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Citi should slash investment banking payroll

It's time for Vikram Pandit to start making Citigroup shine a little more.

The chief executive officer of the U.S. mega-bank can be happy with some of the progress being made, including a continuation of overall positive operating leverage and a rock-solid balance sheet.

But for shareholders, mediocrity is still radiating through the third-quarter storm.

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The headline figure is pretty awful. Profit of $468-million (U.S.) equates to a return on equity of just 1 per cent. It would have been a loss of $118-million if not for a sizable tax benefit.

A couple of big items obscured the bank's underlying performance. Booking changes in the value of its own liabilities as a loss whacked $776-million from revenue. A hit to the value of its remaining stake in Morgan Stanley Smith Barney sizzled another $4.9-billion.

Strip those and the tax gain out and Citi earned a more respectable-looking $3.3-billion.

Even then, the return on equity amounts to only 7 per cent. The return on tangible equity would be 11.8 per cent, but relies on a large dose of optimism.

First, the figure ignores $40-billion of tangible common equity that's tied up with the bank's deferred tax assets. The implied tax rate on earnings of $3.3-billion is a low 26 per cent. And a third of that profit comes from releasing loan loss reserves.

Mr. Pandit's hands are partly tied. It'll take years for the bank to earn enough money to utilize the tax deferrals and release the equity set against them. The unwanted dross in Citi Holdings, though diminished, remains a drag. And only the Federal Reserve can authorize a U.S. bank to return capital to shareholders.

Absent a rapid increase in business, Citi has one other lever: cutting expenses. They have dropped slightly as revenue has increased. A Breakingviews analysis shows that slashing Citi's investment banking pay to 30 per cent of the unit's revenue would increase the group's ROE to about 8 per cent. That's hardly sparkling, but Citi's stock trades at a bleak 57 per cent of book value.

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Even parting just a few more clouds would make things brighter for suffering shareholders.

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