Activist ValueAct Can't Get Good Citigroup Without the Bad One

(Bloomberg) -- Citigroup Inc., soon after the financial crisis, split itself into two banks — a good one and a bad one. Citi said it was going to sell the latter, which included a subprime loan portfolio and other businesses that had gotten it into trouble. But it never did. Eventually CEO Michael Corbat did away with the charade and recombined them. But Citi’s split personality remains. Some investors may be signaling that has to change.

ValueAct Capital Management disclosed on Monday that it had taken a $1.2 billion stake in Citi, making it one of the activist hedge fund’s largest positions. ValueAct says it likes Citi because it owns some of the most important plumbing in the U.S. and global financial system. Citi has an unrivaled cross-border payment processing network that allows it to move money pretty much anyplace in the world. It was one of the reasons cited for essentially declaring the bank too big to fail during the financial crisis. ValueAct also thinks Citi has the cash to increase dividends and buybacks. The hedge fund isn’t the first to see Citi as low-risk capital return play.

In its letter to investors, ValueAct said that it thinks in the current environment “the winners and losers will be decided by strategic focus” and not “product breadth, appetite for risk and investment in trading talent.”

The problem is that none of that truly describes Citi. Yes, it has the utility-like transaction-processing business, but more and more of its profit growth has been coming from riskier businesses. The bank has pushed its credit-card business, which has bolstered lending profits but also loan losses. Citi’s trading business rose 3 percent in the first quarter from a year ago, but the amount of risk it was taking on a daily basis was up 8 percent. Its value-at-risk figure at the end of the quarter was also up nearly 20 percent from its average in the previous three months. Citi has a large staid corporate debt underwriting business, but it’s also increasingly a leader in collateralized loan obligations, which is among the hottest but also riskiest portions of the commercial debt business.

Citi’s strategy in the past few years has been to package its staid transaction processing business with some of Wall Street’s riskier businesses. And it’s worked, mainly. Citi’s profits and returns are up. Investor interest is not. Shares of the bank have trailed most of its rivals over the past year and a half, which is probably what is attracting ValueAct.

It’s possible ValueAct doesn’t quite get this, but as one of the more savvy and successful activist investors around, that’s not likely. It’s more likely that ValueAct, which says it supports Corbat and the bank’s current mix of businesses, is looking for a lot more change than it’s letting on. While slicing and dicing is what activist investors like ValueAct like to do, that’s not really possible with the big banks, or at the very least won’t be quick or easy. Regulators can block, or force, management changes, including board appointments, which limits just how much pressure activists can apply. And splitting up Citi may not even been possible. Those staid businesses bring clients into the bank’s more risky businesses, which make the whole bank more profitable. ValueAct may want the good Citi. But it may find, as Citi did a few years, that it will have to live with the bad one as well.

  1. Citigroup did wind down a large part of the so-called bad bank over eight years, including disposing of its direct subprime lending operation.

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