Last week was Citigroup’s turn. Citi is one of the world’s best-known banking brands, and was once America’s largest bank by market capitalization.
Last week, investors knocked 60% off the value of Citi’s stock, in a nerve-rattling selloff that was too reminiscent of Bear Stearns and Lehman Brothers for comfort.
Citigroup is too large to fail. It has about 200 million accounts in more than 100 countries. Its balance sheet has $2 trillion in assets. They also have more than $1 trillion in off-balance sheet assets. (The latter are of great concern because they’re not subject to the same reserve and capital requirements as the normal stuff.)
Here's the term sheet that appeared on the FDIC’s web site in the wee hours this morning. Usually the authorities try to get things like this done by 7pm Eastern time on Sunday nights. But tonight they had a bit more wiggle room because markets in Tokyo are closed for a holiday.
Market reaction as I write (around 6am ET) is mildly positive. The US Treasury yield curve is flatter overall with higher yields in the belly.
The Treasury and the FDIC have essentially agreed to guarantee the value of certain assets of Citigroup, in a manner that shares a few features with prior bailouts, like the “Maiden Lane” structure engineered by the New York Fed for Bear Stearns, and the Treasury’s conservatorship of Fannie Mae/Freddie Mac.
Let’s see if I can explain this really simply.
Citigroup, the Treasury, and the FDIC will sit down and identify about $306 billion of Citi’s assets. (Most of them are securities backed by residential and commercial mortgages.) They’ll all agree on a notional current value for those assets.
Citi will be responsible for the first $29 billion of losses (if any) that are realized on these assets. (The $29 billion includes amounts that Citi has already reserved to protect against losses in these assets.)
The Treasury’s TARP program will take the second loss, up to $5 billion. And the FDIC takes the third loss, up to $10 billion.
If there are losses beyond that, the Federal Reserve will fund them by way of a non-recourse loan.
In return, Citigroup will give $7 billion in new preferred shares with an 8% coupon, that will be split between Treasury and the FDIC.
Also, Treasury will give Citigroup $20 billion in new capital from the TARP program (that’s the famous $700 billion bailout fund). This is on top of the $25 billion in new capital that Citi got from TARP last month, when Secretary Paulson did his Don Corleone imitation.
Among the other covenants are that Citigroup may not pay its common shareholders a dividend of more than a penny a share per quarter for the next three years. And they must agree to limits on executive compensation.
It’s not an exaggeration to say that the US taxpayers acquired a bank tonight. The government definitely would like to see new capital from private sources come into Citigroup, but the structure of this deal acknowledges the remoteness of that possibility.
The fact that Citigroup agreed to these terms is also an acknowledgement that their capital position was a lot weaker than they were willing to admit as late as last week. And the government is acknowledging that they will not allow Citigroup to fold.
You’ll object that simply backstopping 10 percent of Citigroup’s asset book hardly amounts to a taxpayer acquisition. But Citi’s common shareholders are left with almost no rights and very little discernible value in this deal. And there's a clear presumption that if Citi needs more support in the future, it will be there. This is about as close as you can come to an acquisition of the bank by the taxpayers without actually using the word.
There is precedent for this kind of thing. In 1994, Sweden nationalized every single bank in the country, except for the handful that were willing and able to recapitalize from private sources. But most of the nationalizations were reversed within about two years as conditions stabilized.
At this moment, the future of the world’s financial system is simply opaque. Citigroup is now on explicit taxpayer-funded life support. Whether and how they emerge as a private company again are strictly TBD.
And the question for the coming week will be: Who’s next?