Monday, March 02, 2009

Citi Is Scrambling To Survive

The near bank nationalisation of Citgroup sent its shares spiraling downwards. Didn't Roubini advocate bank nationalisation? Was the move bad? The government's term sheet proposed the conversion of
Citi preferred stock into common at a price of $3.25. The face value of Citi preferred stock is $25, implying 7.69 shares of common to be received per preferred share (at $3.25). If all the preferreds convert, the common shareholders will see a 75% dilution. What that means is that assuming earnings go back to what it was 5 years ago, the EPS would have to see a similar 75% dilution in real EPS just by the sheer amount of new common shares. So, if you think Citi was going back to $40 like in the old days - similar earnings 5 years ago would only make the current Citi share to reach $10, and that is a wildly optimistic view now. Citi should be locked under $5 for the next few years.

Following the announcement, Citigroup traded at around $1.60 on Friday, a preferred share holder would effectively had an an implied value of $12.30 of common stock per preferred share. Citi preferreds traded down to a low price of $4.5 early in the day, after closing at $5.50 Friday, however they quickly inverted and hit a high of $9.25 as people realized the potential arbitrage, before closing for the day at $8.05 on volume of 46.5 million shares. This was an excellent arb opportunity whereby you can short 7.69 shares of common for every share of preferred purchased. This arb is worth nearly 50% return. I do believe that the government's move was "positive" for Citi. However there are some unknowns still in the conversion amount, and added to that the arb opportunity caused persistent selling in the second half of the day.

The uncertainty also affect the arb in addition to shaking down the share price. There was a footnote in the Citi illustrative example of how preferred to common conversion would take place, where Citi noted that the government will provide separate treatment for private and public preferred shareholders: "Ownership assumes conversion of publicly issued preferred stock is done at a significant premium to market, while the U.S. Government's and privately placed preferred are done at par." Which is to say the rest of the preferred stock's conversion rate is still unconfirmed.

The arbs are now hoping that the premium for their publicly purchased preferred shares will be lower than the "guaranteed" 50% return they would pocket if they executed the trade at the end of the day, as otherwise they face massive losses on the conversion. If not, the whole arb trade will collapse and you will see massive short covering in Citgroup shares.

The government's move is good as it will give effective control to the government, hence the bank would be more than likely to be biting the bullet on some of the niggling issues which many troubled banks have been neglecting to do - sell down the toxic assets; work closer with private equity and hedge funds to take some of the toxic assets off the books. The other good from the move is that Citi will save from having to pay dividends/interest on the preferred stocks that have been converted. Don't laugh, that is worth some $10bn over the next few years, which is as good as receiving a capital injection of $10bn to Citi.

The other reason for the sell down is the amount new to be converted stock that is coming onto the market for Citi by the preferreds. The key to raising confidence in Citi was to massively increase its tangible common equity, a measure of capital that shows the value attributable to common shareholders. TCE doesn't include securities such as preferred shares. Citi's TCE prior to the new move was at a shaky 1.5%, now it should go above 4.3%. Citi still has to convince Singapore's GIC and Abu Dhabi I.A. to convert their preferreds - a move not palatable to them but in the end they will have little choice really. Expect Citi shares to swing wildly over the next few days but I expect reality to sink back in and go back above $2, some short covering to come in as well.

p/s photo: Marion Caunter


Anonymous said...

Sounds like a good opportunity to put in a long trade ...nice story

Hin Lun said...

Good analysis. I do agree it's a long term positive move. As you rightly pointed out, the EPS dilution will be less than the implied 75% because of the elimination of preferred dividends. Goldman had estimated that the normalised earnings power will fall by about 50%.

solomon said...

Well, I am convinced that the preferred share conversion is one of the effective ways to curb extra money flowing out, than the exec pay cap.

With the closing price of USD1.6 on Friday, Citi is almost like or lower than the price our CIMB.

If one believe that this patience (Citi) can be nursed, considering the worldwide biz model, does it sound good than Maybank cash call?? For those who are not convinced, they may want to see another AIG in the making??

What can the govt do if the ammunication of interest rate and stimulus runs out? Would slashing of tax rate be the next? By then, the Govt coffers will soon run dry lo?

My conviction is the market, whether equities or commodities, needs a meaningful rally to bring the consumer to spend....only hope and believe will steer us through.

Datuk said...

Judging from the balance sheet position, the qualities of its assets and liabilities, factor in the on-going asset devaluation and the nature of banking businesses in depression period, it wouldn't be wrong to say that only one phrase can used to describe citi bank: the death of citi, another casualty of great depression of 2008-2010.

If the above message still not get across to you....amen. God Bless You.

Sorry, that statement was quoted to my personal friend somewhere in oct-nov 08 when citi broke below US$10 and he was in the process of accumulated 50K share...

Today, same message to others even the share is quoted US$ 1.60..

see said...

Sorry for off topic.....Dali, were you invited to the Sime Darby's PR stint schmoozing bloggers regarding the Labu airport? Read here

Too bad you could have thrown questions they couldn't answer

Ivan said...

Ivan say only can have long Citi if Citi is below US1 ^_^

Sorry. No ofense.

Arn said...

This guy seems to think Citibank is dead already:

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