The Not-So-Big ‘C’

No, it’s not Cancer.

Nor, as the date might imply, Christmas.

Not even Chrysler, as it was for so many decades on Wall Street.  The not-so-big C is Citicorp, which was reduced to raising equity capital last week at a price so low that even the Federal government acting on behalf of taxpayers said “no thanks”, and held onto their stock.

At its low in March, Citicorp had a market cap under $25 billion, and a share price just over a buck a share.  If senior members of the team had been offered long-term stock as part of their compensation and retention packages at that point, the $10 million per year types could already be looking at 2009 as a $40 million year.

Not only that, if they held their stock for another few years until vesting and the company survives in part because of their contributions, they could be looking at individual compensation packages, subject to capital gains only, that would leave them with hundreds of millions of after tax dollars, each, for seeing the company through this terrible time.

Today, with the stock still trading at $3.35 a share (less than half its price last January), market cap is up to nearly $95 billion, including the $15 billion raised last week.

The strange thing, for me, is listening to the CNBC cheerleaders claim that Citi can’t attract and retain A quality players for its team.  Who are they kidding?  The goal of every starry-eyed wannabee billionaire on the prop trading desks or Associate in the M&A departments of Wall Street is to become a hedge fund or private equity manager.  The reason?  So they can take their yearly pay in equity for eventual long-term gains.

For the first time in many decades, young Wall Streeters in 2009 had the chance to be employees with all those niceties like benefits packages and regular healthy salary checks (last time I checked, getting by on $40,000 a month in cash salary is still possible, even in New York City), and get in at the bottom for a run that could be just as financially rewarding as starting their own hedge fund.  On top of that, the mean old government is making them take their pay in the form the hedgies all strive for, taxed only when you take it out, and only at the long-term capital gains rates.  I can’t think of a better chance to eat that cake while having it.

The real payoff comes from the upside the Fed has virtually guaranteed Citi and the other banks who lend to corporations.  Recently the index of below investment grade (“junk”) corporate syndicated bank loans rose to its highest level for the year, giving Citi and JP Morgan huge unrealized profits in their portfolios of C & I (commercial and industrial) lending.

Junk bonds have come roaring back as a public vehicle, and the spreads have tightened but still sit at very wide levels.  A big deal just hit the street and got absorbed and upsized at 9.25%.

Think about what 9.25% means.  That’s nearly 900 basis points above today’s funding rate for banks.  If the bank were to hold such a bond for a year, and hedge its exposure only for years 2 through 10 or 2 through 5, the raw return on capital is astounding during that first year.  After all, a junk-rated bond or bank loan only requires 8% capital held against it.  If the credit work is adequate (ie the borrower does have the capacity and willingness to pay, even under stress), then the bank holding that paper gets their capital essentially doubled in a year.

Given that their losses in consumer loans and mortgages can be recognized over time to shelter the earnings from holding corporate debt, the big banks are being recapitalized at an astounding rate.  In Citi’s case, they are earning more than $50 billion a year in net interest margin.  Pretty impressive for a stock valued under $100 billion in market cap with book value nearly twice the current stock price.

If I were choosing the best upside/downside trade among the banks (as a place to work), I’d be trying to get all the stock they would give me, and hold my salary to what I needed to pay the utilities, tuition and the like.

If you need any more convincing that this is silly to complain about, look at what Goldman did.  They weren’t giving out stock to their top guys to be good citizens.  They were doing it at a place in the cycle where the chance to make money in finance is as good as it ever will be, and where they can lock in low, back-ended taxation on the compensation they give their people.  Such a deal!

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3 Responses to The Not-So-Big ‘C’

  1. mike friedman says:

    Right On, Howard! Some Republican individuals have been saying – in public – that the fate of the republic is in jeopardy if the Gummint controls Wall Street pay plans, amounts to Marxism. If Citibank survives and keeps its best employees, it means that premise is false. If Citibank survives, and does better without its highest-paid employees, that demonstrates that the free market works, and it works better without the big earning people. Of course it is possible that Citibank will fail altogether, and the right-wingers will get to say that it is because of Gummint interference, not because free enterprise wrecked the company so badly that the Government could not get it back in business.

    • hhill51 says:

      Mike —

      I have to object. Not to your sentiment, but to the phrases “free enterprise” and “Republican”.

      There hasn’t been anything resembling free enterprise in our banking system since the taxpayer deposit guarantee was put in place. In fact, that was exactly the issue in the S&L crisis — all the money got sucked away by the most “optimistic” (or larcenous) thrifts from the ones that acted prudently. Since the risk was the same for any deposit, only the guys that promised higher returns get the dough, while the careful ones get starved.
      Those aren’t “Republicans” who hate government. They are something else that has no place in governing. If they hate government that much, then they should stop trying to take it over. If they keep spending hundreds of millions each year to take power, I can only conclude that they really want the power so they can can pillage the public treasury.
      At least that’s what they do (as opposed to what they say).

      • M_War- says:

        Mr. HH-

        It’s amazing how the longer I study the ‘actual facts’ and your (among others’) perspective on who/what is actually in control here, and who is calling the shots (and their real purpose) the more I realize how right you are.

        Many Thanks for helping this former RepubliCorpProNeoConLeftRightParadigmBelievingBrainwashedFREAK break his programming…

        Thanks Again!
        M_War-

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