As Citigroup appears close to settling its investigation with New York State Attorney General Eliot Spitzer, at least one independent analyst is questioning the strength of its core businesses. However, a sell-sider says the financial services giant's bonds will continue to benefit from spread tightening in the corporate market.
Dave Hendler, analyst at Creditsights, argues that Citigroup's credit card business may no longer benefit from reduced funding costs as interest rates appear to have bottomed. He also makes a case that the conglomerate has not cut costs to keep pace with rival firms. In its retail brokerage business, for example, Citigroup has not reduced net headcount since the first quarter of 2001. Merrill Lynch has cut staffing by 25% over that same time, and Morgan Stanley has reduced 4% of its brokerage staff, Hendler says. He further argues that a decline in underwriting business will also hurt Citi relative to other firms, which have made larger cuts to their investment banking departments. Though Citi's 5.625% subordinated notes of '12 (Aa2/A+) were bid at 114 over the curve last Tuesday, Hendler sees 125-130 as a more appropriate level. "I wouldn't say ratings downgrades are around the corner, but we're laying the groundwork for those types of concerns," he says.
However, Joe Labriola, head of U.S. credit research at BNP Paribas, sees continued spread tightening for Citigroup, assuming that the headlines subside, even if the economy continues growing below potential for the next several quarters. He particularly recommends the senior subordinated paper, as it trades 30 basis points wide of the 6% senior subordinated notes of '12 (Aa1/AA-). Labriola argues that, even taking a conservative view of the historical relationship between the senior and subordinated paper, 15-20 basis points is a more appropriate differential.