Citigroup (C) is closing another one of its proprietary trading groups, according to Bloomberg. The decision comes in the wake of the increasing scrutiny measures under the Volker Rule that are aimed at reducing the exposure of lenders such as Citigroup to risky trading activities. Other banks such as Goldman Sachs (GS) and Morgan Stanley (MS) are already in the process of divesting themselves of their own proprietary trading businesses.
Citi’s $400 million proprietary hedge fund business used the company’s own capital to bet positions based on mathematical models that predict stock price changes. The bank is reported to have relocated its talent to other divisions such as its capital advisory business, and fund manager Shakil Ahmed will now be heading the electronic market making division.
Under the new structure, banks would have to raise client capital to run risky trading activity — a proposition that could lead to decreasing margins, as well as less independence for fund managers.
Our price estimate is $60, which is almost 60% ahead of the current market price.
Sales and Trading Volumes Will Not be Affected Drastically
We estimate that Citigroup derives 35% of our $56 price estimate from its sales and trading division. The division managed $255 billion of debt and fixed income securities and $59 billion of equity and equity based derivative instruments in 2010.
The closure of the $400 million fund will not impact the overall capital invested in the sales and trading business. However, the move may lead to a decline in the margins of the business, as prop trading yields higher returns. Our estimate is that the sales and trading division will manage $66 billion in equity related assets by the end of 2011, and we expect this number to grow to $117 billion in the coming years. Our forecasts for the operating margins of the division are around 57%-58%.
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