Monday, February 23, 2009

Bailout Nation: U.S. May Draw Citi Into Tighter Embrace


Bank nationalization is hanging over the market. But as far as taxpayers go the last thing we want is common stock. The reverse should be happening: common stock holders and existing debt holders should be getting crammed down in any reorganization that includes bailout funds, that is, taxpayer dollars.
Fears that Citigroup would succumb to the fate of American International Group and be outright nationalized sent its stock into a tailspin last week, ending Friday at a paltry $1.95. That gives Citi a market capitalization of just over $10 billion. One year ago, it had a market value of over $137 billion, and even that was considerably less than in Citi's glory days.

Though the deal believed to be under discussion would incur no additional costs to taxpayers, it would hammer common stockholders. News reports Sunday evening had the bank, either voluntarily or at the behest of the government, converting preferred shares held by the government into common shares, which would dilute existing stockholders. The government could end up holding 40% of the company's equity.

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U.S. May Draw Citi Into Tighter Embrace

For the third time in four months, Citigroup is looking for government help to shore up its capital.

The question is whether more government involvement above and beyond the $45 billion the bank has already taken in two installments in October and November, not to mention the guarantee against losses on $300 billion of assets, would do anything to restore confidence.

Fears that Citigroup would succumb to the fate of American International Group and be outright nationalized sent its stock into a tailspin last week, ending Friday at a paltry $1.95. That gives Citi a market capitalization of just over $10 billion. One year ago, it had a market value of over $137 billion, and even that was considerably less than in Citi's glory days.

Though the deal believed to be under discussion would incur no additional costs to taxpayers, it would hammer common stockholders. News reports Sunday evening had the bank, either voluntarily or at the behest of the government, converting preferred shares held by the government into common shares, which would dilute existing stockholders. The government could end up holding 40% of the company's equity.

Citigroup wouldn't comment on the reports, except to reiterate a statement it made last week when the nationalization rumors were making the rounds. "Citi's capital base is very strong and our Tier 1 capital ratio as measured at the end of the fourth quarter was 11.9%, among the highest in the industry. We continue to focus and make progress on reducing the assets on our balance sheet, reducing expenses and streamlining our business for future profitable growth," a spokesman said.

Citi, reeling from $18 billion in losses for 2008 and massive exposure to the consumer loan market, is already in the process of splitting itself in two. It's taking more than $800 billion of unwanted assets and businesses, like mortgage lending and consumer finance, and segregating them in a new business unit with its own management, who will spend their time selling the assets or otherwise disposing of them.

It also sold a majority of its crown jewel, Smith Barney, to a joint venture with Morgan Stanley.

The rest of Citi, which is returning to its pre-1998 name Citicorp, will continue on and presumably perform better without those money-losing assets and noncritical businesses. The remaining businesses will include corporate and retail banking, private banking and wholesale services around the world.

Announcing the plan in January, CEO Vikram Pandit explained, "This new structure will provide a wide range of options going forward to continue strengthening our core franchise."

But Citi faces a stress test by the government, and the results might not be pretty. Like many other banks, Citi faces mounting consumer loan losses, which are only being exacerbated by rising unemployment.

The stress testing, which is mandatory for the 15 biggest U.S. banks with more than $100 billion of assets, begins in the coming weeks. The Treasury Department, which is running the program, wants to find out whether the banks would have the capital they needed to continue to lend and absorb more losses if the economy were to weaken more than expected. Some think this stress testing, which is part of the Treasury's new Financial Stability Plan, means the government is imposing stricter capital standards on banks.

The fear is that any testing scenario will create a situation where there are clear winners (banks that don't have to take additional capital from the government but will likely be forced to anyway in a "voluntary" program to give the plan legitimacy), and clear losers (banks that will get capital injections that come with all sorts of additional restrictions on executive compensation, among other things).

Banks that go through a stress test will get access to a Treasury-provided "capital buffer" (an additional preferred equity stake) to bridge the time until the bank can raise the capital on the private markets. Given the restrictions that will likely accompany additional government injections, most see banks favoring raising capital in the private markets, if at all possible.

Citi has a number of wealthy constituents backing it, including Saudi Arabia's Prince Alwaleed bin Talal, whose fund has taken a major hit in the last few months. Other investors include the Abu Dhabi Investment Authority, the Government of Singapore Investment Corporation and the Kuwait Investment Authority. Some executives at Citi get stock awards that vest if the stock improves by a multiple of three in the next four years. Pandit, along with some other senior executives, didn't participate in the awards.

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