By Anastasia Donde
The government bailout powered financial stocks in 2009 and led to big gains for hedge funds confident enough to bet on a recovery. But with the U.S. Treasury selling its stakes in banks like Citigroup and the economy teetering, is the trade over?
No way, say those who argue that today’s suddenly cheaper stock prices make banks like the embattled Citi a bargain. Leading the charge is Bill Ackman, founder and chief executive of Pershing Square Capital Management, who recently plowed as much as 9% of his fund into Citi. Other hedge funds, including Balyasny Asset Management, SAC Capital Advisors and Lansdowne Partners are following suit.
Taking the other side are Perry Capital, Diamondback Capital and Third Point Management, all of which have dumped their Citi shares, while Eton Park Capital Management and Harbinger Capital Partners reduced their stakes.
Citi has proved a tricky play for hedge funds. Coming out of the crash of 2008, Citi was arguably in the worst shape of the big banks and a popular short. But in May 2009 hedge funds got caught in a short squeeze as Citi shares rebounded on the bailout, and many stayed away from the stock.
Citi shares got as high as $5 in August and December of last year but fell to less than $4 following the government’s announcement on March 29 that it would soon be turning its preferred into equity and selling its 27% stake in the bank. To Ackman, that made Citi a bargain.
Ackman stated his case for investing in Citi in June, when he wrote to investors: “We believe recent events surrounding the financial reform bill, alleged fraud at Goldman Sachs, the overhang of the U.S. government’s 27% stake in Citi and distress in Europe have created a compelling opportunity to purchase Citi shares at a discount.”
According to Ackman, it’s a “favorable moment in history” for a large financial institution that offers a variety of services. “The combination of extremely low-cost funds and deposits, relatively high spreads on new loans, more conservative lending standards and a less competitive lending environment creates an opportunity for large profits from the traditional banking business of collecting deposits and making loans,” he wrote.
A bonus is that Citi will be allowed a shield from taxes on earnings for the next few years. Ackman purchased the stock at $3.64 per share, which he argued was “at a meaningful discount to their fair value.”
Another big hedge fund holder of Citi, according to the most recent Securities and Exchange Commission filings, is Paulson & Co., which has 506.7 million shares and is one of the largest holders in Citi.
Even though founder John Paulson has started scaling back on U.S. holdings in general because of market volatility, he is retaining his stake in Citi, according to second-quarter SEC filings.
Paulson’s Recovery funds, which invest in financials specifically, were down 12.6% in the second quarter, according to the letter. They were up 2.37% for the year. Paulson declined to comment.
David Tepper of Appaloosa Management is another Citi bull, with 57.8 million shares as of June 30, according to an August 13 filing. After gaining 117.5% in 2009, Appaloosa’s Palomino Fund, the offshore version of Tepper’s flagship fund, is up 12.09% this year through July.
Ackman’s Citi argument rests on the fact that the bank is shedding legacy assets and then will have its core regional consumer banking, securities and banking, and transaction services to power earnings.
Richard Bove, an analyst at Rochdale Securities who has been following Citi for 30 years, is also bullish on the bank. “There is a good outlook for Citicorp, which sells credit cards internationally and is in a fast-growth market,” he says, noting that Citi is one of the largest suppliers of these services in the world and one of the biggest capital markets players with a strong capital backing.
The bad stuff is in Citi Holdings, whose assets the bank plans to sell. Bove thinks the market is ripe for such sales, given the demand for distressed debt and high-yield. He adds that hedge funds, as well as institutions, are expected to buy into Citi now, given its growth potential and the low stock price as the government unwinds its stake.
Of the funds that increased their shares in Citi in the second quarter, Balyasny upped its stake to 3.1 million from 1 million, according to SEC filings. SAC increased its Citi shares to 4.8 million in the second quarter from 148,000 in March, while Lansdowne is holding about the same amount as before, with 57 million shares.
But not everybody is keen on Citi’s potential. Perry, for example, sold its entire stake in Citi in the second quarter, even though Citi was one of the winners in that quarter, according to a July 19 investor letter. “Given the appreciation of the stock price and our renewed concerns about GDP growth and the ramifications of financial reform, we decided to liquidate this investment,” the letter says. Perry is up 9.09% for the year through July 31.
In May, Dan Loeb’s Third Point also sold its entire Citi stake, which had been the fund’s second largest U.S. equity position in the end of 2009, and Loeb expressed positive views on the stock as recently as January. In a June 15 letter to investors, Loeb said he changed his views after hearing President Obama’s speech on financial reform, two days after the Democrats lost Ted Kennedy’s Senate seat to Republican Scott Brown.
“I became concerned that he would take a politically popular populist (and therefore negative) stance on the banks, and so sold our significant positions in those two financials as well as most of our position in Barclays, " Loeb wrote. Third Point declined to comment further. Third Point Offshore gained 13.88% for the year through July 31.
Diamondback Capital dropped its entire 1.3 million stake in Citi in the second quarter, but some hedge funds simply reduced their stakes. Eton Park more than halved its investment by dropping the shares to 60.5 million in the second quarter from 138 million at the end of 2009. Harbinger reduced its shares to 35 million from 70 million between March and June.
The U.S. Treasury has been easing out of Citi since announcing its plans in March, but the stock has yet to rally significantly. It closed at $3.86 on August 18.
Pershing Square lost 2.1% in May and and 2.8% in June. Even without much help from Citi, Pershing Square gained 0.90% in July and is up 3.79% for the year. AR
