The WSJ reports that Citigroup (NYSE:C) wants to issue up to $5 billion of equity to repurchase a corresponding number of shares from the U.S. Treasury. This is a great idea that benefits both taxpayers and Citigroup’s shareholders. Citi does not have enough common equity capital to repurchase the government’s shares outright. Yet, if it issues new common equity to reduce the government’s stake, no capital is lost.
Citi’s shareholders should be cheered that managers are taking steps to exit the government ownership. Taxpayers should be eager to lock in some of their paper profits on the Citigroup stake. On the $25 billion investment that was converted into common shares, taxpayers are looking at paper profits of over $11 billion on the 7.7 billion shares of stock and the 210 million warrants that they received for that cash infusion. It would be hard to quickly reduce this stake through open market sales alone without pushing down the share price. Yet, a larger underwritten sale of the government shares may be possible without a large negative impact on the share price. Typically, seasoned equity is issued at a two to three percent discount from the previous day's closing price.
My solo and joint research shows that banks that have too little common equity make bad lending and investment decisions. Yet, as long as Citigroup is reducing the government’s common stock stake by issuing an equivalent amount of new privately held common stock, regulators and taxpayers have nothing to worry about.