Citigroup’s Collapse Is Unthinkable, What Are The Other Options?

Citigroup (C) is one of the largest banks in the world.  I don’t think that they will be allowed to fail. The counter-party exposure is too large.  Let’s consider some of the facts:

• Citigroup has raised about $50 billion of capital from sovereign wealth funds and $25 billion from the US Government in the past year. On Monday, it announced that it would cut 52,000 jobs, double the number previously indicated, to help to reduce costs. Those cuts will come on top of the 23,000 that it has shed in the past nine months as the fallout from the housing crisis continued to take its toll.

• Citigroup is expected to need up to $100 billion (£67.5 billion) in the next 18 months from another government bailout. Prince Alwaleed, the Saudi Arabian billionaire, is Citigroup’s largest individual shareholder with a stake of just under 4 per cent. He pledged his support for the bank, saying he “strongly believes” that the stock is “dramatically undervalued” after falling nearly 80 per cent this year.

• Prince Al-Walid bin Talal bin Abdul Aziz Al Saud: (born 7 March 1955) is a member of the Saudi Royal Family, and an entrepreneur and international investor. He has amassed his fortune through investments in real estate and the stock market. As of 2007, his net worth is estimated at US$29.5 billion, according to the Arabian Business rich list published December 2, 2007. He is ranked byForbes as the 20th richest person in the world, and is the second richest man in royalty next to the Sultan of Brunei. He has been nicknamed by Time magazine as the Arabian Warren Buffett.

• The Prince’s activities as an investor came to prominence when he bought a substantial tranche of shares in Citicorp in the 1990s when that firm was in difficulties. With an initial investment of $550 million to bail out Citibank caused by underperforming American real estate loans and Latin American businesses, his holdings in Citigroup now comprise half of his wealth worth US$10 billion.At the end of 1990 he bought 4.9% of Citicorp’s existing common shares for $207m ($12.46 per share)-the most that he could without being legally obliged to declare his interest. In February 1991, as American troops stationed in Saudi Arabia were preparing for war with Iraq, the prince spent $590m buying new preferred shares, convertible into common shares at $16 each. This amounted to a further 10% of Citicorp and took his stake to 14.9%.
• The Economist has expressed doubts about the source of income of Prince Al Waleed and whether he is a front man for other Saudi investors. According to it, he has not earned enough income from his investments to pay for all that he has spent in the 1990s. The mystery goes back to that first stake in Citicorp. The prince has declared that this money came entirely from his personal funds. He says he started out in 1979 with a loan of just $30,000 from his father. He also mortgaged a house that his father had given him, raising approximately $400,000. And each month, as a grandson of Ibn Saud, he receives $15,000. “You could barely clothe a Saudi prince for such sums, let alone furnish him with a multi-billion-dollar empire. Nevertheless, by 1991 Prince Alwaleed had felt able to risk an investment of $797m in Citicorp”, writes the newspaper.

Let’s think about the word “fail” for a minute.  It’s a word that is bantered about a lot lately, but I think we need a better definition of the word.  When we talk about a “failure”, really, what we’re trying to do is predict the possible outcomes of the crisis.

• Stop all operations -  Cease all operations tomorrow, declare bankruptcy.  I find that this is an unthinkable.   As I mentioned above, this option is not really likely due to the counter-party exposures. If you think GM (GM) and Ford (F) failures would have an impact on the economy, Citigroup failure would be devastating.  Equity holders would be wiped out in this scenario.

• Government bailout - Have the government step in and backstop all the potential liabilities.  This could be a deal where the government buys some preferred stock, ahead of the equity holders.  This would be similar to some of the other deals we’ve seen.  This would most likely not wipe out equity holders, but would depress values even further.  I don’t view this scenario as “most” likely.  The government balance sheet is getting stretched thin enough already.  It would be politically un-popular for the government to pump a lot more money into Citigroup, in light of GM, F and Chrysler’s begging for $’s.  If the government provided a “watered down” bailout, then it might not have the intended effect of saving Citigroup.  It could be  perceived as a government mis-step.

• Merger - I could view this as a potential solution.  It’s not likely that it would be merged with one of the other US banks, although not implausible.  Citigroup will most likely need deposits to shore up their capital base.  My sense is that most of the other US banks are not big enough to make a difference.  Citigroup’s derivative exposure is huge.  I think that the US Treasury has tried to setup firewalls with their capital injection process.  They’ve identified Citigroup as one bank that they consider too large to stop operating.  They want to minimize concentration in the banking sector as much a possible.  They don’t want too many assets and liabilities tied together under one corporate entity.  If a merger occurs, then it could take place with a non-US entity.  Perhaps the US could make it attractive for non-us entities to step in and merge with Citigroup.  They could provide a package of tax incentives for the next 10 years or something.  I could see a possible 3 way deal with a Sovereign Wealth Fund, US Government, Non-US Government or another large counterparty - all making a contribution to support the bank.  In general, I think that this would be the best scenario for the equity holders.  It would satisfy all counter-parties and creditors and would most likely become a catalyst for higher equity prices.

Under all circumstances, the government and the bank seem to have now moved into that “zone” where they have to announce something.  Some sort of constructive action needs to be announced to settle the frayed nerves of all parties involved.  My sense is that we might get some sort of announcement before the weekend is over.  I’m sure that there are all night discussions taking place about how to best resolve the crisis.  The equity markets wait to hear…

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