How Citigroup, CEO Pandit Turned Themselves Around

Just a year after being relegated to the pile of near-dead banks crushed by the credit crisis, Citigroup is back.

Investors both big and small have been taking massive stakes of Citi's shares that at this time in 2009 were teetering around the $1 mark.

Vikram Pandit
Vikram Pandit

The venture to the brink of penny-stock territory was a torturous one, but that all seems to have changed as Citi's top officials are assuring investors that a return to profitability is on the horizon.

The company's return from its seemingly destined march to the graveyard has coincided with the rising star of embattered CEO Vikram Pandit.

"For the most part, Citi's done a good job of improving its balance sheet and its capital position," said David Konrad, banking analyst at Keefe, Bruyette & Woods. "It's going to be a long, long road there, but he's actually got a little bit of momentum on his side now."

Citi's stock , though off a bit in Friday trading, has risen about 12 percent this week, 23 percent this year and 157 percent in the 12 months since it hit an intraday low of 97 cents.

Market interest has been enormous. The stock traded at an average volume of 1.2 billion shares in the previous three trading sessions, nearly three times its normal level.

There are multiple reasons for why the stock has become so popular.

Investors are beginning to warm to financials in general as concerns have waned over the effect that increased government regulation would have on trading activity.

In Citi's case, that interest has increased as Pandit and other company officials talked up the company's position—and an offering of preferred shares earlier this week came in "multiple times oversubscribed," as one analyst put it.

That enthusiasm in turn has come from a general belief that Citi has been efficient in shedding the higher-risk and lower-performing entities that got it in so much trouble in the first place. Of course, billions in government aid hasn't hurt, either—the Treasury Department still holds a 27 percent stake in Citi that it is seeking to unwind.

Citi was among the most high-profile victims of the subprime mortgage collapse, losing billions when the bets it made on securities underwriting risky loans collapsed.

"You can pretty much forget about the past," Michael Yoshikami, president and chief investment strategist at YCMN Advisors, said. "Citigroup for all practical purposes is going to be a brand new company and it has to be assessed as a brand new company. What they did in the past doesn't exist anymore."

Central to Pandit's strategy to reorganize the group into a more stable company was isolating the toxic assets that remained on Citi's $1.3 trillion balance sheet.

The company has been broken into two parents that encompass the still-sprawling Citi empire: Citicorp, home of the new and improved Citi; and Citi Holdings, where the company's rancid assets have gone to die.

Citi also shed 51 percent of its position in Smith Barney to Morgan Stanley ; its German retail bank, Japanese holdings and Commercial Credit unit and is planning to spin off life insurer Primerica through an initial public offering.

Pandit had come under withering criticism for presiding over an essentially unmanageable financial superstore that had lost its vision, but that sentiment has shifted.

"We've asked ourselves, are we in the client business or not?" Pandit said in a late-January interview with CNBC. "If we are in the client business—which we are—then do these businesses belong with us or not? If they don't then we've sold them. We've been moving in that direction and we plan to keep going that way."

Analysts have taken note and are giving Citi generally positive marks and maintaining a solid outlook for the company.

While KBW's Konrad has a $3.75 target for the stock and Goldman Sachs is neutral with a $3.50 target, JPMorgan is overweight Citi at $5.50 and Barclays Capital analyst Jason Goldberg recently said he is overweight Citi with a $5 target.

Rochdale Securities analyst Dick Bove drew more attention to Citi earlier this week in a CNBC interview during which he praised the company as a long-term investment after some difficulties ahead.

Bove's view came in part because of momentum in banks generally as the industry recovers from the 2007-08 collapse of the financial system.

"If we go out two-three view is that the dividend payout ratios in banks are going to go back up to 40 percent, and if people were to buy these banks at the present time, they're looking at extraordinarily high yields based on where the dividends could be, say, in 2013," he said.

Pandit: 'Long-Term Profitability is Clear'

In the near term a variety of factors pose threats, including a remaining level of uncertainty about the economy and geopolitical problems. JPMorgan also cited regulatory risks, worse credit losses than expected and the unpredictability of fixed-income markets.

As such, not everyone is ready to give the company a total thumbs-up yet.

"Earnings could be sub-par for at least the next few quarters given the pressures of the credit cycle," Scott Sprinzen, a managing director in financial institutions for Standard & Poor's, told "But we don't see a return to the substantial losses that they incurred over the past year, year-and-a-half."

Citigroup Center
Citigroup Center

S&P holds a an A-plus rating for Citigroup's banking activities and single-A for the holding company.

"They've been doing a lot in terms of bolstering their capital and liquidity and downsizing the balance sheet," Sprinzen said. "They've also divested things for the sake of bolstering capital which, given their druthers, they might have wanted to keep."

The reaction from investors on both the retail and institutional levels has been remarkable.

Fairholme Capital and Paulson & Co. have both made large moves in Citi over the past several months. The lower-than-expected 8.5 percent yield this week's sale of $2 billion trust preferred auction fetched sparked additional interest.

A lower yield reflects strong demand as the seller can offer a lower payoff to get investor interest. The preferred sale also provided hope to other banks in Citi's boat that the ability to raise capital is strong. as they have to start repaying government bailout funds.

Citi even has begun to attract interest from options investors again.

Normally a stock priced so low is considered a de facto option because of its risk, but traders are now picking up call options as sentiment grows that the stock could rise.

"What we're seeing is a lot of institutional interest that's doing this," said Mike Khouw, director of US derivatives trading at Cantor Fitzgerald. "Essentially people are saying this is a stock that can move."

While many analysts are treating warily Citi's claims that it could soon return to the days of $20 billion annual profits, the appetite for the once-dead stock definitely is back.

Pandit, in his CNBC interview, said the company has cut leverage to a 12 to 1 ratio, has $200 billion of liquidity and $36 billion in reserves—a position analysts cite as a strong positive for Citi—and is "completely concerned with making sure we're profitable as a bank."

"We come into 2010 very strong positioned," he said in remarks that foreshadowed testimony he gave to Congress earlier this week that Bove described as "ebullient." "The long-term profitability picture is clear."