Why You Shouldn't Be Worried About Citigroup's Pending Settlement

When Citigroup finally settles with the Justice Department, it will go a long way toward putting the mortgage crisis in the past.

Jun 17, 2014 at 7:00AM

Citigroup (NYSE:C) is one of the cheapest bank stocks in the market, and for some pretty good reasons.

For starters, the company has tremendous international exposure, and it is impossible to know how the bank would fare in the event of another downturn. The bank also has well over $100 billion in legacy assets on the books, and if the default rate of the portfolio jumped, it could be very bad for Citigroup's bottom line.

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Now the market has yet another reason to de-value Citigroup: it was just announced that talks between the bank and the U.S. Justice Department broke down over a massive difference in settlement offers.

Apparently, the Justice Department wants to make an example out of Citigroup and is seeking more than $10 billion.

What's this settlement about?
Just like several other banks, Citigroup has been under investigation by the Justice Department for allegedly misleading investors about the quality of mortgage-backed securities sold during the mortgage crisis years.

As mentioned, the Justice Department is reportedly seeking a settlement of more than $10 billion, which is a lot but is not unprecedented. JPMorgan Chase & Co. paid $13 billion in response to similar charges, in what is currently the largest bank settlement in history. Bank of America is also facing a settlement of a similar amount.

However, sources say Citigroup offered less than $4 billion to resolve the matter, which apparently prompted prosecutors to stop the negotiations and move forward with their lawsuit against the bank.

Should investors be worried?
Not really. Citigroup and all of the other big banks have known these settlements were coming for some time now, and have been stashing money away to cover them.

Plus, the $10 billion figure being tossed around in the media is likely much higher than the bank will actually have to pay, simply because of the lower volume of MBS the bank sold as compared to its peers.

The real number will likely be somewhere in the middle of the $4 billion Citi has offered and the $10 billion the government wants, and an amount on the lower end of that range would make more sense. Sure, JPMorgan Chase paid out $13 billion to settle similar charges, but the company sold about six times the amount of mortgage-backed securities Citigroup did.

One analyst estimates a $6 billion fine, which may be a little more than the bank has in reserves. However, he says the bank's share price is already pricing in up to $3 billion in legal costs above and beyond the current reserves.

In short, this is no surprise to Citigroup and the bank should be able to put this mess in the past for far less than $10 billion.

It's all priced in and more
Admittedly, there is a lot of uncertainty surrounding Citigroup. However, the bank has done a good job so far of improving its asset quality and capital levels.

The Citi Holdings assets are still substantial, but great progress has been made in winding down the portfolio, and it's just a matter of time before it's all gone.

And, the legal settlements that have been plaguing the banks for several years now may be coming to an end. In fact, rival Bank of America recent announced the Justice Department settlement is the last big one the bank has to worry about.

Even with the uncertainty, I believe the odds are well in the shareholders' favor, especially considering Citigroup trades for just 86% of the value of its tangible assets. While the prospect of uncertain legal settlements and over $100 billion in remaining "legacy assets" might make you nervous, any big headlines create even better buying opportunities in this long-term winner.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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