(Bloomberg News) Citigroup Inc., the third-biggest U.S. lender, said it may incur a "significant" third-quarter charge after Morgan Stanley submitted an unexpectedly low valuation for the banks' jointly owned brokerage.
Morgan Stanley, negotiating to buy an additional stake in the brokerage from Citigroup, put the fair-market value of Morgan Stanley Smith Barney at about 40 percent of what Citigroup said the brokerage is worth, according to a regulatory filing. Citigroup valued its 49 percent stake in the venture, with more than 17,000 advisers and $1.74 trillion in client assets, at about $11 billion, its filing yesterday shows.
The differences in estimates by the two firms, which are negotiating terms for Citigroup's sale to Morgan Stanley of a 14 percent stake in the venture, created the need for a third-party appraiser, according to the filing. Citigroup may take a $3.3 billion writedown on the sale in the third quarter, Ed Najarian, an analyst at International Strategy & Investment Group Inc., said in a note. That would exceed the $2.88 billion average profit estimate of 13 analysts in a Bloomberg survey.
"It certainly would be disappointing if the writedown turns out to be that large," Gerard Cassidy, a Royal Bank of Canada analyst based in Portland, Maine, said in a phone interview. "It's like labor arbitration. Both sides know if they go really wide with the arbitrator, that's going to influence the middle of the road."
Citigroup still believes its estimate is "reasonable and supportable," the company said in the filing. The deal between the two New York-based banks is set to be completed by Sept. 7.
"Each firm will now have to support its valuation to the third-party appraiser, which will create an interesting dynamic," Chief Financial Officer John Gerspach told investors on a conference call today.
Najarian assumed that the third-party appraiser would value Morgan Stanley Smith Barney "close to the midpoint" of the two firms' estimates, according to the note. Citigroup would have to revalue its stake to $7.7 billion from $11 billion under this scenario, Najarian wrote.
Jeanmarie McFadden, a Morgan Stanley spokeswoman, and Citigroup's Shannon Bell declined to comment on Najarian's calculations.
Citigroup Chief Executive Officer Vikram Pandit, 55, tagged the unit for sale in 2009 after the bank took a $45 billion U.S. bailout. Morgan Stanley acquired a controlling stake that year and has a right to buy the entire brokerage.
The bank doesn't include the Smith Barney stake as capital under Basel III rules, so a writedown won't affect Citigroup's capital position under the new requirements, according to the filing. The Basel Committee on Banking Supervision is seeking to make the financial system safer by requiring banks to hold a bigger cushion against losses.
A writedown of about $3.2 billion would be a "semi-non- event" for Citigroup because the sale will help the firm's requirements under Basel rules, Charles Peabody, an analyst with Portales Partners LLC, wrote in a note to clients today. The bank is exiting a "business with poor returns," said Peabody, whose rating on Citigroup shares is the equivalent of sell.