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Massive Intervention in Citigroup This Morning

By: Francis Cianfrocca (Diary)  |  February 27th, 2009 at 08:33 AM  | 

RESIZE: AAA

Something quite major happened in finance this morning. All week, officials like Ben Bernanke and Tim Geithner have been hinting that nationalization is not the way to save the banking system.

So today they only nationalized Citigroup halfway.

As part of the TARP plan, and also in a supplemental purchase, you the taxpayer have purchased about $45 billion worth of convertible preferred stock in Citigroup. Today, the government has made a deal with Citi to swap about $27 bn of that preferred for common.

Since the entire market value of Citigroup’s common stock was slightly below $27 bn as of yesterday’s close, the deal amounts to creating about as much new stock as existed beforehand. So each existing share is now worth about half as much.

And in pre-market trading, they’re down just about… half. See, financial modeling works after all. The massive dilution and the fear of more to come (possibly affecting other banks) is weighing heavily on stocks this morning, and they will open sharply lower.

I don’t have time now for a fuller explanation, but you’re probably wondering why they did this after a week of saying nationalizations are bad. I would say it’s because of the unique character of Citigroup.

Remember how we (*cough* Larry Summers and Robert Rubin *cough*) repealed the Glass-Steagall Act ten years ago and made possible the creation of an American version of Europe’s “universal banks”? That was done mostly to enable the ambitions of Sandy Weill, then Citi’s CEO.

Citi went farther than anyone else in this direction and thus is perhaps half bank and half broker dealer.

Ok, hang with me, this gets a bit tricky. A commercial bank doesn’t necessarily need to mark their toxic assets to market if their intention is to hold them to maturity. Therefore, you could make a case that, based on reasonable financial accounting, banks like JP Morgan Chase are indeed undercapitalized but NOT insolvent.

Citi is different, because so much of what they do involves securities held for sale that have now landed on their balance sheet, and because of their large trading operations. It’s consistent to argue that Citi’s assets should be aggressively marked to market. And on this basis, Citi is unquestionably insolvent.

Today’s move was only a matter of time.

This post also appears at MarketsAndPolicy.com

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  • djemi

    After reading this piece I went here

    http://www.foxbusiness.com/story/markets/futures-slightly-lower-government-announces-citi-deal/

    and read this

    The new shares issued to the government would carry a conversion price of $3.25 a share, according to Citigroup, much higher than Thursday’s closing price of $2.46 a share.
    (does this mean the taxpayer is taking a loss straight up?)

    However, shares of Citi were now moving sharply lower by more than 50% heavy pre-market trading, pushing the financial company’s stock to as low as $1.20 a share. It was dragging down the other financial houses such as Bank of America (BAC: 4.15, -1.1, -20.95%), JPMorgan Chase (JPM: 23.03, n.a., n.a.%) and Wells Fargo (WFC: 14.28, n.a., n.a.%) as well.

    Based on the maximum conversion rate, the conversion program would give the U.S. government a 36% stake in the struggling financial giant.

    Citigroup said that the conversion program helps boost Citi’s tangible common equity, which is the gauge the U.S. Treasury Department is using for its banking industry “stress tests,” from $29.7 billion to $81 billion.

    “This securities exchange has one goal — to increase our tangible common equity,” said Citi Chief Executive Vikram Pandit in a statement.

    So is all of this so that Citi can pass some kind of government imposed test so it can keep the taxpayers money its already got and get more of it in the future?

    • Francis Cianfrocca

      The conversion price of $3.25 reflects the value of the class of preferred shares that the Treasury is participating in. They have a liquidation preference and a coupon payment that is a superior claim on the company’s earnings, so it’s meaningless to compare them to the common on a per-share basis.

      What happened is that Citi created new common stock (albeit at an extremely low price, one you’d never accept unless under duress). This directly adds to the shareholder equity on their balance sheet.

      Since no money changed hands, you can think of it as the preferred stock giving up its various rights and becoming exposed to the same losses that the common is exposed to. That’s why this is a positive for Citi’s overall capital position.

      Another quite interesting thing is that the share exchange involves preferred stockholders other than the Treasury. Apparently they’re all participating pari passu.

      • djemi

        So your saying this is all a paper thing, more shares at a lower price. X number of shares muiltiplied by Price P equals shareholder equity on the balance sheet has gone to say 2X number of shares muiltipied by Price 0.aP where A is greater than 5 to increase the shareholder equity on the balance sheet.

      • 6eorge Jetson

        Preferred stock represents the penultimate claim to the assets of the enterprise, standing only in front of the common stockholders.

        We the taxpayer paid $45 billion in two installments last fall for the right to $45 billion upon a Citicorp-initiated redemption, plus interest while outstanding of 5% for the first five years and 9% thereafter (to encourage redemption).

        At the time, it was known that the taxpayer was overpaying for those second-to-last rights (which in the absence of dealmaking would not get paid at all if the assets were to run out in the liquidation of superior claims). Some economists have attempted to model this valuation. For illustration, let me pull a number out of the air, say the $45 billion claims purchased were worth $30 billion. (Which would mean that the $27 billion par value of common stock traded away today was worth $18 billion last fall).

        Since then, as the value of claims on Citicorp have certainly fallen, so has the value of our taxpayer preferred stock claim. Roughly, then, we the taxpayer traded something less than last fall’s value for a common equity stake that the market seems to be valuing at ~$11 billion.

        The market is telling us that the common stockholders “of record yesterday” had value taken away from them. I suspect that we the taxpayers faired decently, and the passive participant, the bondholders at the front of the seniority line, benefitted the most.

        • 6eorge Jetson

          traded away today was worth $18 billion last fall.”

  • http://www.RedState.com/ETCartman Kenny Solomon

    Dow Futures down 140 as of this post.

    Popcorn being made along with some fresh lemonade. I “hope” there’s no more “change” today.

    Cheers !

    • djemi

      but after the union pension funds buy up about 11% – 15% of the stock in Citi, then the Democtatic party will own Citi.

  • bk

    It sounds from what you said that we can halve the value and then have it again, so does that mean that this morning over $20B of taxpayer money vanished into thin air?

    27 / 2 = 13.5 / 2 = 6.75 and 27 – 6.75 = 20.25

    <Since the entire market value of Citigroup?s common stock was slightly below $27 bn as of yesterday?s close, the deal amounts to creating about as much new stock as existed beforehand. So each existing share is now worth about half as much.

    And in pre-market trading, they?re down just about? half. See, financial modeling works after all. The massive dilution and the fear of more to come (possibly affecting other banks) is weighing heavily on stocks this morning, and they will open sharply lower.

  • JDidSaint

    Does that mean that Obama holds 36% of the vote on board decisions or can a lot of that be nonvoting shares?

    • Brian Hibbert

      That means they have voting rights.

      • JDidSaint

        And yikes.

    • itrytobenice

      the gobmint gets to replace the entire Board of Directors.

      And since one of their favorites, Robert Rubin, was in place on the board as it began circling the drain, we should not expect great things now.

  • texas214

    My take is that CITI is technically insolvent, however the government did not want to take it over for several reasons, i) size matters, it’s just too big, ii) the ‘systemic” risk we are always hearing about, and iii) Robt Rubin had gotten huge soveriegn and wealth funds to invest and leaving those people at the alter with a failed bank would have impacted the Dem’s negatively going forward.

    They want to make the claim they are now the better party on the economy and if CITI fails, with Rubin having been at the helm during the run up, their argument starts to have holes shot in it. When their vaunted Treasury Secretary that they like to hold up as an example as all things great in their party would over see the largest bank failure in history it doesn’t look good.

  • Alberta

    How are these not zombie banks?

    Black, or anybody, please explain to me why these banks are crucial to the system. Market has pronounced judgement, these things are penny stocks now. Are people still doing business with Citi? Real business?
    Citi is dead. Please explain why a dead bank must be kept alive for the good of the system. The whole notion doesnt pass the smell test.

    This whole thing is people with influence using said influence to avoid taking their medicine. Corporate welfare is bad enough, its even worse when people pretend that its crucial we indulge.

    • Francis Cianfrocca

      You have to find a home for those. You can’t just kill Citigroup as if it were IndyMac. There’s no one out there with enough financing power to chomp down $2T. Especially if (depending how you value them) they’re only really worth something like $1.5T (which would mean you have to make someone lose half a trillion dollars).

      • Alberta

        The losses have to be taken. Reality demands it, no?

        If you killed off Citi, the good stuff it has can be put to market and auctioned off to the whoever pays the most for it. The bad stuff? Sorry hombre, somebody is going to get screwed, Id simply prefer it be shareholders and bondholders of Citi and not the taxpayer.

        Of course, that boats left the station I understand that. But I dont buy this notion that because the company has failed so spectacularly we have to bail it out, or else. Or else what? Some company that decided to do business with this shady bank will lose its loan? So? If its credit worthy other banks will want its business, if it isnt it goes bankrupt.

        2 trillion in assets implies these assets are worth 2 trillion. The 1.9 trillion in liabilities to me suggest that these assets are not. Black your a smart guy dont give me this stuff. You want to chomp down 2 trillion? DEVALUE THEM. ITS CALLED PRICE. Auction them off. The price will get low and people will buy them. Nobody may be able to soak up 2 trillion, but nodoby is asking them too. Soak up the assets at X. Let the market set X.

        This systematic stuff is a crock. If we have 20 (I think thats what Bernanke said) banks that are integral to the system (Bernankes definition 100 billion or more in assets) Im sure we could have done with the other 19 devouring the 20th.

        Call me crazy or stupid or whatever. This whole bailout nation stuff is a joke, Black, and the consequences of putting all this power into the hands of government people who have shown in the past they want a version of the world that is poorer, more inefficient, racist, sexists, quota driven, class warfare driven, is a very poor idea.

        How can people make the argument that putting the system into the hands of Reid Pelosi Obama, who hate the system ideologically, who are hostile to the investor class, is better then letting it crash and burn and rebuild?

  • streetwise

    They create the impression that this makes Citi more risky. Of course, as Francis notes, it makes it safer. More equity, more safety. Of course, more equity, more dilution for the existing shareholders. Life is tough, and then you die. :>)

    Also, Citigroup is the entity with the shares, not Citibank. The bank holding company encompasses the bank, the brokerage (Citi/Smith Barney) and the other subsidiaries.

    The interests of the nation and the shareholders are not the same here. The national interest is to restore confidence in the banks by improving their capitalization. The private shareholders’ interest is in the stock price.

    • Francis Cianfrocca

      n/t

      • streetwise

        Being a Citi depositor, it’s no more than I deserve, though. :>)

  • The_Gadfly

    I didn’t feel that way until recently, but after this week, they can burn.

    For more than twenty years I’ve had a good relationship with the bank, but they’ve screwed me on rates for the last time. I’m not good at opening mail and sending out checks on time, so I setup my payments to go out automatically. Last month what I owed went up a bit more than I expected, and the payment I sent wasn’t quite enough, so they defaulted my account over $12, Even though having caught it on Friday, they got $25 one day late. The same week I got a surprise from Prudential about a policy my Dad bought for me about the same 20 years ago. Premiums for that were going to triple. So the Prudential policy is getting cached in, and the payment is paying off the whole credit card. Both institutions lose out on this deal. Prudential won’t get any more premiums from me, and Citibank won’t get any interest payments from me. Granted, $10K ain’t much compared to their multi-trillion dollar problem, but that’s how the economy shrinks-a whole lot of little people like me getting tired of getting screwed by places like Citibank that want one set of rules for themselves, and a different set for peons. I’d be perfectly willing to put up with the $39 late fee, but not 24.9% on the balance for something that close.

    • The_Gadfly

      should have been “cashed” not “cached.”

  • NC_Red_State

    I just cound not stomach that the next time they send out my new card, it will be a red and blue picture of the Obama on it.

    Credit cards will be the only currency his profile will deserve, once this is all said and done.