At the beginning of last week Citigroup unveiled massive layoffs; in the middle of the week it agreed to put $17.4 billion worth of the remaining Citi-advised structured investment vehicles on its books; and by the end of the week Citi shares were trading below $4.00. So yesterday the Treasury Department, the Federal Deposit Insurance Corp., and the Federal Reserve stepped in, plowing $20 billion from the Troubled Asset Relief Program into the giant and agreeing to backstop $306 billion in uncertain loans and assets. Citi will still have to cover the first $29 billion in losses. Beyond that the government will absorb 90 percent of potential losses, with Citi shouldering the rest. Treasury and FDIC will receive $7 billion in preferred stock as part of the deal.
Citi said the “program significantly strengthens Citi’s key capital ratios by generating approximately $40 billion of capital benefits as follows: $20 billion from the TARP investment; $3.5 billion, the portion of the $7 billion preferred stock fee recognized for capital purposes; [and] $16 billion of benefits resulting from the asset guarantee.” The infusion will put the bank’s Tier 1 capital ratio at 14.8 percent.
The move got mixed reviews from analysts and other financial market participants. “You won’t have a deposit run at Citigroup,” says one observer. “It’s a pretty good compromise, but it’s no magic bullet. Citi’s balance sheet is materially weaker than its peers. The bank is simply too big to fail, and it will have to do whatever it takes to get its revenues and costs in line.”
Deutsche Bank research analyst Mike Mayo is less than enthralled. “The best benefit we see to the new Citi plan is that other large banks should now have an incrementally stronger counterparty,” he writes in a company alert. While giving a nod to “new capital, a cap for some losses, less extreme tail risk, and likely more confidence [with] depositors and debt holders that should protect against a downward spiral,” Mayo cites greater government involvement, continued loan risk and “no changes in corporate governance (yet)” as drawbacks.
Betsy Graseck, analyst at Morgan Stanley, writes, “U.S. government’s ring fencing of [Citi’s] $306 billion in troubled assets is a strong positive for the system and for Citi shareholders.” She continues: “On paper, Citi shareholders are diluted near-term by the cost of the incremental preferred stock. However, we expect that Citi’s shares should rise too as the cost of this preferred coupon and a lower dividend is offset by the reduction in tail risk of these trouble assets.”
The Citi rescue package won’t be the last, according to Edward Harrison, a banking and finance analyst at Global Macro Advisors. “Because fractional reserve banking is inherently reliant on depositor, investor, and counter-party confidence, we risk further episodes of a similar nature unless toxic assets are stripped out of the system and potentially insolvent banks are swiftly dealt with by the government,” he notes on seekingalpha.com. For a day, at least, investors seemed cheered by the news: The Dow Jones Industrial Average closed at 8,443.4 yesterday, up 4.8 percent from Friday, and Citi jumped to $5.95 from $3.77.