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Investors losing faith in Citigroup

Analysts speculate that the nation's fourth-largest bank needs to make a deal sometime in the near future.

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By David Ellis, CNNMoney.com staff writer

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The government's latest plan to inject capital into banks could complicate any attempt by Citigroup to build up its retail branch network.
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Citigroup shares have lost more than half their value so far this year.

NEW YORK (CNNMoney.com) -- What now, Citigroup?

That is the biggest question that investors are itching to have answered by the nation's fourth largest bank by deposits.

It has certainly been an interesting time for the New York City-based firm to say the least. Earlier this month, it was one of the first nine banks chosen by the Treasury Department to receive a cash injection in exchange for stock. Citigroup will receive $25 billion.

However, since Treasury made that announcement more than two weeks ago, shares of Citigroup have tumbled 15% and are trading only slightly above their 52-week low, leading many on Wall Street to wonder what Citigroup's management can do to get back in the good graces of Wall Street.

The prevailing opinion among analysts is that Citigroup (C, Fortune 500) is looking to do what many other banks have done lately - acquire deposits.

In just the last few weeks, JPMorgan Chase (JPM, Fortune 500) agreed to buy failed savings and loan Washington Mutual last month. Wells Fargo (WFC, Fortune 500) unveiled plans to purchase all of Wachovia, trumping a government-brokered deal that Citigroup had in place just for Wachovia's banking operations. And just last Friday, PNC (PNC, Fortune 500) said it would acquire troubled regional bank National City.

"Citigroup right now looks like it is still standing in a game of musical chairs where everyone else has a seat," said Lawrence Creatura, portfolio manager at Clover Capital Management in Rochester, New York, which oversees about $2.5 billion and owned shares of Citi as recently as the end of June.

Citigroup had about $280 billion in deposits domestically, and $780 billion worldwide, as of the end of the third quarter. The domestic figure, however, is just about a third of the number that Bank of America (BAC, Fortune 500), JPMorgan Chase and Wells Fargo each control, taking into account their recent mergers, according to research firm SNL Financial. (Bank of America is buying investment bank Merrill Lynch.)

Analysts say for Citigroup to catch up with its peers at home, it would need to do several smaller acquisitions or purchase a large bank.

That's what Citigroup hoped to do with the planned purchase of Wachovia's (WB, Fortune 500) banking assets before Wells Fargo (WFC, Fortune 500) stepped in with its offer for the whole company.

Citigroup should be capable of pulling off a major deal now that the banking giant has $25 billion in capital to play with. It also doesn't hurt that there are dozens of struggling regional banks just waiting to be acquired by a stronger peer.

However, the likelihood of Citigroup doing a deal now appears to be more difficult than it was just a month ago. For starters, many of the most likely takeover candidates for Citi have already been scooped up.

One possible target for Citigroup could be the failed California-based lender IndyMac, notes Anton Schutz, president of Mendon Capital Advisors, a firm that invests in financial stocks, including Citigroup.

The government has yet to publicly announce a buyer for IndyMac.

"It is not the most awesome franchise," said Schutz. "But I think Citigroup wouldn't mind adding to its deposit franchise in California."

At the same time, the Treasury Department is also investing in regional banks, which may empower them to do deals of their own as opposed to running into the arms of a much larger rival like Citi.

That's not to mention the two other new major players that Citi has to contend with for deals -- Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500).

These two Wall Street investment banking icons recently converted to bank holding companies and are expected to try and bulk up their deposit base.

Morgan Stanley revealed on Wednesday that it raised $3 billion in the past four weeks through certificates of deposits (CDs) and added that it planned to ramp up its commercial banking operations.

And both Morgan and Goldman are receiving $10 billion from the government, cash they could potentially use to shop for banks.

No move, no problem?

Speculation about Citigroup's next move certainly picked up this week following reports that CEO Vikram Pandit rebuffed a merger proposal by Goldman Sachs chief Lloyd Blankfein in September.

Even as chatter continues about the possibility of a pairing with Goldman, or even a tie-up between Citigroup and Morgan Stanley, some experts have argued that Citigroup is under no pressure to act - at least not right at this moment.

"I don't think they have to do anything today," said Ralph Cole, a portfolio manager at Portland, Ore.-based Ferguson Wellman Capital Management, whose firm oversees $2.2 billion but does own shares of Citigroup. "There is plenty of work to be done at Citi internally."

That includes the company's massive restructuring plan announced last spring, which involves shedding more than $400 billion in assets.

Citigroup has certainly made a lot of progress on that front, but the company's latest quarterly numbers suggest that the company still has a ways to go.

Just two weeks ago, Citigroup reported a $2.8 billion loss due to mortgage-related writedowns and credit issues. It was Citigroup's fourth consecutive quarterly loss.

And with no signs of improvement in the housing market or the broader U.S. economy for that matter, big banks like Citigroup are facing the grim prospect of having to set aside even more money for bad loans.

Currently, analysts are forecasting the company to report a profit of just a penny per share in the fourth quarter.

Schutz said there may be other options for Citigroup and its $25 billion in newfound capital, including buying Freddie Mac and Fannie Mae debt, which could arguably help push down mortgage rates.

"You would have a heck of an internal rate of return and be doing a service to debt markets," said Schutz.

But as rivals rush to buy other deposit-based institutions as a funding source, experts say Citigroup may have no other choice but to follow the herd by acquiring another bank.

"You want to be positioned as one those [banks] that are strong," said Lisa Dong, bank research analyst at Westwood Holdings Group in Dallas, which oversees nearly $8 billion. To top of page

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