Citi revived but its ills are not cured
By Peter Thal Larsen and Adrian Cox
Published: November 24 2008 19:36 | Last updated: November 24 2008 19:36
Ever since the Swiss state bailed out UBS last month, executives of the banking group have touted the plan as a blueprint for other governments seeking to rescue their troubled banks.
At first glance, the US government has taken a similar approach in recapitalising Citigroup. However, there are some important differences between the two plans that raise the question – does the government’s move mark a definitive end to the US bank’s problems?
The Citigroup bail-out represents an attempt to deal with the two aspects of the bank’s problems: a huge portfolio of potentially toxic assets – loans that have, or could, go bad – on its balance sheet, and a perceived lack of capital to absorb future losses from the economic downturn.
In broad terms, this resembles the UBS plan, where the Swiss government effectively removed toxic assets worth $60bn from the bank’s balance sheet. UBS’s losses on the assets were capped at $6bn. In return, UBS issued the Swiss government with $6bn of notes that are convertible into ordinary shares.
The Citigroup plan also underscores the evolution of the US authorities’ thinking on bailing out banks. Under the original Troubled Asset Relief Programme, launched in September, the US government set out to spend $700bn buying troubled assets from its banks. This morphed into a plan to use the funds to recapitalise banks by buying preferred stock.
“The initial proposal to buy bad assets wasn’t workable because you just couldn’t value them,” says Geoffrey Wood, a finance professor at City University’s Cass Business School. “You had to get capital into the banks.”
The Citigroup bail-out effectively combines both approaches: the government is largely capping the bank’s future losses on $306bn of assets, while boosting its capital by buying $27bn of preferred stock. Executives on Monday suggested that such an approach could also be applied to other US banks.
But, importantly, Citigroup’s exposure has not been fully capped: it will absorb the first $29bn of pre-tax losses on the assets, and a further 10 per cent of any losses above that figure. The assets are currently priced at their level at the end of October, although those assets that are valued on a mark-to-market basis will be revalued before the US government deal is completed.
Gary Crittenden, Citigroup’s chief financial officer, on Monday stressed it was “a very remote possibility” that the losses on the assets would rise above $29bn. The main attraction of the US government’s guarantee, he said, was to allow Citigroup to reduce the risk weighting it must attach to the assets to 20 per cent, freeing up capital.
The other question is how the US government’s recapitalisation of Citigroup will affect the business in the future. Mr Crittenden argued that the $27bn injection would boost the two most important measures of balance sheet strength: its Tier One capital ratio, and the ratio of its total common equity to risk-weighted assets.
However, rival bankers point out that the US government’s preferred shares cannot absorb any of Citigroup’s future losses until the common equity has been wiped out. They also point out that dividend payments on the US government’s preferred shares in Citigroup – which now total $52bn – will absorb a substantial amount of the bank’s future profits.
All this suggests that Citigroup will, at some point, have to rebuild its common equity base. As one banker put it on Monday: “This deal has clearly given Citigroup the oxygen to breathe and to look at their options, but it hasn’t necessarily put Citi back on a going concern basis.”
Copyright The Financial Times Limited 2008
http://www.ft.com/cms/s/0/b505415e-ba57-11dd-92c9-0000779fd18c.html
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