“Take a look at stocks in the Citigroup shares are in the as you can see up 4%. And they expect the bank to face another $44 billion in loan loss the over the next 18 months, but says the capital is now strong and that’s enough to give the stocks a boost.” — Fox Business Network 8/24/2009
In early afternoon trading, shares of Citigroup (NYSE:C) have risen as much as 5% on very heavy volume. The news surrounding Citi today is that analyst David Trone at Fox-Pitt Kelton has said that the bank still faces huge loan losses; however, he also said that the bank is adequately capitalized to survive thanks to the “painfully dilutive” conversion of preferred shares to common equity. On the face of it, this sounds like a dire prediction, but the market has interrupted this as a positive. Which makes us wonder what were the market’s expectations for Citi previously?
It stands to reason, based on the strength of Citi today, that the market was anticipating that loan losses could have been worse, possible even endangering the survival of the bank. The analyst note also said that Citi could potentially face even steeper losses of $68 billion if the economy takes a turn for the worse over the next eighteen months. When you consider the fact that Citi currently has a market cap in the mid-$50 billion range (depending on what source you use, this is the largest we have seen), that could put the bank in serious jeopardy and hurting for more capital.
Pardon us for being a wet blanket, but this sort of news does not inspire confidence in Citigroup. We always knew that there were skeletons in the closet of Citi’s balance sheet, but this analyst opinion being “better-than-expected” is scary. We are not sure what the future holds, but it does seem at least fairly likely that the economy will see a W-shaped recovery. This report suggests that Citi would have a very difficult time facing the second leg down without further assistance. With the government already owning 34%, is there any doubt who will foot the bill for that infusion were it necessary?
David Faber of CNBC has made the point that Citi is still only beginning to see the effects of the dilution from forced conversion, and when everything is concluded there will be 23 billion shares outstanding. That is 4x the number listed on Yahoo Finance and more than twice the number listed on Google finance. All of that dilution should be complete in the next few weeks. To expect Citi’s share price to hold at this level over the next few weeks could be a very tall order.
Our valuation at Ockham remains Fairly Valued as it may in time turn out to be a great buying opportunity, but we are risk averse for the long term. Dilution is indeed going to be painful to common shareholders. With the latest opinion from Trone being taken as a sign of good news, we are staying far away from recommending buying these shares. The bank is in a the process of a huge restructuring, and is possibly splitting the company into a dual structure. There is just too much not too like here, and too many unknowns. For our investment style, it is simply not worth the risk.