Citigroup Unravels

"For those people who have a concern about nationalization, this announcement should put those concerns to rest."
 -- Citigroup CEO Vikram Pandit, this morning

Really? Sure, Citigroup's (NYSE: C  ) odds of being completely taken over may have diminished for the time being, but it's a stretch to claim that nationalization has been avoided on a morning when Uncle Sam now holds up to a 36% ownership stake.

As has been the rumor all week, taxpayers will convert a large chunk of the $45 billion of preferred stock into common shares to help bolster the bank's tangible common equity ratio -- the capital first in line to absorb future losses. $25 billion of taxpayer preferred will be converted into common shares for a 36% ownership stake -- similar (but smaller) to the partial nationalizations of AIG (NYSE: AIG  ) , Fannie Mae (NYSE: FNM  ) , and Freddie Mac (NYSE: FRE  ) .

Ready for some demoralizing numbers?

  • As I write, Citigroup has a market cap of $9.3 billion.
  • A 36% ownership stake, therefore, is worth $3.3 billion.
  • I'm no Einstein, but $3.3 billion seems like quite a bit less than $25 billion.

In other words, taxpayers are getting a really, really awful deal that effectively locks in huge losses on the money already injected, save for some meteoric rebound (like another finance bubble) in the coming years.

Will it work?
As Pandit mentioned this morning, "This securities exchange has one goal -- to increase our tangible common equity."

Of course it does. Citigroup's tangible common equity (TCE) ratio has been well under 2% for some time now, with as little as $29 billion supporting $1.9 trillion of tangible assets, many of which are mortgage-backed loans in one way or another. That amount of leverage -- effectively over 60-to-1 -- turns the bank's balance sheet into a house of cards at precisely the same time it's trying to reduce risk.

With the new capital structure, TCE will strengthen from $29 billion to as much as $81 billion (other preferred shareholders are converting to common, not just the government). Hence, its TCE ratio will climb from about 1.5% to about 4.4%. That's certainly a step in the right direction -- and higher than Bank of America (NYSE: BAC  ) , JPMorgan Chase (NYSE: JPM  ) , or Wells Fargo (NYSE: WFC  ) -- but no one in their right mind would claim that it's enough for Citi to adequately cover the impending losses it'll face over the next few years.

Why? A few reasons. First, as Foolish colleague Alex Dumortier pointed out late last year, Citigroup holds $157.6 billion of "level 3" assets, assets that typically have no market, no buyers, no valuation transparency, and often shady logic supporting their existence. No one knows for sure (and that's the problem), but since banks typically use their own models and assumptions to value these assets, odds are they're worth substantially less than their carrying values presume.  

Second, a 4.4% TCE ratio wouldn't even be adequate in normal times, let alone the black hole of credit mayhem that banks are staring at today.

Citigroup has massive exposure to home loans, credit-card loans, and commercial-backed loans, all three of which are staring at a dark, dark future. Housing prices, for example, may fall as much as 22% in 2009, according to projections used by the U.S. Treasury. Combined with the worsening outlook for credit card and commercial real estate, that could spell over $100 billion in Citigroup losses over the next two years.

What now?
For Citigroup, this marks, what, the third iteration of government support? The reason Uncle Sam has to come back time and time again is because the problems keep getting exponentially worse, and the corresponding "bailouts" are too little, too late. I don't see how this latest move is any different.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase is a former Motley Fool Income Investor recommendation. The Motley Fool is investors writing for investors.


Read/Post Comments (11) | Recommend This Article (40)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 27, 2009, at 2:53 PM, FinancialFellow wrote:

    To think I thought I got a bargin on Citigroup when I bought it at $3....

    In case you haven't seen it yet here's a very good video that explains why companies like Citigroup got to this point. It's very, very good and entertaining: http://financialfellow.com/2009/02/25/a-simple-explanation-o...

  • Report this Comment On February 27, 2009, at 3:04 PM, rolls20 wrote:

    I only have one question...now that Uncle Sam holds common share's of the company, does that mean that the stock will never be valued at zero?

  • Report this Comment On February 27, 2009, at 6:23 PM, javnnf wrote:

    $0.01 is not zero!

    MF continues to fool others by claiming that:

    the "Motley Fool Stock Advisor has outperformed the S&P 500 by 31 percentage points".

    I don't know if that is true or not. But why one would by the whole portfolio? any selected set might be performing -80% points. That is what the their HG and 5-* stocks have done. (CBI, WFMI, BPOP, WTI, STP, ..)

    This is the name of Capitalism! Wild and lawless cowboy ride. Some times it is Bernie Madoff, sometimes somebody else, like Enron. The whole Wall St is a ponzi scheme!!

  • Report this Comment On February 28, 2009, at 12:35 AM, jerryguru69 wrote:

    Kudos for finally explaining this TCE RATIO junk to me. Newswire stories about this were more confusing than enlightening. I also now understand more clearly the mathematical mechanics of those who complain about too much leverage. Is it too late to cash out with my original bet on KBE and go play Chutes and Ladders with the kids?

  • Report this Comment On February 28, 2009, at 1:16 AM, MonetaryBoard wrote:

    Great insight! I have some questions though regarding the math relating to the "demoralizing numbers" mentioned above.

    Isn't the 36% ownership that the government will have in Citi POST conversion? If so, the number of shares outstanding will increase from 5.5billion shares now to about 21 billion shares, with the government owning close to 8 billion shares. At friday's closing price of $1.50, this equates to a value of $12 billion - still a significant paper loss of $13bn for the government (and the taxpayers), but not as bad as the $21.7bn loss inferred from the numbers above...

  • Report this Comment On February 28, 2009, at 1:27 AM, scambo99 wrote:

    when the fools say they have outperformed the S&P by 4 percent or so they put a tricky slant on things. They have 7 funds which are all in the red but they do their math like this. They are down something like 4% so they subtract the minus 39% the S&P is down so they can say they are up 35% over the S&P. Only they can do math like that but the real news is they are down in ALL of their funds.

  • Report this Comment On February 28, 2009, at 2:20 AM, jpjjp wrote:

    Banks are stupid

    Fools are smart

    This port was a waist of my time

  • Report this Comment On February 28, 2009, at 2:21 AM, nicko168 wrote:

    Based on the past weeks, the stock market has been a place for the guys to rally & show their frustration towards "Robin Hood".So, no matter what stocks u thinking of..forget it....

    Ultimately, do you know who's the real fools? Ha..Ha..

    Real fools are the one who plunge their own economy to zero together with the $787 billion stimulus plan. Why?

    They'll be slapping their own face caused it opens up the opportunities & competition to the "third" world to buy all the "CHEAP" US Companies..Arabi, China, Kuwait & maybe Iran, Iraq etc...

    Based on the recent news, US companies are selling off thier valuable assets (technologies, bank etc) in order to pull through the crisis & who are they selling to? Make a guess....AIG went to China, Singapore etc selling off their stakes..Another is selling their US technologies or commodities caused they're ridden by billions of dollars debt....At the end of the crisis, what will the US companies who once holds the supremacy in technologies, banking etc become? "Zero" is my answer...

    Who the losers? The real losers are the next generation facing the real US....

    There's a old chinese teaching:

    "To break one chopstick is easy..

    To break a bunch of chopstick, is difficult"

    To the real fools, WATCH OUT!!! Ha..Ha...

  • Report this Comment On February 28, 2009, at 11:43 AM, jesse2159 wrote:

    Citi is too big to fail is nonsense. Countries fail. Citi will have to be nationalized eventually then broken up into bite size pieces that can be absorbed by other responsible banks. The "new and improved" trade to common shares delutes current share holders to absorbing massive losses, stretches out the pain, and causes the crisis to be prolonged indefinately. Of course, Citi is helping by not fully disclosing it's exposure to toxic assets. Maybe their trying to prevent a lynch party from forming at their front doors. Nationalization doesn't mean that the managers are going to be replaced by government employees, it means that they will have to do what they are paid to do to unraval the mess they made while being watched closely, something they may not have undestood is necessary for out of control egos.

  • Report this Comment On March 01, 2009, at 10:12 AM, ifyouaskme wrote:

    I have always kept up with current events and have always wanted to be able to invest outside of my pension plan but with kids, college, etc it remained just on my todo list rather than on my completed list.

    However, with the massive drop in the overall indicies and the actions taken by President Obama I think now is the time to jump in.

    Over the last couple of days I have visited many sites and found them all to be less than concerned about my financial well being as reflected by the total absence of real educational material. Then I found Motley Fool.

    I material provided for the education of newbies was clear. But more importantly their was sage advice about getting rid of high interest debt first, and how to invest with little money, but cautioning against borrowing to invest via margins. The site rang true to me, my test is always who does this person or company defend, protect, etc. In this case I clearly felt the answer to that question was ME.

    I voted for President Obama for the same reason. From his speeches, his books, and most importantly his actions it is clear to me that his primary goal is to protect the average Joe or Jane, aka ME.

    I notice a lot of emotional, and in my opinion angry/hateful, rhetoric about the stimulus package and the possible nationalization of Citi. I don't understand the comments for I have read the stimulus package and it is founded on common sense and the fundamental provision that we must invest in ourselves for no one else will.

    Investing in ourselves seems to be what this site and all the other investing sites is all about. So I find it confounding do see such emotional and obviously uninformed rhetoric. As I said the entire stimulus plan is available for download via several PDF files. The transparency of President Obama's approach in providing full details should be another source of confidence. Never in US history has a President been so forth coming, and perhaps only makes sense since never in history has so much national and Wall Street type activity been conducted in a clandestine, non-disclosing manner.

    As I said in the beginning I believe now is the time for me to educate myself on how to make wise investments in stocks and bonds. Because from everything I have read when the overwhelming majority of taxpayers find extra money in their paychecks beginning in April they will get the second boost to their discretionary spending power. The first being the dramatic drop in hyper-speculated oil and gasoline prices.

    Lastly, I would ask anyone here to answer the following questions.

    Who sponsored the legislation that legalized/resurrected credit default swaps (aka bucket shops outlawed in 1909 for its stake in the 1907 crash)? Is it true that it was inserted in the bill to fund the Federal Government during the last days of the Clinton Administration?

    Who or what group created the sub-prime loan?

    How did Hedge Funds come into being?

    Who sponsored the deregulation that opened the door to others previously prohibited from buying up oil?

    How long after key personnel left the WSJ in 2008 as a result of alleged breeches by Rupert Murdoch with respect to previously agreed upon editorial rules of conduct did the Stock Market nose dive?

    From everything I have read Lehman Brothers was find until a run was created through speculative doomsday reporting. From where did this speculative reporting emanate?

    It seems to me those angry at the government for trying to fix the problems really should be angry at the former administration for allowing our financial system to be infected with deregulation, and unethical/immoral financial instruments and business practices.

    So let's get behind investing in ourselves whereby we will reap returns on our investments and in the end make our nation that much stronger.

  • Report this Comment On March 01, 2009, at 10:48 PM, regulatethem wrote:

    what if Citi did bad debt write-offs; some each year and then was properly regulated? how is Citi different than any other? what if Citi valued their own debt, took the bailout money, then figured out how to value more debt and get more bailout money?

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