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Analyst sees $8 billion Citi writeoff after Merrill move

BANGALORE (Reuters) - Citigroup Inc C.N may write down about $8 billion in the third quarter from its exposure to collateralized debt obligations (CDOs) after Merrill Lynch & Co MER.N agreed to sell its CDOs at a sharp discount, Deutsche Bank analyst Mike Mayo said.

A Citibank branch is pictured in Singapore, January 22, 2008. REUTERS/Alywin Chew

The analyst also forecast a third-quarter loss and widened his 2008 loss estimate for Citigroup, the largest U.S. bank by assets.

On Monday, Merrill Lynch agreed to sell $30.6 billion of CDOs, a kind of repackaged debt, to an affiliate of private equity fund Lone Star Funds for just $6.7 billion, or about 22 cents on the dollar.

“We do think the CDO sale is large and diversified enough to be applicable to others with similar exposure and that the monoline settlements will pave the way for similar enough transactions,” analysts at UBS said.

They said Citigroup has the largest exposure to both CDOs and monoline bond insurers, and that investors could expect further incremental write-downs in coming quarters.

On Monday, Merrill also said it would take a $5.7 billion third-quarter write-down as it unloads huge amounts of risky debt, and would raise $8.5 billion by selling new stock.

Citigroup has $22.5 billion of net CDO exposure, and based on Merrill’s write-downs the New York-based bank could have another $7 billion of write-downs, Deutsche Bank’s Mayo said.

The bank may also incur a $1 billion loss on its remaining $2 billion exposure to the bond insurers, Mayo added.

“Citi should still be able to absorb much of these charges and credit costs in general given an estimated $20 billion of second-half 2008 pre-provision, pre-tax earnings and the sale of its German retail business...but the decision about raising new capital could be closer than we previously thought,” Mayo wrote in a note to clients.

Mayo cut his third-quarter estimate by $1 to a loss of 59 cents a share. For 2008, he expects Citigroup to post a wider loss of 80 cents a share, from a loss of 66 cents a share.

According to Reuters Estimates, analysts on average expect Citigroup to earn 26 cents a share in the third quarter. For 2008, they expect the bank to post a loss of 87 cents a share. Mayo maintained his “hold” rating on the stock.


The fire-sale nature of Merrill’s CDO deal will add to concerns that the global credit crisis, which has already led to more than $400 billion of write-downs and losses at major banks, still has a long way to run.

“The read across of the new clearing price on ABS CDO (22 cents on the dollar) is causing stress tests everywhere. Of the US names we cover this has the largest impact on Citigroup,” a note from a Merrill Lynch stock salesperson said.

Goldman Sachs analyst William Tanona agreed.

“The biggest read across to other firms will be Citigroup which has been far less aggressive in their marks on CDOs, in our view,” Goldman’s Tanona wrote in a note to clients.

He said that if Citigroup were to mark its exposure to a level similar to that of Merrill, it would imply a $16.2 billion write-down and roughly $2 per share impact.

“Though Citi defends their marks, due to their earlier vintages and high concentration of commercial paper, we continue to believe they would struggle to obtain their prices in the marketplace today,” Tanona added.

In a separate report, J.P. Morgan Securities analyst Kenneth Worthington said Merrill’s sale of its CDO portfolio brings transparency to the market, but means more write-downs for peers.

“Given the sale of Merrill’s $30.6 billion ABS CDO portfolio, we expect peers will adjust marks, eliminating an incentive to hold on to impaired assets,” Worthington said. “We see this a part of the cleansing process and expect increased liquidity in the CDO market and mortgage markets.”

He also expects Goldman Sachs Group Inc GS.N and private equity companies, with excess capital and fund-raising ability, to be the main beneficiaries from a credit market that appears in the early stage of being on the mend.

Citigroup shares were up about 2 percent at $17.74 in afternoon trade on the New York Stock Exchange. Through Monday, they had fallen 41 percent this year.

Shares of Goldman Sachs were up 4.1 percent at $180.01.

Editing by Mike Miller