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Why Citi investors should never sleep Print E-mail
Friday, 11 December 2009

By Ronald Fink

The agreement with the Treasury Department that Citigroup announced on Monday to repay funds received under the Troubled Asset Relief Program will end the government’s oversight of its compensation practices but not its say over how the bank is otherwise run.

In fact, some analysts expect the Treasury to require the bank to raise more capital to repurchase the rest of the government’s stake. That could weigh on Citi’s stock price, which has fallen some 41 percent this year even after a run up following the government’s help.

The bank’s agreement with the Treasury calls for Citi to raise $20.5 billion in equity and debt and redeem $20 billion that the government holds in trust preferred securities, which it received in exchange for TARP funds. The agreement also calls for Citi to cancel another $1.8 billion in trust preferred securities that the government holds as part of a separate loss-sharing arrangement. Finally, the Treasury has agreed to sell $5 billion in Citi’s common stock that the government holds as a result of other assistance extended through the TARP.

As a result of the agreement, Citi is no longer deemed to receive “exceptional assistance” from the government and will escape the federal limits on executive compensation that arose from the designation.

But the Treasury still holds $5.3 billion in Citi’s trust preferred securities as a result of the loss-sharing arrangement. And even after selling $5 billion in common shares, the government will still hold $20 billion, though it plans to unload these over the next six to 12 months.

A report by the research firm CreditSights released on Monday said that the bank might have to raise more capital to maintain key regulatory reserve requirements while reducing its continued dependence on Treasury support, so as to free up government funds for other purposes. To limit shareholder dilution, the report said the bank may have to buy in much of its outstanding common.

“One of the basic problems with the company’s shareholder valuation is that it has too many shares as a result of its many rounds of capital raising and exchange offers,” CreditSights analysts David Hendler and Pri Da Silva wrote. Citi currently has 23 billion shares of common equity outstanding, 17 billion of which were converted last year from preferred shares through exchange offers, and is expected to add another 5 billion or so as a result of the new equity offering.

In addition, Hendler and Da Silva noted that the end of the loss-sharing arrangement will increase the government’s risk-weighting of Citi’s assets.

So if the bank chooses to redeem the rest of the government’s holdings of trust preferred shares, Citi might have to raise more equity to keep its Tier One ratios of total capital and common equity in line with those of its peers.

“We believe that Citigroup could be required to raise additional capital to terminate the agreement,” the analysts wrote. Without additional capital, they said Citi’s Tier One ratios of total capital and equity could fall below the 11 percent and 8 percent levels that the government currently requires Bank of America to maintain.

The analysts noted that much depends on the government’s new capital reserve requirements, which have yet to be determined.

B of A exited the TARP program last week after paying back $45 billion of rescue funds.

Finally, CreditSights said the government could also require Citi to raise capital as it unloads the rest of its holdings of the bank’s common shares. While Citi is expected to continue to sell assets and buy back other shares, the analysts said that bondholders should not rule out the possibility of an exchange offer for part of the government’s remaining holdings of common.

“We believe that fixed income investors should not totally discount the possibility of another exchange offer so long as the U.S. government maintains a stake in the company,” Hender and Da Silva wrote. They added that their view was based on the premise that the government may wish to “monetize its investment” to fund its small business, mortgage and other economic initiatives.

At least one big shareholder says he isn’t selling. According to Bloomberg, Prince Alwaleed bin Talal of Saudia Arabia, once Citigroup’s largest individual shareholder, said after the announcement of the agreement with the Treasury that he has no plans to sell shares in the bank.

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