The US govt is in talks with Citigroup to convert its preference shares to common taking a 40% stake in the company. This move is expected to shore up confidence of existing shareholders because it will deter the US govt from doing something that wipes out common shareholders as it will also wipe itself out in the process. The problem with GIC converting to common is it will lose 93% of what it invested and the dividends of 7% on the preference shares.
Many analysts believe that Citigroup is insolvent and will need more cash infusions from the US govt that will further dilute existing shareholders and may lead to nationalisation. What the US govt is trying to do is trying to get private money into the rescue so that it doesn't end up with a majority stake. To do this they have to guarantee the value of the bad assets (see the Jim Jubak article on the Geithner plan I posted earlier) instead of going back to Congress for more money.
Whatever it is, it is unlikely Citibank stocks will every climb back up to the price our GIC purchased. The stock is now a playground for the day traders - the gamblers who like the volatility and risk as the stock gyrates on the uncertainty of the company's future. Citigroup's capitalisation is now below DBS! It is a global giant with a big hole in its balance sheet that needs to be filled and this hole is getting bigger and bigger as the recession deepens.
(SINGAPORE) The Government of Singapore Investment Corp (GIC) will say no to converting its preferred Citi shares into common stock now, a news report said yesterday. The Wall Street Journal (WSJ) reported that GIC wants to keep its US$6.88 billion investment in the US bank, but could face a dilemma if Citi reaches an agreement with US officials that includes a greater government role. This came as Citigroup is in talks with the US government to convert the latter's preferred shares into common stock as a means of shoring up investor confidence. 'We are open to considering a request to do so,' a US Treasury spokesman said. On Monday, the Federal Reserve and US Treasury issued a joint statement, pledging their 'determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments'. The statement said the US Treasury would begin applying its new 'stress test' to major banks today and that banks found lacking in capital would be encouraged to seek private investors. If those banks cannot attract investments from the private sector, the government would step in with a 'temporary capital buffer'. The statement said that any government capital will be in the form of mandatory convertible preferred shares, 'which would be converted into common equity shares only as needed over time to keep banks in a well-capitalised position'. Citi is said to be persuading some investors holding preferred shares to convert some of those stakes into common stock. These investors include GIC, Abu Dhabi Investment Authority and Kuwait Investment Authority. When contacted, a GIC spokeswoman declined to comment. However, the rationale for GIC's refusal to convert is clear - it could suffer losses of as much as 93 per cent. Called 'perpetual convertibles', GIC's preferred shares represent a beneficial stake of 5.3 per cent if converted, and it also offers an annual coupon of 7 per cent. But a conversion into common equity will cut off that income stream. Based on the terms of the initial purchase, GIC must convert at a 20 per cent premium above a reference price, which was set based on the average Citi share price in the days following the initial announcement on Jan 15, 2008. Between Jan 16 and Jan 30, 2008, Citi's share price hovered between US$24 and US$27, giving an average of about US$26. Assuming a face value of US$6.88 billion and a reference price of US$26, a conversion will yield a shareholding of about 220.5 million shares (for which GIC must pay just over US$31 a share). At Citi's US$2.14 closing price on Monday, the stake is worth US$471.9 million. 'If GIC is to convert into common stock, the deal must be sweetened quite a lot. They want to make sure that their return will be equal or above the coupon,' WSJ quoted a source as saying. According to analysts, Citi's reason for persuading some investors to convert to common stock is to stop the US government from gaining a majority stake in the bank. But matters are not that simple. Speaking to BT, CIMB economist Song Seng Wun said that if GIC converts its preferred shares into common stock, alongside the US government, this will lead to an enormous dilution of the sovereign fund's stake. 'On the other hand, this may be the only option. If GIC does not convert, and the situation worsens, even the 7 per cent annual coupon may vanish as well,' Mr Song said. Plus, there is also the spectre of a possible nationalisation of the US bank. Given that GIC's preferred shares may be classified under equity, a full nationalisation of Citi could see its entire stake wiped out. The US authorities and Citi have their own issues to deal with. According to reports, the new stress test is likely to measure tangible common equity (TCE) ratios - what shareholders would get back if the company were to be wound up. And Citi is likely to fail the test as its 1.5 per cent TCE ratio is already below the 3 per cent seen as safe. Meanwhile, the Financial Times quoted Jason Goldberg, a Barclays Capital analyst, as saying that the US government would have to convert US$15 billion of the US$45 billion in Citi preferred shares it holds to keep its stake at about 40 per cent. 'However, if, as Citi is pushing for, other holders of preferred shares such as sovereign wealth funds and institutional investors were also to convert their US$30 billion worth of securities, the government could convert more than US$30 billion without gaining a majority stake.'