CitiCrooks:Bad SubPrime Lenders w/o risk sensitivity'
Citi Still Needs To Be Broken Up
Let’s start with a spinoff of the credit card operation
Friday, February 03, 2006
Thomas K. Brown
bankstocks.com
tbrown@bankstocks.com
The latest piece of evidence that Citigroup is a publicly traded white elephant that’s crying out to be broken up comes from a recent filing from the company’s credit card unit. Thanks to the filing, we now have two facts about Citi we didn’t have before: a) the company is much more of a sub-prime card lender than it has so far let on and, b) it’s not generating as high a return on its sub-prime-related exposure as its standalone competitors are. Of these two facts, b is the problem. Citi should be paid for the risk it’s taking. And the way to make that happen, in my view, is for the company to spin its card unit off to shareholders, so that it can punch up to its weight. Chuck Prince, do the right thing! Let your card business go!
I should perhaps start at the beginning. The S.E.C.’s new Regulation AB, which went into effect in January, requires that card issuers who securitize disclose the percentage of their borrowers that are sub-prime (“sub-prime” being defined as a FICO score below 660). As part of its most recent securitization, Citi indicated that fully 26% of its borrowers fall below 660.
There is nothing the matter with lending to sub-prime consumers, of course. (Some of our favorite companies do just that!) The trick, though, is to get paid for the incremental risk you’re taking. And as noted, on that score Citi’s card results seem to be seriously lagging those of its more focused competitors.
Take Capital One, for instance, and you’ll see what I mean. The company has of course long been seen in many quarters as a sub-prime card lender. Thirty-one percent of the company’s card loans are to sub-prime borrowers. And yet, as the table below shows, even though Cap One has a slightly higher portion of sub-prime borrowers in its customer mix than Citi does, its charge-off rate is much, much lower than Citi’s. Take a look:
Pct of Loans That Are Sub-Prime Chargeoff Rate
Citigroup
26% 5.90%
Capital One
31%- 4.20%
Source: Sanford C. Bernstein
It is, at a minimum, a highly counterintuitive piece of data! But wait, you say. Citi’s chargeoffs may be higher than Cap One’s, but the company presumably charges a higher interest rate to its sub-prime customers than Cap One does. Net it all out, and the result is a wash: Citi’s Master Trust is just as profitable as Capital One’s is.
Not! In fact, the typical portfolio yield in Capital One’s trust is significantly higher than it is in Citi’s, not lower. Here’s the data:
Source: The Bloomberg
Put it all together, and Citi has a roughly similar customer mix as Capital One, yet charges a lower coupon than Cap One does and suffers a higher rate of chargeoffs. Which is to say, Capital One tops Citi in virtually every meaningful measure of card lending.
You might argue that Citi, with its vast size, enjoys economies of scale in areas like marketing and processing that Capital One does not. That may be true. (Then again, it may not.) Regardless, any such “scale” advantage would pale in comparison to the huge edge in yield and chargeoffs that Cap One enjoys.
You will have your one view as to why Cap One runs rings around Citi in cards. Here’s mine: Capital One is a highly focused player, and has all the advantaged that focused players have in financial services. Whether the business is mortgage lending, auto lending, or credit card lending, the story is the same: focused players beat generalists every single time.
Which brings me back to the point I started with. Why oh why does Chuck Prince insist on keeping this kludge of a company (whose current P/E is a rip-roaring 10.6 times current-year earnings, by the way) tied up in knots? There’s little doubt that each unit would be a much more effective competitor on its own, unbundled from the others. And think of all the mid-level bureaucracy that could be swept away. As I’ve argued before, Citigroup in parts is almost worth more than the whole. So Chuck, do the right thing—break it up!
/TKB/
The author is a Manager of a hedge fund and co-founder of bankstocks.com. His fund often buys and sells securities that are the subject of his articles, both before and after the articles are posted. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither the author nor bankstocks.com can provide investment advice or respond to individual requests for recommendations. However, we encourage your feedback and welcome your comments on any of the articles on this site. Neither the author nor bankstocks.com has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.
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