his counterparts at other firms for an estimate for the bank’s currency results. None provided one.
“I wouldn’t waste my time on it because I don’t think it’s a significant issue,” said Chris Kotowski, an analyst with Oppenheimer & Co., who has a buy rating on the shares. “Why would you care about any given year’s currency fluctuations? It’s an accounting fluctuation, not an economic or regulatory one.”
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