Please ensure Javascript is enabled for purposes of website accessibility

What's Next for Citigroup?

By Morgan Housel – Updated Apr 6, 2017 at 1:52AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Sadly, nothing good.

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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
$43.06 (-1.78%) $0.78
Bank of America Corporation Stock Quote
Bank of America Corporation
$31.46 (-1.44%) $0.46
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$108.14 (-2.04%) $-2.25
Morgan Stanley Stock Quote
Morgan Stanley
$81.31 (-2.17%) $-1.80
Wells Fargo & Company Stock Quote
Wells Fargo & Company
$42.24 (-2.47%) $-1.07
American International Group Stock Quote
American International Group
$50.76 (-1.05%) $0.54
U.S. Bancorp Stock Quote
U.S. Bancorp
$41.08 (-2.65%) $-1.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.