Fisher Investments Editorial Staff
US Economy

Not a Bair Market

By, 06/11/2009

Story Highlights:

  • Citigroup began converting Treasury's preferred stock into common stock, thus satisfying arbitrary government rules without changing Citi's situation. The result: 75% shareholder dilution and a 34% ownership stake for the government.
  •  Conversion was delayed when FDIC boss Sheila Bair and Treasury boss Timothy Geithner disagreed over disposing Citi CEO Vikram Pandit.
  • Share conversion may be the price Citi investors pay to avoid a government-led boardroom shakeup.
  • Financials continue down the road to better health and aren't the systemic risk they once were—witness the 10 banks set to pay back their TARP funds.

(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

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After much "will they, won't they," it appears the government has given the go ahead for 10 TARP recipients to wipe their hands of TARP and say, "Thanks! But let's not do this again." Eager to shed ongoing government strictures, they know too much fed meddling isn't in their clients', shareholders', or employees' best interests.

Recent feuding over Citigroup reminds us government micromanaging leads to subpar results. Last month's bank stress tests showed though Financials overall were in decent shape, Citigroup was among those shy of the government's various capital targets. To satisfy these new (and somewhat arbitrary) requirements, Citi began converting preferred shares to common stock—$58 billion worth, including $25 billion of preferreds held by the US Treasury. Voila! This increased Citi's "tangible common equity ratio" from under 2% to over 5% and (for now) appeased the feds.

But conversion satisfies an arbitrary government capital objective—it's not a signal of Citi's health. Translating one flavor of stock to another doesn't garner a bank more customers or deposits, and it doesn't strengthen its balance sheet or reduce its liabilities. It does however leave Uncle Sam with a 34% equity ownership stake, and dilutes existing shares by roughly 75%. Not the best news for Citi's long-suffering shareholders.

Conversion was nearly derailed by recent fed wrangling which felt rather like watching two dogs fighting over a bone. FDIC boss Sheila Bair believes Citi is weaker than most believe and wants to protect her investment—the FDIC currently guarantees tens of billions worth of Citi debt. She's working to give Citi CEO Vikram Pandit (a former investment banker) the boot, favoring management with more commercial banking flair. Meanwhile, Treasury boss Timothy Geithner disagrees. He thinks removing Pandit would cause instability and believes it's his call to make—and he may be winning the turf war for now. Either way, executive hiring and firing decisions shouldn't flow from Washington in-fighting. Conversion may be the price Citi investors pay to avoid a government-led boardroom shakeup..

Citi may lag its brethren in paying back TARP and could be further hobbled if the FDIC adds Citi to its "problem bank" list. But despite squabbling by meddlesome feds, Citi is doing what it can to point itself toward better health and a TARP-free future, even if that means satisfying arbitrary requirements. Financials as a whole continue down the road to better health and aren't the systemic risk they once seemed to be. Still, share dilution and the opportunity for further government micro-management makes the Financials sector less appealing for the near future, relative to broader markets.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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