Despite Rally, Citi Is Still Toxic for Many Investors

By Jeff Cox
|  Wednesday, Mar 11, 2009  |  Updated 12:15 PM PDT
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Even as Citigroup shares surged this week and led Tuesday's market rally, few longer-term investors have been adding the stock to their portfolios.

Instead, the stock has served as an efficient trading vehicle, providing quick pops to those able to buy and sell positions rapidly.

As for the prospects of the company longer-term, storm clouds of toxic debt coupled with uncertainty in governmental policy-making have portfolio managers staying away.

"These stocks are dead money for a while," Michael Cohn, chief investment strategist at Atlantis Asset Management in New York, says of Citi and other big money-center banks. "There's a lot of other places to play around. The equity is a mess. It's a big, fat mess."

Citi's (NYSE: C) rally began Tuesday after an internal memo from CEO Vikram Pandit was leaked saying the company was having a good year so far from an operating standpoint.

But in some respects that should come as little surprise--with short-term interest rates continuing lower as central banks have dramatically eased monetary policy, banks with efficient business models actually should be doing well.

"They've laid off a lot of people, they're not allowed to pay anybody anything anymore, they still have a tremendous amount of business, they've reined in their questionable lending practices," Cohn says of Citi. "I don't see how they cannot make money."

Like many of its peers in the industry, Citi has been weighed down by its toxic debt even as the climate for operations has improved somewhat since the credit crisis began. What remains a question mark is how such institutions will fare once their toxic asset writedowns completely unwind.

Some say that if the government changed the accounting regulations away from the current mark-to-market model, it would be a help.

"These guys are in bad shape, but under a different set of rules they're not in such bad shape," Cohn says. "Until you know what the rules are it's very hard to tell what's going on. That's the problem, that's why the market is where it is."

Indeed, Tuesday's rally came undone Wednesday as the indexes searched for direction in the wake of continued uncertainty in the markets and the economy.

Citi came well off its highs for the day Wednesday after a 27 percent surge Tuesday that many attributed to short-covering.

With a haze remaining over what toxic mortgage-based and consumer assets will be worth, and the spread between bid and ask prices still huge, Citi and others in its shoes remains a cipher until the government's actions are clarified.

"The real underlying issue is they have a whole bunch of this toxic debt of various forms with various acronyms that really isn't worth anywhere near what they were carrying it for on-balance sheet or off-balance sheet," says David Twibell, president of wealth management for Denver-based Colorado Capital Bank. "If you were lucky enough to get in a trade over the last couple of days you made a killing, but for most investors that's awfully tough to do."

While questions remained over the bank's future, some suggested that if Citi can at least stabilize that will be a major help to the entire sector and in turn boost the broader stock market.

In addition to the Pandit memo, traders took assuring comments from Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner, as signs that Citi could survive.

"It is systemically important, and if Citigroup can remain solvent and can operate at a steady level and is just in the business of doing banking, that is more importantly a good thing for the rest of the market," says Chris Armbruster, research analyst at Al Frank Asset Management in Laguna Beach, Calif.

"One of the reasons you had such a broad rally was people realize that in the near term some of these banks were oversold but in the long term it's stabilization of the banks that's going to be important for the market."

Yet Citi has an uphill slog toward stabilization.

While Bernanke said the Fed and the government would be there to help derive a price for the troubled assets, much of Wall Street is still clamoring for an end to mark-to-market accounting rules, which many blame for troubles on banks' balance sheets. Pricing the assets will remain difficult as long as bidders on the open market are pricing the assets at 25 percent to par while banks are asking 65 percent, Cohn says.

"Instead of throwing billions down the rat hole, why can't they do the simple things that might work? It doesn't cost them a dime to change those rules," Cohn says. "The fact that it's taken them this long has just been devastating to confidence. There's a whole slew of people who would have been equity investors. They're not coming back for years."

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Cohn is among those who cite Washington policy-makers for many of Wall Street's ills.

"They seem to be more interested in pushing through their agenda cloaked in a bailout program," he says. "It's dismaying to people."

In the meantime, Citi stock could remain volatile.

Armbruster says his firm bailed on Citi this week and wouldn't be a buyer until more clarity in its true position can be achieved.

"When a company goes to the government and needs as much support as Citi got, it seems that the end of their troubles is nowhere in sight," he says. "We think Citi is going to be a sink for money for quite a while...We're not interested in buying Citi, but a stable Citi helps the overall banking sector."

For more stories from CNBC, go to cnbc.com.

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