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What's Next for Citigroup?

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It didn't make many headlines, but Wednesday was probably the most depressing day in Citigroup's (NYSE: C  ) history: the day its massive conversion of preferred to common stock finally began. When all is said and done, taxpayers will own 34% of the hobbled banking giant. Lucky, lucky us.

And unlike other banks, I really mean own. While preferred stock kept the government at a relative arm's length, taxpayers now have direct ownership with voting rights. This gives Uncle Sam power to start making high-level changes, which will dictate Citigroup's future.

What's it all mean for the company? A few things -- some good, some bad, some potentially disastrous.

Money for nothing ...
First, the conversion considerably boosts Citi's tangible common equity (TCE). No new capital is being injected, but the shift strengthens the portion of equity that can absorb losses. Before the swap, Citi's TCE was basically negligible, which could have (and would have) put it on the edge of blowing up, had these actions not been taken.

Post-swap, Citigroup will gain $61 billion of TCE. Using data from last quarter's balance sheet, this should boost its TCE ratio to about 4.8%. While that's still below the historical banking average of 6%, it's also higher than rivals JPMorgan Chase (NYSE: JPM  ) , US Bancorp (NYSE: USB  ) , Wells Fargo (NYSE: WFC  ) , and Bank of America (NYSE: BAC  ) -- at least, before they went on a massive capital-raising campaign. By most measures, Citi is now a fairly well-capitalized bank.

And that's where all the good news ends
Not surprisingly, this comes at a price typically associated with Mafia activity. Current shareholders are being diluted by slightly more than 75%! When the dust settles, Citi will have more than 23 billion shares outstanding, compared to 5.5 billion before the conversion.

This simply means that what's left of the company is split so many ways, it'll be hard to create even trivial shareholder value. This is especially true when you remember that Citi sold most of its only stable unit, Smith Barney, to Morgan Stanley (NYSE: MS  ) , and that it's drastically delevered in recent months. There just simply isn't an earnings-power mechanism anymore.

That sad truth becomes clear when you look at its individual operating segments. During the boom years, Citi had three units it could count on for big profits: credit cards, consumer banking, and institutional clients. (The latter houses the investment banking unit largely responsible for pulling the company down the toilet.)

Now, the credit card unit faces oppressive new regulations and exploding delinquencies that will grow as unemployment rises. Consumer banking has been hemorrhaging money faster than any other segment. And much of the institutional client group is being forgotten about and shoved into Citi's "bad bank" entity, known as Citi Holdings.

CEO Vikram Pandit recently told BusinessWeek: "We want to be Citicorp, not Citigroup, going forward. Citicorp is our global bank for consumers and businesses." To do so, large chunks of the company are not being revived -- they're being killed. Investors hoping for an eventual profit recovery should keep this sobering fact in mind.

The beginning of the end
Tie everything together, and you get a serious trifecta: Citigroup was built on a defunct business model, owns many assets incapable of turning a profit, and now calls the government its largest shareholder. So while it will not fail thanks to government ownership, an eventual breakup of the company looks fairly likely.

Why? Citigroup found itself in these dire straits because its overwhelming size and complexity nearly destroyed the economy last fall. Its new top shareholder, the government, is an organization oblivious to profits, but extremely conscious about the stability of the financial system. It wants nothing more than to bury the words "systemic risk" six feet under. And just as it's doing with AIG (NYSE: AIG  ) , a slow, stable, and controlled dismemberment of Citigroup would achieve the government's goal of eliminating the "too big to fail" problem for good.

Sayonara, Citigroup? As we know it, yes. This is a failed company taped together by a government whose sole mission is to ensure that a disaster of this magnitude never happens again. After the past 18 months, there's essentially zero chance that Citigroup will be allowed to remain in its current form indefinitely.

And you know what? Good riddance.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (57)

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 June 12, 2009, at 3:15 PM, wolfhounds wrote:

    So, what value would you assign C stock? Probably the price of a stock certificate memorabilia.

  • Report this Comment On June 12, 2009, at 7:39 PM, superman0710 wrote:

    i guess it's time to sell those C stocks, huh?

  • Report this Comment On June 12, 2009, at 9:36 PM, rolly707 wrote:

    Hi Morgan,

    Congratulations for such a clear, straight and detailed article, about the projections of the conversion of preferred stocks into ordinary ones !!

    As a Citi stockholder, I was trying to find such information since long ago, however all the past articles I have read were blurry.

    For your words I imagine that Citi is converting into a “Zombie Bank” -good moment for jumping out from that boat-

  • Report this Comment On June 12, 2009, at 9:58 PM, ski88 wrote:

    So whats the best thing to do? Sell the C stocks and pull any cash out of the Citi bank?

  • Report this Comment On June 13, 2009, at 11:05 AM, Popa17 wrote:

    Gentleman, history has always 2 sides, negative, positive and another possible scenario which is the most probable. All comments are as i consider, the worst scenario. Suggest you all go to citi´s site and read statements on all swaps and capital raising activities, there you will find that pretty soon, citi plans a reverse split, what means the start of the stock dilution fight back. If we play citi short term, better sell all your positions and do something else than play in the stock market, but for those who play for at least 18 months or higher horizon, citi is still a good bet ... surelly a bet but with a good potential of reaching a $6 or higher stock value still this year and $10-$15 in a 18 months period. Do not forget about citi´s capacity to lend money and clean up all its operations. Regardless of all the 50% scenario i describe above, i do respect you wise fools´ comments and perspectives, but for those who do not like volatile plays and prefer the assurance of stable blue ships, better buying P&G, Coke, Pepsi, J&J, DEO and expect a 10% return in 18 months or so, very low risk !

  • Report this Comment On June 13, 2009, at 11:12 AM, cmfhousel wrote:


    "Citi plans a reverse split, what means the start of the stock dilution fight back."

    Careful there. Reverse stock splits do not reverse dilution. Total shares outstanding are reduced at the expense of reducing the number of shares investors own. It's no different than trading in four quarters for a dollar bill -- the value doesn't change.


  • Report this Comment On June 14, 2009, at 4:22 AM, 123fgfg456 wrote:

    I disagree the fact that you have included the following analysis in the paragraph. If citigroup is going to report a huge loss due to consumer banking, instutional client and credit cards, all other banks will face the same situation. Is sad that the objective seems lost in your post.

    "Now, the credit card unit faces oppressive new regulations and exploding delinquencies that will grow as unemployment rises. Consumer banking has been hemorrhaging money faster than any other segment. And much of the institutional client group is being forgotten about and shoved into Citi's "bad bank" entity, known as Citi Holdings."

  • Report this Comment On June 14, 2009, at 4:41 AM, 123fgfg456 wrote:

    To reinstate the point made by popal, the current price of Citigroup at USD 3.47 is a fair reflection of its present situation.

    Assuming a 1:5 reverse split, the pps of Citigroup will stand at USD 17.35. This will reduce the outstanding shares from 23 billion to 5.6 billion which is about what is floating in the market.

    Comparing the strength of Citigroup (USD 17.35) to BAC (USD 13.72 )and Wells Fargo (USD 24.48), Citi has some downside and upside after the split.

    I choose BAC and Well Fargo because all three banks are facing similar problems with sub prime mortgage, credit cards default, declining consumer banking and they are about the same in term of size.

    Depending on Q2 result, Citigroup will climb higher if she is able to post a profit that exceed expectation again. Otherwise, she be massively sold off again.

    Citigroup movement should be USD 15 - USD 25.00 on average for pps for the next few months. That mean 3 to 5 USD pps before split. Why 3 dollar or USD 15(after split)? Its mainly due to the conversion price for the preferred at USD 3.25.

  • Report this Comment On June 14, 2009, at 10:30 AM, 123fgfg456 wrote:

    Your blog only mention that you have no faith in BAC management.

    If you don't have faith in any management, you will not buy their stocks.

    "Citigroup is dead.. just like Bank of America in my opinion, read my comments on"

    What I think is that you are just trying to get more traffic for your blog. Nothing in depth was mentioned.

  • Report this Comment On June 15, 2009, at 2:23 AM, steveopti wrote:

    Once the economy get stable, Citi group may well be again on track!

  • Report this Comment On June 15, 2009, at 7:06 PM, plange01 wrote:

    citigroup has to bring in a new ceo someone with real banking experience who can compete with the other major banks or it will be the next major bankruptcy.there is no time left.....

  • Report this Comment On June 16, 2009, at 10:25 AM, mpendragon wrote:

    "Now, the credit card unit faces oppressive new regulations..."

    Citigroup and other credit card issuers have been baiting the public with competitive rates and then tripling or quadrupling those rates when the card holders build any sort of balance. These fairly modest regulations are in response to this clearly abusive practice.

  • Report this Comment On June 16, 2009, at 10:51 AM, plange01 wrote:

    next up for citi is a new ceo and a lot of its upper management and board or its off to bankruptcy is simply falling to far behind its better run rivals and is running out of time to catch up....

  • Report this Comment On June 17, 2009, at 4:35 PM, VerySharp wrote:

    S&P didn't cut the rating for Citi.

  • Report this Comment On June 18, 2009, at 12:21 PM, plange01 wrote:

    next up for citi is a new ceo and much of its board..or just bankruptcy...

  • Report this Comment On June 19, 2009, at 8:50 PM, xetn wrote:

    The taxpayers do not have voting rights. The as proxy, government has voting rights. Judging by how well they manage to run the economy, C will die a long slow death.

  • Report this Comment On June 20, 2009, at 12:03 AM, jmac55 wrote:

    Check out Citibank defaulted loans relative to the other giant banks:

    And CitiMortgage REOs at:

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