"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.
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.
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