Citigroup Makes Plans For Lowered Government Stake

Top-level management at Citigroup Inc. (C) is conceiving plans to downsize the U.S. government’s 34% stake in the company through a multibillion-dollar stock offering. Under the plan, Citigroup would issue new shares to the public and the Treasury Department would sell at least a portion of its Citigroup holdings.

The Treasury Department acquired 7.7 billion shares of Citigroup common stock last week in return for a chunk of its holdings of Citigroup preferred shares, which the Treasury received when it pumped $45 billion into Citigroup.

The company is considering a secondary share issue of as much as $5 billion along with the government selling a portion of its stake. Citigroup is aiming for a transaction to materialize in the fourth quarter of 2009.

In general, Treasury officials are open to being repaid by institutions in which they have investments, based on the pre-requisite that they demonstrate adequate capital and liquidity, and also appropriate debt-equity ratio. As a result, Citigroup cannot replace the common stock held by the government with debt, but must either conduct a secondary issue or find a buyer for the government’s stake.

If the U.S. chooses to sell some of its Citigroup shares, taxpayers could get a profit. The government converted its $25 billion of preferred stock into common stock at $3.25 per share. Citigroup’s shares closed Monday at $4.52. That means the government’s 7.7 billion shares could have gained about $9.8 billion.

To ensure the exit of the government’s stake with credibility, we think that Citigroup should show at least a few quarters of respectable results and signs of consistent profitability in the future. While Citigroup has reported net income for the last two quarters, the company still is struggling with ever increasing loan defaults and tens of billions of dollars of unwanted, risky assets.

However, Citigroup’s plans to cut back the government’s stake reflect a rebound from the gloomy days of the financial crisis. It remains to be seen how the Obama administration starts winding down the government’s interventions into the financial system amid continued concerns about the health of the banking industry in general and Citigroup in particular.

Citigroup will release its third quarter 2009 earnings on Oct 15, 2009 with a conference call scheduled later in the day to discuss its results. Ahead of its results, we maintain our Neutral recommendation on the stock.

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