Haraz N. Ghanbari/AP
Citigroup Chief Executive Officer Vikram

Latest Government Aid to Citigroup: What Does it Mean?

February 27, 2009 06:30 PM
by Anne Szustek
After the federal government raised its stake in Citigroup, the institution announced that it’s converting much of its preferred stock to common equity.

Citigroup Plans to Convert Preferred Stock

The U.S. Treasury agreed to raise its ownership of Citigroup from 8 percent to approximately 36 percent on Friday as part of its third attempt since October to keep the behemoth financial institution afloat.

Citigroup, once the nation’s largest bank, is putting payment of dividends on common and preferred stock on hold, and will exchange common stock for up to $27.5 billion in preferred stock at a conversion price of $3.25 a share, a 32 percent premium over Citigroup’s Thursday closing share price of $2.46. The government is to match this conversion, up to $25 billion, in government-held preferred shares into common equity under its Capital Purchase Program.

This latest financial self-buffering comes amid news that Citigroup posted losses of $10 billion during the fourth quarter of 2008. Citigroup shares dropped to their lowest price in 18 years on Friday, losing nearly 40 percent in value from the previous closing bell.

The deal does not provide Citigroup with immediate cash. However, it does increase the bank’s tangible common equity (TCE), a measure of financial stability that takes into account the value of a company’s common shares. During this recession, TCE has come to be viewed as a better test of resilience than assessing Tier 1 capital, which comprises a company’s preferred stock, common shares and occasionally deferred tax assets.

“On the basis of Tier 1 as risk capital and based on our Tier 1 of 11.9%, we have been very well capitalized,” Citigroup Chief Executive Vikram Pandit was quoted as saying by MarketWatch. “However, the markets became increasingly focused on TCE and the stock price and preferred shares reflected this focus.”

The U.S. government has so far plied Citigroup with $45 billion in federal cash, in addition to “a government backstop to cap losses on $301 billion of toxic assets,” CNBC reported. Although the bank is not being completely nationalized, this latest prop-up does grant the government more voting power and say in how the bank is to be managed.

"The government is the new boss,” Mike Holland, the founder of money manager Holland & Co in New York, told CNBC. “Every major decision is something that is not going to come out of Park Avenue, but is going to come from Washington, D.C.”

Citigroup plans to rebuild its board with new, independent directors. Of the bank’s current 15-member board, five are either approaching retirement age or do not plan to run for reelection.

Background: How Citigroup got to where it is

Citigroup’s Jan. 14 sale of brokerage unit Smith Barney to Morgan Stanley in a bid to shore up capital raises the question: Is bigger really better? Former Citigroup chair and CEO John Reed looked back on Citigroup’s expansion in the late 1990s. “The specific merger transaction clearly has to be seen to have been a mistake,” Reed told the Financial Times.

Historical Context: Prior nationalizations

The Federal Reserve and four other Canadian and European central banks said in December 2007 that they would inject close to $64 billion in emergency short-term loans to banks in an attempt to alleviate the global credit squeeze.

In September 2008, insurer American Insurance Group (AIG) received an $85 billion loan from the Federal Reserve with an 11.5 percent interest rate. The loan effectively nationalized roughly 80 percent of the conglomerate. AIG said it plans to pay back the loan in full by selling off assets or bringing in more investors.

It was announced during the second half of last year that the FBI was investigating the insurer, as well as bankrupt investment bank Lehman Brothers and mortgage companies Fannie Mae and Freddie Mac. Those two mortgage providers were themselves taken into U.S. government conservatorship in September.

Reference: Preferred stock; investing guide


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