Citi's Move to Shed Broker Fails to Stem Cash Worries

Citigroup inched closer to selling a stake in its Smith Barney retail brokerage business to Morgan Stanley, but its shares tumbled as investors fretted over the bank's expected fourth-quarter loss and future capital needs.

Mary Altaffer / AP

Morgan Stanley would essentially combine Citigroup's Smith Barney unit with its own retail business to create the world's largest brokerage, according to sources.

Citigroup , the third-largest U.S. bank by assets, would retain a 49 percent stake in the joint venture, and receive a payment in excess of $2.5 billion as well as a bolstered capital position. Morgan Stanley would expect over time to buy the entire business.

The two banks have agreed on major terms, and are expected to announce a deal by mid-week, a person familiar with the matter said.

A joint venture could give Citigroup an additional $5 billion to $6 billion of tangible common equity, a boon since it is under U.S. government pressure to shore up its balance sheet.

Separately, the Wall Street Journal reported Monday that Citigroup could post a fourth-quarter operating loss in excess of $10 billion, underscoring the depth of its difficulties.

VIDEO: What's next for Citigroup?

"They're selling one of the crown jewels, which you only do if you really have to," said Bill Fitzpatrick, an analyst at Optique Capital Management in Milwaukee, which does not own Citigroup shares.

Citigroup shares hit their lowest level since Nov. 25, two days after receiving a big rescue package from the U.S. government.

The Morgan Stanley deal would be fraught with risks. The combined businesses may be able to cut costs in areas like trade processing and real estate, but extracting cost savings could be difficult in a weak market, analysts said.

"It will take three years to successfully merge these operations together," Bernstein Research analyst Brad Hintz told clients on Monday. "In the meantime, the retail business will face a severe downturn." Brokerage deals often trigger an exodus of financial advisers to competitors -- and the resulting loss in valued client assets.

The risk of an exodus may be mitigated by the fact that there are few better alternatives for brokers looking for jobs.

"My sense is, there's turmoil right now wherever you go," said Tony Riotto, a recruiter for brokers and private bankers. "There are a lot of people in this business who are just happy to have jobs."

The deal is structured to give Citigroup cash and capital upfront, with the opportunity to benefit if the business improves in the future.

Morgan Stanley would expect to buy more of the joint venture later, but at a price to be determined in the future rather than now, according to a person familiar with the deal. And Citigroup would be entitled to revenue from the business for at least another three years, the source said.

Citigroup has lost more than $20 billion in the four quarters ended Sept. 30. Its market value has shrunk to around $32 billion, less than rivals with just a fraction of its assets.

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