Citi Squeezed in Debt Market as JPMorgan, Wells Lure Deposits

By Bradley Keoun, Bryan Keogh and Elizabeth Hester

Oct. 20 (Bloomberg) -- Just when deposits became the big prize in banking, Citigroup Inc. missed the brass ring.

The bank's proposal two weeks ago to buy Wachovia Corp. would have created the biggest pool of deposits in the U.S. -- ``unassailable'' as a source of stable, cheap funding and ``well in excess of the next-largest competitor,'' Chief Financial Officer Gary Crittenden said at the time.

Instead, having lost a takeover battle with Wells Fargo & Co., New York-based Citigroup slipped to No. 4 in deposits and has to hustle for them alongside banking newcomers Goldman Sachs Group Inc. and Morgan Stanley. With debt markets in flux and terms of the government's bailout plan changing by the week, Citigroup needs more deposits to temper a surge in the cost of financing its $2.05 trillion balance sheet.

``Clearly they missed out,'' said Stephen P. Wood, a senior portfolio strategist in New York for Russell Investments, which has $180 billion in assets under management, including at least 5.8 million Citigroup shares. ``Short-term credit is dried up. Those institutions with long-term asset bases and lower costs of capital are in a more profitable situation.''

Total deposits at Citigroup fell 2.9 percent in the third quarter to $780.3 billion, while New York-based JPMorgan Chase & Co., Wells Fargo of San Francisco and Bank of America Corp. in Charlotte, North Carolina, reported gains. JPMorgan's deposits rose 34 percent to $969 billion, fueled by last month's takeover of Seattle-based thrift Washington Mutual Inc.

Bank of America, Wells

Bank of America said deposits increased 11 percent to $874 billion, including accounts gained with the July purchase of Countrywide Financial Corp. and inflows from retail customers three times greater than the industry average.

Wells Fargo's deposits climbed 4.3 percent during the quarter to $353.6 billion. With the $447.8 billion of deposits that Charlotte-based Wachovia reported as of June, Wells Fargo will leapfrog over Citigroup to $801.4 billion.

Citigroup spokeswoman Christina Pretto said that even with the third-quarter decline, overall deposits remain ``strong.'' What's more, ``we have seen strong deposit inflows from our main deposit-gathering business, corporate clients, including $55 billion at the end of September alone,'' she said.

After about $660 billion of writedowns and loan losses at banks worldwide, investors already wary of buying long-term bonds from financial institutions are increasingly unwilling to buy their commercial paper, or debt that matures in less than nine months.

Commercial Paper Rates

The quoted rate on three-month notes for Citigroup, the world's third-biggest issuer of commercial paper, was 4.32 percent rate on Oct. 17, up from 2.75 percent a month earlier, according to data compiled by Bloomberg. The rate is well above the Federal Reserve's 1.5 percent target rate for overnight bank loans -- so high that Citigroup and other companies have had to shift to shorter maturities for commercial paper, including overnight, where rates are lower. Before August 2007, when surging subprime-mortgage defaults began to roil credit markets, Citigroup could issue three-month commercial paper near the target rate.

Citigroup had about $29 billion of commercial paper outstanding as of Sept. 30, spokeswoman Pretto said. That's behind only General Electric Co. of Fairfield, Connecticut, with $88 billion, and JPMorgan, with $55 billion, according to their earnings statements.

FDIC Guarantee

Recent government actions have helped drive down average rates on short-term notes issued by financial institutions. On Oct. 7, the Fed announced it would provide a ``backstop'' for the $1.5 trillion commercial-paper market by agreeing to buy the debt from banks and other companies when investors are scarce. Last week the Federal Deposit Insurance Corp. said it would guarantee newly issued debt of the nation's banks, including commercial paper.

Average rates on three-month commercial paper issued by banks fell to 3.55 percent on Oct. 16 from a nine-month high of 3.99 percent on Oct. 6, according to Fed data. They are still well above the August average of 2.76 percent, before the bankruptcy of New York-based Lehman Brothers Holdings Inc.

``Credit markets will need much more time to digest and react to the new programs put in place,'' CreditSights Inc. analyst Brian Yelvington said in an Oct. 16 report.

4% Solution

That may help explain why Citigroup representatives fanned out across San Francisco's financial district on Oct. 17, handing out fliers promoting six-month certificates of deposit with 4 percent interest rates. Similar fliers are going out this month in every major market where Citigroup operates, as part of a drive led by Citibank North America CEO Peter Knitzer to recruit new savers, spokeswoman Janis Tarter said.

The average rate Citigroup was paying on deposits in the third quarter was 2.9 percent, according to a presentation on its Web site.

Vikram Pandit, 51, Citigroup's chief executive officer is struggling to end a year-long string of net losses totaling $20 billion amid the worst financial crisis since the Great Depression. The bank reported a $2.82 billion third-quarter loss last week after writing down securities linked to mortgages and credit-card loans.

``Citigroup's failure to secure a merger agreement with Wachovia, which would have improved Citi's funding profile and earnings over time, magnifies the macroeconomic headwinds the company faces,'' Deutsche Bank AG analyst Mike Mayo said in an Oct. 10 report.

Foreign Deposits

Citigroup's deposits represent 38 percent of total assets compared with 57 percent at Wells Fargo, 48 percent at Bank of America, and 42 percent at JPMorgan.

Crittenden, Citigroup's CFO, said in an Oct. 16 interview that the bank's deposit base was ``a very large number by any measure'' and that the company has a higher percentage of long- term debt funding its assets -- about 20 percent. At Wells Fargo, the figure is 17 percent, compared with 14 percent at Bank of America and 12 percent at JPMorgan.

Citigroup's deposits outside the U.S., about 64 percent of the total, shrank in the third quarter, partly because they were in foreign denominations that slid against the dollar, Crittenden said. About $13.5 billion of the $23.2 billion decline in total deposits stemmed from Citigroup's pending sale of its consumer- banking unit in Germany, he said. The bank sold the operations partly to capture an after-tax $4 billion gain that will bolster its capital base.

Having a bigger share of international deposits puts Citigroup in a better spot because ``our growth opportunities are outside the U.S.,'' while competitors battle on the domestic front, Crittenden said.

`Unique Opportunity'

``We had an opportunity to buy Wachovia that was a unique opportunity that fit a certain set of criteria that we had,'' he said. ``That opportunity was taken away from us, so our strategy goes back to the dominance of our network outside the U.S.''

CreditSights analyst David Hendler said Citigroup's foreign deposits may not be as dependable as those in the U.S.

``They make the case that their international deposits are very stable,'' Hendler said. ``But these are unusual times. They may be stable right now, but you don't know how long that's going to hold up given the volatility and the difficulties in the marketplace.''

Deposits can be used by banks for both short-term and long- term funding. They consist of savings and checking accounts that can be cashed out on demand and certificates of deposit with longer maturity dates.

Goldman, Morgan

``That's the name of the game these days, trying to get deposits,'' said Charles Carlson, chief executive officer of Horizon Investment Services LLC in Hammond, Indiana.

New York-based Goldman Sachs and Morgan Stanley converted themselves from securities firms into bank holding companies last month so they could gather deposits.

One of Goldman's main sources of funding -- repurchase or ``repo'' agreements, in which money is lent against bonds or other collateral -- has become more difficult to obtain because repo lenders are worried about trading markets for the collateral, according to an Oct. 7 report by Merrill Lynch & Co. analyst Guy Moszkowski.

``Goldman Sachs intends to grow its deposit base both organically and through acquisitions,'' said spokesman Michael DuVally.

Goldman is offering three-month certificates of deposit with a 2.45 percent rate, according to Chicago-based InCapital LLC, which underwrites certificates of deposit for retail customers. By contrast, the firm's senior unsecured notes due in three months yield 7.6 percent, according to Trace, the Financial Industry Regulatory Authority's bond-pricing service.

Battle for Deposits

Such competition for deposits may attract fickle customers who aren't wedded to a local bank branch and who move their money whenever someone else offers a better rate, said Robert Albertson, head of investment strategy at Sandler O'Neill & Partners LP in New York.

``What some people consider deposits, you have to ask how much of that came in because they kept raising rates,'' said Albertson, a former head of banking analysis at Goldman Sachs.

All banks may benefit from a recent surge in deposits, as savers and investors move money out of stocks, bonds and other investments into bank accounts. Total U.S. commercial bank deposits have swelled by 10 percent since September 2007 to $7.27 trillion, according to the Fed. Certificates of deposits and other ``timed deposits'' of less than $100,000 held at commercial banks jumped $85.6 billion in September, the biggest increase in at least 11 years, and reached a record $957.8 billion on Oct. 6, Fed data show.

New Branches

``I've never seen this much liquidity move into one product,'' Tom Ricketts, InCapital's CEO, said in an Oct. 9 interview. ``In times of crisis, people don't care what the yield is, they care that it's safe.''

The Emergency Economic Stabilization Act signed into law Oct. 4 by President George Bush raised the FDIC's guarantee of bank accounts to $250,000 from $100,000.

Banks get deposits by opening new branches to lure savers and peddling certificates of deposit to individuals and businesses. It isn't easy: A new branch costs $1 million to $4 million and can take two to three years to collect enough deposits to become profitable, according to data compiled by JPMorgan.

Another option is to buy banks with deposits. Outside of the four biggest U.S. banks, there are at least four others with more than $100 billion of deposits, according to regulatory filings. They are Minneapolis-based U.S. Bancorp, with $136 billion; Atlanta-based SunTrust Banks Inc., $120 billion; Bank of New York, $120 billion; and Cleveland-based National City Corp., $101 billion.

Citigroup's Options

On an Oct. 17 conference call, Crittenden said Citigroup may take ``advantage of opportunities'' if the right ones come along.

The Wachovia bid ``demonstrated Citigroup's willingness to do deals,'' said David Kaytes, managing director at consulting firm Novantas LLC who works with financial institutions in New York.

Citigroup could buy dozens of the 100 or so smaller banks that Institutional Risk Analytics managing director Christopher Whalen expects to fail in the next year. Such a strategy would prove costly because the bank would have to spend money to integrate computer systems and other operations, Kaytes said.

It may also get some bites on those fliers in San Francisco.

``Consumers are going to be moving lots of money around,'' Kaytes said.

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Bryan Keogh in New York at bkeogh4@bloomberg.net; Elizabeth Hester in New York at ehester@bloomberg.net.