Citigroup: Dilution of Grandeur
In for a penny, in for 36%. On Feb. 27, the U.S. government committed to holding more than one-third of Citigroup's (C) common shares in a deal to bolster the fallen financial giant's capital base, and shook up the financial giant's board in the process. The Treasury Dept. agreed to convert up to $25 billion in government-held preferred shares in the bank to common equity, provided private investors contribute an identical sum. That's the third major aid package for Citigroup since mid-October. The news knocked the already pulverized shares lower on Feb. 27.
Also on Feb. 27, investors weighed reports on a sharper than expected drop in U.S. economic output for the 2008 fourth quarter and some mildly encouraging news on sentiment in the consumer and manufacturing sectors.
Here's a sampling of what Wall Street analysts and economists had to say about the Feb. 27 news:
Nicholas Smallwood, Daiwa Securities (8601.T)Citigroup has announced an additional $9.6 billion goodwill impairment in the 2008 fourth quarter, increasing the 2008 net loss by around $9 billion to $27.7 billion. At the same time, the U.S. Treasury said that it would convert up to $25 billion of the Citi preferreds it holds for common stock. This would not be a unilateral action by the government, but would have to be matched by similar moves from other preferred holders. For every $1 they convert, the government will also convert $1. Assuming the maximum possible conversion, the government could end up owning 36% of Citi. We are not surprised by the government's action—indeed, creeping nationalization of the large, damaged U.S. banks has been on the cards for a while. We believe this will be an ongoing theme.
However, the additional goodwill impairment was a surprise. We could see other substantial goodwill writedowns to follow RBS (RBS) and Citi. Bank of America (BAC) appears to be the most likely candidate, having paid a 70% premium for Merrill Lynch, which went on to lose around $15 billion in the 2008 fourth quarter alone. And the combination of the large writedown and the dilution of ordinary shareholders is a recipe for a very volatile end to the week for Citi's share price.
Jaime Peters, Morningstar (MORN)Since Citigroup will suspend the dividends paid on any preferred shares not converted, the current preferred shareholders have a strong incentive to convert. Trust preferred distributions will remain unchanged and may or may not be eligible for the conversion. Overall, Citigroup could bulk up its common tangible equity from $29 billion to $81 billion if there is full participation. Current existing common shareholders will be left holding just 26% of the company, while the government might own as much as 36%. While we anticipated the government's stake increasing to at least 35%, the privately and publicly held conversion will dilute shareholders more than anticipated.
David Greenlaw, Morgan Stanley (MS)An even weaker than expected report, with Q4 GDP growth revised down to -6.2% (not far from our original forecast) from -3.8%, the fourth worst quarter since the Great Depression, with bigger drops only recorded in 1982, 1980, and 1957. The downside relative to expectations was driven by extraordinary weakness in consumption and a bigger fix to the weird initially reported spike in inventories. The somewhat bigger downward revision to inventories in Q4 had a marginal positive implication for Q1, and on a preliminary basis we now see Q1 growth running at -5.9% instead of -6.0%. This would make the Q4/Q1 period the second worst for the economy since the Great Depression (with a worse two-quarter decline only recorded in 1957-58 as a result of an auto strike)—and there are no signs of any looming improvement at this point.
Michael Englund, Action EconomicsThe Michigan sentiment index was boosted a tick in the final February report to 56.3 from the 56.2 preliminary figure, hence leaving the index still above the cyclical low of 55.3 in November, as well as the 51.7 all-time low from May of 1980. The February current conditions index was knocked down to 65.5 from 67.1 in the preliminary report and 66.5 in January, which still leaves this index above its 57.5 all-time low in November. The expectations index retained most of its massive February drop in the preliminary report to 50.5 versus 49.1 previously, and 57.8 in January. This measure is now above the prior cycle-low of 49.2 last June.
The financial crisis, collapsing economy, and fears about the exploding government deficit and the associated stock price declines and yield and price increases are weighing on the various confidence surveys, despite the intent of the stimulus plan to do just the opposite.
Beth Ann Bovino, Standard & Poor'sThe U.S. Chicago purchasing managers' index improved to 34.2 in February after dipping to a multidecade low at 33.3 in January. It was a bit better than the 33.5 that markets had expected. However, the internals were more mixed. The employment index dropped to 26.2 from 34.8, while new orders held at 30.6, about the same as the 30.7 reported last month. Prices paid slipped to 37.8 from 39.8. While a bit better than market expectations, the improvement is at odds with the Philly Fed and Empire State index, to take some of the shine out of the figure.