Is Citigroup going to be nationalized?

The U.S. government could soon own as much as a 40 percent stake in Citigroup (C) , according to the Wall Street Journal, but will the bank be nationalized? Stockholders feared nationalization on Friday, sending the stock below $2 a share because they assumed their ownership would be greatly diluted.

The government won't get it's 40 percent stake by putting in more money. Instead, it will agree to convert its current $45 billion of preferred stock into common stock. There's no universal definition of what constitutes nationalization of a bank, but if the government does end up with a 40 percent stake, that gets close to full control and will certainly mean the government will be calling the shots.

Citigroup also hopes to persuade other private investors who hold preferred shares to convert to common stock, including the Government of Singapore Investment Corp., Abu Dhabi Investment Authority and Kuwait Investment Authority, according to the WSJ. With these additional new common stockholders, government control becomes much more of a reality. Do you think these foreign entities would back the U.S. government if it wanted certain changes in the way Citigroup operates? Probably not.

What's driving this shift from preferred stock to common stock is a measure of bank health called the "tangible common equity," or TCE, which is one of the most conservative measures of bank health. Generally, it's believed that TCE should be at level of about 3 percent of assets. With the drop in Citigroup's stock value, its TCE now stands at a dangerously low 1.5 percent. Converting all these preferred shares to common stock would certainly boost that TCE.

When the government first injected the money into banks last year, it was worried about the bank's Tier 1 status. Tier 1 is the ratio of a bank's capital adequacy. By Tier 1 measurements most big banks appear healthy. Citigroup's Tier 1 ratio is 11.8 percent, well above the level needed to be healthy.

Stockholders outside the U.S. like the idea of converting preferred shares to common stock, even though it will likely dilute the current stockholders' stake. Citigroup stock jumped 24 percent in Germany and is soaring over 17 percent in pre-market trading. Will U.S. stockholders receive the news as warmly? Rumors last week of nationalization sent bank stocks on a downward spiral, could this news change their opinion?

Lita Epstein has written more than 25 books including the Complete Idiot's Guide to Value Investing.
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