No Quick Escape for Citigroup

The financial giant's shareholders aren't celebrating the multibillion-dollar commercial paper rescue plan it's formed with JPMorgan and BofA

The market was expecting that the big story for Citigroup (C) on Oct. 15 would be the mega-bank's release of third-quarter earnings. Instead, Wall Street got a twofer: Not only did Citi report its worst quarterly earnings in years—widely expected thanks to this summer's subprime-related credit market disruptions—but news hit of a multibillion-dollar plan to help the company and other big financial players avoid a meltdown in the commercial paper market.

Though the details are still hazy, the plan calls for Citi to join with JPMorgan Chase (JPM) and Bank of America (BAC), to create a fund that would buy up about $100 billion of debt held in instruments known as structured investment vehicles, or SIVs. The idea is to inject liquidity into key parts of the credit market, preventing a further collapse in the value of mortgage-backed debt.

The main beneficiary of the rescue plan, reportedly organized but not funded by the federal government, may be Citi. It reportedly holds about $80 billion of such debt in SIVs. Yet, despite this supposedly good news, Citi shares ended Monday's trading session down 3.41%, or $1.63, to $46.24.

"Breadth of Problems"

Yes, the stock's slide matched the poor earnings numbers. Citi earned 47¢ per share in the third quarter, vs. $1.10 a year ago. That's a 57% drop, but the bank had already warned of even worse results.

The stock's drop accelerated throughout the day. As the market had more time to digest the details of the rescue plan and the quarterly results, it may have raised a troubling suspicion: The ambitious SIV fund may offer temporary relief to some parts of the credit markets. It may relieve some worries about Citi and offer an insurance policy against complete meltdown. But the news may have prompted suspicions that problems for Citi and the credit markets stretch far beyond this one measure.

On Oct. 15, "the breadth of problems became that much more clear," says Deutsche Bank (DB) analyst Mike Mayo. Citi announced a shake-up of its executives last week, but Mayo has been pushing for big changes at the very top of the company. "Almost every investor we talk to feels that there needs to be a change," Mayo says. The main target of complaints is Chairman and Chief Executive .

Rival Losses

The list of problems for Citi, analysts and investors say, starts with the damage done this quarter by problems on credit markets, especially in mortgage-backed debt. But Citi saw losses deeper than many of its rivals. Some losses "were greater than would have been expected from that market dislocation and simply reflect poor performance," Prince admitted to analysts Monday morning.

One problem was how Citi managed its risks. Analysts say that while other banks used other financial instruments to hedge their debt risks, Citi mostly didn't.

Citi also has been criticized because expenses are rising faster than revenues at the global, 332,000-employee company. Management made some progress in cost-cutting earlier in the year but the pace has slowed. Other problem areas include slow business in Japan.

"Underlying Momentum"

Prince defended the company's performance on Oct. 15, asking investors to ignore the one-time jolt of credit problems. "The underlying momentum across many of our businesses continues very strong," he said. International revenues, for example, were up 30%.

Part of the problem for Prince, some analysts say, is that it's very hard for one man to stay on top of everything that's going on at Citi. "Citigroup is an insanely large business," notes Morningstar (MORN) analyst Jaime Peters. Nonetheless, she says, Citi has a powerful business model, with strong growth opportunities and rising market share in many businesses. Terrible results in one area are easily outweighed by strong results elsewhere in a company with Citi's market capitalization of $232 billion.

Homeowner Liability

With all the talk about SIVs and complex rescue plans, it's easy to forget the original reason credit markets have felt such pain: Millions of Americans are having trouble keeping up on their home mortgages, subprime or otherwise. The bad loans out there scared holders of complex mortgage-backed debt instruments. And nothing in the new rescue plan will improve homeowners' ability to make their loan payments.

"This is going to be a chronic problem that goes on," says Bill Larkin, a portfolio manager of fixed income at Cabot Money Management. He thinks, eventually, the government will need to step in with a true bailout for homeowners.

Prince and His Demons

Though Citi might have hit bottom last quarter, "things are going to be slower to recover," says Standard & Poor's equity analyst Frank Braden (Standard & Poor's, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP)). Previously, Citi executives had sounded optimistic about a return to normal conditions in the fourth quarter of 2007, but they seemed less optimistic on Monday, Braden says.

Prince's job will be on the line, notes the analyst. "He's going to be judged [on] how soon they can come out of this mess," Braden says.

Despite news plans to rescue Citi from credit market problems, Monday's news suggested the company may be wrestling with the demons of bad debt for quite some time.

Before it's here, it's on the Bloomberg Terminal.