Shares of Citigroup Inc. and other large-cap banking companies fell sharply Thursday as the market weighed the likelihood of further Fed interest rate cuts and several downgrades from analysts, including two who called Citi's capital levels into question.
Citi's shares were among the steepest decliners among large-cap banking stocks, closing down 6.9% as a confluence of factors weighed on the $2.4 trillion-asset company.
One analyst said Wednesday that Citi may have to cut its dividend, because of weak capital, and the company announced more executives had left its capital markets unit.
"Citi's ills are endemic of the whole system, but they are magnified at Citi," even if the threat of a dividend cut might not be an issue investors fear will spread to other banking companies, said Peter McCorry, a senior trader with KBW Inc.'s Keefe, Bruyette & Woods Inc.
But other factors also drove down bank stocks Thursday, observers said. "Investors were more concerned about the macro environment than about Citi's capital," said Jeffrey Harte, an analyst with Sandler O'Neill & Partners LP.
Mr. McCorry said "everybody was set" for a 50-basis-point cut Wednesday by the Federal Reserve Board. The central bank trimmed its overnight funds rate by 25 basis points, to 4.5%, and sent a message that further cuts would depend on economic data rather than falling stock and bond markets, he said.
"The thought that the Fed is not going to be here" to bail out the market in December "has changed some opinions," Mr. McCorry said.
The American Banker index of 225 banks fell 5.5%, while the Nasdaq bank index closed down 4.7%. The Standard & Poor's 500 fell 2.6%, as did and the Dow Jones industrial average.
JPMorgan Chase & Co., which along with Citi is one of two banking components in the Dow, fell 5.7%. Bank of America Corp. closed down 5.3%.
Meredith Whitney, an analyst with Canadian Imperial Bank of Commerce's CIBC World Markets Inc., wrote in a note issued Wednesday that Citi might have to raise as much as $30 billion to replenish its depleted tangible capital ratio of 2.8%, and might have cut its dividend. Citi's shares closed at $38.51 Thursday, their lowest since April 2003.
"Based upon our thesis that over the near term Citi will be forced to sell assets, raise capital, or cut its dividend to shore up its capital ratios, we believe the stock will be under significant pressure and could trade into the low $30s," Ms. Whitney wrote. She downgraded Citi's shares to "sector underperformer," from "sector performer."
Ms. Whitney also downgraded Bank of America , to "sector performer," from "sector outperformer." She wrote that she expects its capital markets gains and its mortgage, credit card, and deposit fee income to decline.
Betsy L. Graseck, a Morgan Stanley analyst, downgraded Citi to "underweight," from "overweight," and wrote that the downgrade reflects her concerns about the company's exposure to collateralized debt obligations, subprime loans, structured investment vehicles, "and thin capital levels." Citi declined to comment Thursday.
Ms. Graseck also downgraded B of A and Wells Fargo & Co., to "equal-weight," from "overweight," citing their consumer lending businesses. Morgan Stanley downgraded the entire large-cap bank sector to "cautious" from "attractive," because "there will be contagion from subprime housing to prime housing to auto to card loans." B of A did not return a call seeking comment. JPMorgan Chase and Wells declined to comment.
Citi confirmed that Michael Raynes, head of structured credit, and Nestor Dominguez, co-head of collateralized debt obligations, left Wednesday. Their departures came after a shake-up of Citi's investment banking business on Oct. 11, two days before the company said its third-quarter earnings fell 57% from a year earlier and days after its first profit warning in six years.
A hedge fund investor, who asked not to be named, agreed with Ms. Whitney's assessment of Citi.
"It was the right call," he said of the downgrade. "They need more capital" and a dividend cut is one way to get there, he said. Citi's "tangible capital is probably the lowest in the industry," and it might use the discount window again. It used the window this summer, as did JPMorgan Chase and B of A.
On Wednesday the Fed lowered its discount rate by 25 basis points, to 5%.
Investors have long been concerned about Citi's earnings, particularly if credit quality continues to deteriorate and the company has to take the structured investment vehicles it sponsors on to its balance sheet, analysts said. Sandler O'Neill's Mr. Harte said the prospects of a dividend cut seems to have aggravated those concerns, particularly among those who do not follow the banking sector closely.
Mr. McCorry put it this way: "When the doctor says, 'Your heart is bad, but, by the way, you have lung cancer,' which is the one that gets you?"
However, Mr. Harte and Richard X. Bove of Punk, Ziegel & Co. argued that a dividend cut might not be necessary, because Citi has sufficient capital. Mr. Harte noted that Citi's Tier 1 capital ratio was 7.4%, which he said is "not bad." Tier 1 is "more relevant" than tangible capital, he said. Mr. Harte rates Citi "buy." Mr. Bove wrote in a research note issued Thursday that Citi generated $18 billion of cash flow, and $13.6 billion of profits, in the first nine months of the year.
"These numbers do not suggest that the company is strapped for cash or lacking in equity," he wrote. Citi could decide to sell some of its investment portfolio "if need be."
