Ah, the magic of accounting. One minute it’s there and then it’s gone. Or, more likely in this environment, it’s gone and then maybe, if you’re lucky, it’s suddenly there. Confusing? Yep.
See for instance, Citigroup’s deal with Morgan Stanley.
Jan. 12 (Bloomberg) — Citigroup Inc. may book a gain of as much as $10 billion by selling control of its brokerage to Morgan Stanley, helping to replenish capital depleted by the biggest losses in the bank’s history, a person familiar with the talks said…
The pretax gain would come from writing up the value of Citigroup’s Smith Barney unit to a new price set by the deal, said the person, who declined to be identified because the talks are confidential. The gain of $5 billion to $6 billion after taxes would flow into Citigroup’s capital, a loan-loss cushion so eroded that the New York-based bank had to get $45 billion of rescue funds last year from the U.S. government.
Cue head-scratching by pundits, including, for instance, Felix Salmon at Portfolio.com, who attempted to do the maths based on a broker basis. The Financial Times, meanwhile, is talking about a $6bn gain, citing people familiar with the deal.
In any case, John Carney at Clusterstock offers this explanation:
… putting its assets into a joint venture half owned by a competitor will allow Citi to suddenly mark-up the value of those assets. The $3 billion paid by Morgan Stanley represents the “make whole” price-the difference between Morgan’s contribution and Citi’s-and could give the whole thing a value of as $20 billion. Citi will own just under half of the JV, which gives it around $10 billion.
…That $10 billion will replenish its capital, off-setting nearly all of the net losses Citi suffered in the first nine months of 2008.
We’re not sure it’s that easy. Paying $2 or $3bn for a 51 per cent stake to result in a $20bn valuation seems a little steep. If it is doable, however, it would be, as noted by Clusterstock, a much-needed boost for Citi, which sank something like 17 per cent in trading yesterday. In fact, it’s down 80 per cent in the past 12 months and that’s despite a government bailout and other support measures. The bank, the market knows, still needs capital.
And so, we find Perception is Reality running this little tidbit, citing an FT story from back in July.
In the story, Citi is quoted as having $10.8bn worth of deferred tax credits in its Tier 1 capital. That, incidentally, went up to something like $28.5bn by the end of September, according to a much-quoted Bloomberg opinion piece that described Citi’s capital as “all casing, no meat.”
Deferred tax credits can only count in Tier 1 capital if there’s income to tax. Given that Citi has made losses so far this year and looks set to post another for Q4, we would think it’s becoming increasingly difficult to rationalise the tax credits to itself, regulators auditors or the market.
But, there’s a way out of the predicament.
The FT story cites one Robert Willens, a tax and accounting consultant who teaches at Columbia Business School:
One way, Willens said, would be for Citigroup to convince its regulators and auditors that it has a plan to sell a greatly appreciated asset at a large profit sometime in the next four quarters.
Cue the sale of Smith Barney. This would not only help Citi book that $10bn gain but also help it preserve billions of tax credits.
In otherwords, more casing, still no meat. Yum.
Related links:
Citi of over-leveraging – FT Alphaville
Citigroup’s ‘capital’ was all casing, no meat – Bloomberg