Pressured Citigroup Spins Off Brokerage

Smith Barney Deal Is Step One as Bank Forced to Raise Cash

Federal regulators have taken an unusually active role in the affairs of Citigroup, telling the New York financial giant that it must raise capital from private sources and take whatever steps are necessary to restore investor confidence in its financial viability, according to people familiar with the situation.

Citigroup's deal to spin off its Smith Barney retail brokerage, announced yesterday, is the first step in a broader plan to sell valuable business units to raise the money that the company needs to endure, those sources said.

The goal is a company that resembles the Citicorp of the mid-1990s, a smaller and more traditional bank that is focused on serving major corporations worldwide, and retail customers in a handful of countries including the United States, Mexico and South Korea, said the sources, speaking on condition of anonymity because they were not authorized to speak publicly.

The company is under pressure from regulators in part because it has accepted more than $45 billion in federal support and in part because its health is important to the broader financial system. But the company is making its own strategic decisions, the sources said. Regulators have set a destination, but they have allowed Citigroup's management to chart the course.

Citigroup will combine Smith Barney with the wealth management division of long-time rival Morgan Stanley. Citigroup will own 49 percent of the joint venture and get a cash payment of $2.7 billion from Morgan Stanley, which can buy the rest of the joint venture over a five-year period.

The deal will create a brokerage that rivals the recent combination of Merrill Lynch and Bank of America. Morgan Stanley Smith Barney will employ more than 20,000 people in the business of selling stocks and other financial products to investors across the world.

Citigroup originally planned to announce the Smith Barney deal when it reports earnings next week, as part of a broader unveiling of its strategic plan.

Analysts project the massive financial company may have lost $3.5 billion during the fourth quarter. Investors have lost confidence, leaving the company's stock at its lowest levels in a decade and critically impairing its ability to raise money from traditional sources. The company has been forced to focus on selling some of its more valuable pieces.

Citigroup's operations are overseen by two regulatory agencies, the Office of the Comptroller of the Currency and the Federal Reserve.

The company already has accepted federal help twice, a first infusion in October of $25 billion and a second infusion one month later of $20 billion, plus a guarantee capping the losses on more than $306 billion in outstanding loans.

In the aftermath, both agencies, which maintain permanent staffs at large financial institutions, have added people at Citigroup to keep closer watch on the company's short- and long-term decision-making, according to people familiar with the matter. The unusual scrutiny reflects the level of concern among regulators about the depth and complexity of the company's problems.

Both agencies have chosen to act quietly, rather than subjecting Citigroup to a public enforcement order detailing the improvements the company is required to make. That has raised the eyebrows of some observers, particularly because taxpayers now hold a roughly 7.5 percent stake in Citigroup.

"Whatever regulators are doing is basically known only through press reports. What is so wrong with a formal enforcement order? We do it for the First Bank of Two Bits," said Karen Shaw Petrou, managing partner of Federal Financial Analytics.

Spokesmen for both agencies cited policies against commenting on specific institutions.

Citigroup is the product of a 1998 merger between Citicorp, a giant retail and commercial bank then led by John Reed, and Travelers, an insurance and financial conglomerate patched together by Sandy Weill. The historic deal created the first in a generation of financial supermarkets, which aspired to offer a comprehensive range of products to the full spectrum of customers, from poor families to multinational conglomerates -- and for that matter, nations.

Citigroup's downsizing plans will leave few remnants of Travelers.

Richard Bove, a banking analyst with Ladenburg Thalmann, called the company's plans "an end to the dream that John Reed and Sandy Weill had."