Government Taking A Bigger Stake In Citigroup: A Better Appearance For Citi?

It appears that the government is close to a deal in which they will take a larger stake in Citibank (C):

From the WSJ:

Citigroup Inc. and the U.S. are close to an agreement in which the government will substantially increase its stake in the bank and will demand boardroom changes in return, according to people familiar with the matter.

The deal, expected to be announced Friday morning, is designed to ease jitters about the soundness of one of the world’s largest financial institutions. Under terms being finalized late Thursday, the Treasury has agreed to convert some of its current holdings of preferred Citigroup shares into common stock, a move that could better protect shareholders against future losses

As a condition, the government is demanding that the New York company overhaul its board of directors, the people said. Treasury will call for Citigroup’s board to be comprised of a majority of independent directors. Chief Executive Vikram Pandit is expected to keep his job under the agreement.

The government will convert its stake only to the extent that Citigroup can persuade private investors such as sovereign wealth funds do so as well, the people said. The Treasury will match private investors’ conversions dollar-for-dollar up to $25 billion.

The size of the government’s new stake will hinge on how many preferred shares private investors agree to convert into common stock. The Treasury’s stake is expected to rise to up to 40% of Citigroup, the people said…

…The conversion will come at the most-favored price, meaning the government will get the best price of the private shares that are converted. Citigroup has already begun talking with preferred shareholders about the conversion, people familiar with the matter said.

The conditions imposed by the government were hammered out over a week of negotiations. They are designed to make up for the fact that taxpayers will bear greater risk holding common stock rather than preferred. The common shares also won’t pay dividends, unlike the preferred stock.

While the government isn’t injecting additional taxpayer dollars into Citigroup, the agreement will help the company by boosting a key financial metric known as tangible common equity, which essentially measures what shareholders would have left if the company were liquidated. The government and banks have concluded that beefing up tangible common equity was a key to arresting the downward spiral in financial companies’ shares.”

More details can be found here.

A couple of things:

Appearances: this whole thing looks like legalized accounting chicanery that will enable Citibank to “appear” more stable per regulatory and other requirements, as opposed to a move that legitimately improves the bank’s financial condition. I’m not saying that taking debt off the books doesn’t help, but that this really is more about making things appear better from an accounting perspective than it is about making a tangible improvement to the bank’s financial condition.

Nationalization: if a private equity firm or a group of investors were to acquire a 40% stake in Citi, begin making changes to the board, management, etc, we would say that the company had been taken over, yes? Well now that the government has done the same, it’s fairly safe to say that arguing that the bank hasn’t been nationalized is purely academic at this point. For all intents and purposes Citi is now  state controlled bank, and while it may not be technically nationalized the level of control is virtually the same.

My concern on a go-forward basis is that the government will force Citi to make decisions that are more to serve political agendas than the health of the business. After all business sense was  ignored in the favor of politics, with respect to how the Mortgage GSEs were managed.

Vikram’s Farcical Reign: Can someone tell me why the former head of a failed hedge fund that cost Citibank billions is now running the bank? Can we truly say that Chuck Prince and Vikram are truly all that different aside from the fact that Vikram managed to get out before his hedge fund imploded?

In many ways this is rather reminiscent of when UBS fired its COO and replaced him with their Chief Risk Officer after a $3.4 billion mortgage securities write down in 2007, apparently they thought that the best thing to do was to promote the guy in charge of managing risk who didn’t see the big risks coming.

You can read more on the situation via the following:

Earlier coverage on the potential agreement with the WSJ, which discusses the global implications of the deal, including the possibility that Citi would have to sell off Banamex it’s Mexican banking arm, as well as having to deal with regulatory and ownership issues in various countries around the world.

An article discussing Citi’s issues with the amount of control/influence the government was exerting on the bank before this deal was even announced; you can also find a slide show on the topic here.

Source:

The WSJ: “U.S. to Take Big Citi Stake and Overhaul the Board” — Deborah Solomon, David Enrich, February 27, 2009.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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