Citi Seeking Authorization To Increase Common Stock From 15 Billion To 60 Billion

Citigroup filed a proxy today in which it disclosed it was seeking to increase its authorized common shares outstanding from 15 billion to 60 billion. While the preferred to common conversion was expected to increase the total common from 5.4 billion to 22.8 billion, the 60 billion number, which obviously was not picked out of a hat, implies that the bank will likely proceed with its creeping equitization plan and potentially dilute the Citi common stock by more than another incremental 100%.

In the meantime, the Common-Pref arb holders are sweating their gonads off day after day, as the exchange which was supposed to close months ago, is still off somewhere in the nebulous and stagflationary future. Of course, when you are paying 100% annual repo rates for those 7.3 shares of common short, every single day bites more and more of your "guaranteed" IRR off. Bloomberg had this to say on the persistent mirage that is the closing date:

Citigroup Chief Financial Officer Edward “Ned” Kelly said on a May 7 conference call with analysts that the SEC must sign off on the exchange documents before the offer can proceed. The bank separately needs to complete an agreement with the U.S. Treasury Department to convert as much as $25 billion of government-held preferreds into a 34 percent common stake.

Once the exchange offer is formally extended, the bank will keep it open at least 20 business days before closing, according to the filing.

“We plan to launch this as quickly as we can,” Kelly said on the May 7 call.

In a note to investors yesterday, Sanford C. Bernstein & Co. analyst John McDonald wrote that “questions remain about both the timing and amount” of the pending offer.

“While it is difficult to gain any clarity on this issue, we sense that Citi will likely complete its preferred-to-common exchange in early- to mid-third quarter,” he wrote.

Looks like Ned and the SEC are fully set on precipitating total and complete IRR shrinkage, and wrecking whichever funds are still left in the trade. Once that is done, the subsequent 100%+ dilution once the CRE volcano finally explodes, will make any remaining longs very unhappy. Sphere: Related Content

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Citi Needs Up To $10 Billion In New Capital

WSJ out with a stunner, explaining the reasons behind the delay of the stress test releases until May 7th. And if Citi, which already has done some massive creeping equitization of its preferred stock is still in this much pain, one can only imagine what lies in store for Bank of America and even Wells Fargo.

From WSJ:

Citigroup Inc. may need to raise as much as $10 billion in new capital, according to people familiar with the matter, as the government continues negotiations with banks over the results of its so-called stress tests.

The bank, like many others, is negotiating with the Federal Reserve and may need less if regulators accept the bank's arguments about its financial health, these people said. In a best-case scenario, Citigroup could wind up having a roughly $500 million cushion above what the government is requiring.

For certain banks who can't raise new funds from private investors, federal regulators are allowing banks to consider giving the government stakes in their common equity, people familiar with the matter say. That would help fill their capital needs but would also raise thorny questions about how close a role the U.S. will play in their daily operations.

The outcome of the stress tests could play a major role in shaping the next phase of the U.S. government's intervention in the nation's ravaged financial system. After the results, banks will have 30 days to give the government a plan and six months to put it into effect. The banks are expected to reveal their plans next week.

Concerned about investor and depositor panic, government officials have said banks needing more capital should not be viewed as being at risk of collapse. In fact, the government has said it would not allow any of the 19 banks undergoing the test to fail.

Banks have been scrambling over the past week to refute the Fed's preliminary conclusions. Bankers say those negotiations are part of the reason the government has pushed back its announcement of the results.

"The gloves have been taken off, and there's some real battles going on right now," said Gerard Cassidy, a bank analyst with RBC Capital Markets.

The last paragraph from the WSJ article is simply the most stunning example of the banks' ongoing hypocrisy:

Some banks are haggling with the Fed over how it calculated their projected 2009 and 2010 revenues -- a central factor in gauging banks' ability to absorb losses. Some have pushed the Fed to use their strong first-quarter performances as a baseline, even though many acknowledge their first-quarter results are likely unsustainable.

They are haggling with the Fed based on their "strong" first quarter results (which were all due to taxpayer gifts to every single bank via the AIG funnel)? Come again? Are there any boards of directors left at any of these firms to supervise the sheer lunacy that management teams projectile vomit in the general direction of Barak Obama, Tim Geithner and CNBC's audience?

Why should Chrysler creditors be forced to suffer and be scapegoated in front of the entire world, while we don't know who one single large creditor of a Citi or of BofA is? .... but we can speculate...Hey Obama/Tim - how about some bank creditors suffer a loss here and there too in your witch hunt against "all those self-serving Wall Streeters." Does it maybe have to do with the fact that these are not really Wall Streets at all but the very same gullible fools who are supposed to lap up the $1 trillion + in USTs you will be shovel feeding over the next year... yes, the same investors who still have their investment in Freddie and Fannie marked at par compliments of Uncle Sam and Joe Taxpayer.

All is good though: CNBC just announced that all is priced in, and that no bad news can ever move the market lower as everything negative has been factored in every single stock price in perpetuity and then some.

Enough with the hypocrisy! When is Lewis Black going to do a Wall Street special?

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Fed To Tell BofA, Citi To Raise Billions More In Capital

WSJ has yet another leaked version of the stress test results. In summary, both Bank of America and Citi will be urged to raise up to billions more in capital. As this is likely yet another form of PR manipulation, ZH will not comment on this topic until more data is available.

Of course, if the news is true, it would be an epic failure both for the administration, which first strongarmed Lewis to buy Merrill, using lawsuit-worthy mechanisms, and now is forcing the company to raise even more capital as a result of ML's losses, and also for Ken Lewis himself, who repeatedly stated that he will not need to raise more capital, at roughly the same time as his flamboyant disclosure over BofA record Q1 profitability. Class action lawsuit attorneys everywhere just caused Mumm champagne sales to spike through the roof.

Regardless, the news has done a trick on futures which have taken a sharp turn lower in the past hour or so. Tomorrow bank stocks will look like Bremen during the Battle Of Britain.



hat tip Matt Sphere: Related Content

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The Citi Market Barometer

When Zero Hedge first presented its thesis about a likely upcoming mega squeeze in Citi common concurrent with the bank's shares trading at $1, some readers expressed their dismay with our lack of intellectual capacity. Less than two months later, and $3 dollars higher, the situation has changed... at least for the Citi shorts.

However, has the situation changed for the bank itself? Citi, along with the the rest of the banking sector beat modest earnings expectations. But is Citi to be lumped into the JP Morgan and Goldman Sachs camps, the latter guilty of such Julian to Gregorian legerdemain that it makes the alleged $3 billion in commodity-related undermarks in December (and funneling them through FICC no less) and subsequent MTM reversion seem tame in contrast. Egan Jones, easily the best rating agency (which is not really saying much when your competition is the buffoonery conglomerates known as S&P and Moody's), had the following choice words in their developing analysis of Citigroup:

Accounting and government magic - the recasting of FASB157 enables financial institutions to defer the recognition of losses with the result that C's March trading profits swung from a $6.8B loss to a $3.8B gain. Another item worth reviewing is the decline in interest expense from $16.5B last year to $7.7B this year. Nonetheless, much more equity capital is needed. Beyond the conversion of preferred to common, watch the form of any additional capital. The Fed and Treas. have guaranteed $306B of C's assets, have injected $45B in preferred and converted to common leaving few additional options. The problem is that C has $2T of assets ($3+T including off balance sheet assets) whose values are depressed by 10% to 20%. C needs to be watched.

Egan Jones is not alone in their condemnation of Citi's grotesque Criss Angel-esque interpretation of reality. The consensus seems to be thumbs down for the bank, even though the latter, together with the balance of the worst companies in the S&P, has benefited mightily from the less and less connected to reality "crap rally" (but more and more connected to quant fund deleveraging and viability).

What happens now? The market has reached a very curious inflection point, which is eerily reminiscent of what happened to the basis trade in the post-Lehman days (just ask Boaz Weinstein for advice if the equity market is cheap now). Liquidity is disappearing - in fact with every market uptick more and more quants and L/S funds deleverage if they can, while some are stuck and have turned their phones off entirely. Ironically, the higher the market goes, the higher the probability that we will see not just a few small quants blowing up, but some of the big guys also taking a bullet to the temple. In a hypothetical case where a $100 billion+ provider of market liquidity ceases to function the market will break, pure and simple: this is not a directional bet, this is a volatility bet.

Ironically Citi common is now the basis trade reincarnated in the ongoing market melt up. As liquidity becomes scarcer and scarcer, Citi's stock price is likely among the best barometers: this manifests in lack of borrow, in high trading costs, increasing repo rates, as well as the threat, despite repeated promises to the contrary, of an adjustment in the common-preferred conversion rate. In an extreme example it is easy to see the stock skyrocketing to multiples of its current price, however when (not if) fundamentals take over, the way down will be quick and painful.

And while Jim Cramer likely top ticks the rally yet again, and Barney Frank wants to guarantee every risky asset in the United States in another misguided attempt of postponing the D-Day for all the fiscal and monetary insanity happening in this country, the FDIC announces that 2 more banks have failed (bringing the 2009 total to 25), which will cost the FDIC (aka taxpayers) $100 million and $143 million, respectively. And while we are on the topic: Sheila, maybe you can at least tells us if the FDIC's Depository Insurance Fund has finally gone negative, especially now that your brilliant actions have made it unneccesary for banks to use the TLGP and thus pay the FDIC the recently increased TLGP fee?

PS: Based on these headlines, maybe Messrs Dudley and Kohn can join Mr. Cramer in the Wall Street Top Tickers cheerleading camp (Zero Hedge to provide its thoughts on Mr. Kohn's misrepresentation of reality shortly). Then again, if even the market custodians of the Federal reserve are doing all they can to get every last retail investor to believe this bear market rally is for real and incite a market liquidity event, then there truly is no hope.

Fed’s Dudley Says Fears of Scrutiny Under TALF Are ‘Misplaced’

Fed’s Kohn Says Emergency Lending Isn’t Creating Taxpayer Risk Sphere: Related Content

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Exclusive: AIG Was Responsible For The Banks' January & February Profitability

Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turns keeps on duping U.S. taxpayers into believing everything is good.

I present the insider perspective of trader Lou (who wishes to remain anonymous) in its entirety:

"AIG-FP accumulated thousands of trades over the years, all essentially consisted of selling default protection. This was done via a number of structures with really only one criteria - rated at least AA- (if it fit these criteria all OK - as far as I could tell credit assessment was completely outsourced to the rating agencies).

Main products they took on were always levered credit risk, credit-linked notes (collateral and CDS both had to be at least AA-, no joint probability stuff) and AAA or super senior portfolio swaps. Portfolio swaps were either corporate synthetic CDO or asset backed, effectively sub-prime wraps (as per news stories regarding GS and DB).

Credit linked notes are done through single-name CDS desks and a cash desk (for the note collateral) and the portfolio swaps are done through the correlation desk. These trades were done is almost every jurisdiction - wherever AIG had an office they had IB salespeople covering them.

Correlation desks just back their risk out via the single names desks - the correlation desk manages the delta/gamma according to their correlation model. So correlation desks carry model risk but very little market risk.

I was mostly involved in the corporate synthetic CDO side.

During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever".

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks - effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities - run a chart from say last September to current of say S&P 500 and Itraxx - credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period."

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman's terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers' money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.

And the conspiracy thickens.

Thanks to an intrepid reader who pointed this out, a month ago ISDA published an amended close out protocol. This protocol would allow non-market close outs, i.e. CDS trade crosses that were not alligned with market bid/offers.

The purpose of the Protocol is to permit parties to agree upfront that in the event of a counterparty default, they will use Close-Out Amount valuation methodology to value trades. Close-Out Amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the Market Quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.

Of course ISDA made it seem that it was doing a favor to industry participants, very likely dictating under the gun.

Industry participants observed the significant benefits of the Close-Out Amount approach following the default of Lehman Brothers. In launching the Close-Out Amount Protocol, ISDA is facilitating amendment of existing 1992 ISDA Master Agreements by replacing Market Quotation and, if elected, Loss with the Close-Out Amount approach.

"This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility," said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. "The Protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances."

And, lo and behold, on the list of adhering parties, AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment).

So - in simple terms, ISDA, which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. In traditional equity markets this is a highly illegal practice. ISDA is allowing retrospective arbitrary trades to have occurred at whatever price any two parties agree on, so long as the very vague necessary and sufficient condition of "market quotations may be difficult to obtain" is met. As anyone who follows CDS trading knows, this can be extrapolated to virtually any specific single-name, index or structured product easily. In essence ISDA gave its blessing for below the radar fund transfers of questionable legality. The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least.

This wholesale manipulation of markets, investors and taxpayers has gone on long enough.

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The Ridiculous Marks of Toxic Assets (part 2)

Following up on Tyler's earlier post, it's important to put the potential PPIP assets in perspective to the overall holdings of the banks.












Citi is clearly the most interested party in this whole thing, with a whopping 44% of its total assets tied up in legacy assets. As Citi is valuing these things at such a ridiculously high level, Citi stockholders are going to be closely watching the PPIP proceedings and how the players approach their bidding strategy. The benefit of the PPIP-leverage is it is likely to boost valuations higher than they would be without the PPIP leverage/backstops - it remains to be seen if that benefit will be substantial enough to stem the bloodloss at Citi.

Another interesting tidbit is that the weighted average ex-Citi is still at a pretty high 9%. If the valuations for these legacy assets drop from the 90-100 range to roughly half that (which doesn't seem wholly unreasonable) that's an instant 5% drop in assets across the entire financial industry.

The takeaway from this whole thing is that the PPIP program is wrought with conflicting interests, and every movement in valuations for deals is going to have a huge impact beyond the specific parties of that particular deal. Stay tuned...

Update: Institutional Risk points out the gap between Geithner/Bernanke's pricing of these legacy assets at around 80 cents/dollar and the market's pricing at between 20-40 cents/dollar. Further, it highlights the possibility of these following to 15 cents/dollar by Q3 - implying a 37.4% net asset markdown for Citi and a 7.65% net asset markdown across the entire financial industry. Sphere: Related Content

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Before Citi Is Forced To Move Its HQ To Weehawken

Nothing like the threat of little public lynching to get transparency...

For Immediate Release
Citigroup Inc. (NYSE: C)
March 19, 2009

Citi Clarifies Media Reports about Office Consolidation

New York - In response to numerous misleading media reports regarding the office consolidation at Citi's global headquarters at 399 Park Avenue, Citi issued the following points of clarification:

* The consolidation of our executive headquarters at 399 Park Avenue is part of an ongoing global effort to substantially reduce expenses.

* Over the last two quarters, reported premises and equipment expenses are down by $100 million, and Citi expects to realize significantly more savings in 2009.

* Globally, office density will be 120 usable sq. ft. per person by the end of 2009, down from 132 usable sq. ft. per person currently.

* The consolidation of the executive headquarters at 399 Park Avenue is part of the global cost savings initiative and will result in the reduction of space on the executive floors by 50%, going from two floors to one and subleasing the remaining space.

* This consolidation and subsequent costs are for all executive office space at 399 Park Avenue, not just the CEO's office.

* Citi is doubling the overall occupancy rate on the remaining floor at 399 Park Avenue by creating smaller offices, increasing work station to office ratios, and by utilizing alternative work strategies.

- Occupancy on the remaining floor goes to 177 from 89 currently.

* The 399 Park Avenue office space consolidation, through densification and sublease, is estimated over the life of the lease to net $20 million in savings, an amount well in excess of the project costs. This estimate is based on conservative assumptions regarding the price and timing of the sublease.

* This consolidation is about cost savings and anything reported to the contrary is misleading.

Premises and Equipment Expenses

Q208 Q408
$1.834 B $1.737 B

(Source: Citi 4Q08 Financial Supplement)

Total Global Real Estate Space (million square feet)

Q208 Q408 Projected Q409
100.2 94.3 83.9

Selected 2008/2009 Site Dispositions (New York City only)

Square Feet

250 West Street: 371,625
77 Water: 94,252
731 Lexington Ave: 176,030
333 W. 34th: 338,411
787 Seventh Ave: 270,311
Citigroup Center: 175,076

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A Graphic Representation Of The Citi Arb Carnage, Over $5 Billion In Losses

It took all of 2 weeks for the Citi Common-Preferred arb to become Volkswagen Jr. And if the administration feels abnormally nasty, this could become a fast money hedge fund neutron bomb that would make the Volkswagen megasqueeze seem like dress rehearsal for the Mormon tabernacle choir. But don't take my word for it: here is just how it looks graphically. The screen below is a Bloomberg CIX screen based on the formula: (C Common)*7.31 (pro forma for the 0.95 price adjustment) - (C AA Preferred). Now in an ideal world for there to be no Common-Preferred arbitrage, this would have to be equal or close to zero. Indeed this was the case for a while, when the $1 delta was embedded in the arb due to the risk of regulatory change in the final outcome of the deal (i.e. preferred getting converted into less than 7.31 shares of common). Then over the past three days something went horribly wrong and the arbitrage exploded. As ZH wrote earlier, the increasing borrow pulls by both retail and institutional holders of underlying stock, as well as some potential Orwellian not so invisible hand here and there, and all the funds who had shorted 7.69 shares of common for every preferred share they bought started to get a nauseous case of Volkswagen deja vu. It will be very poetic justice if the funds who barely survived VOW GR, end up imploding as a result of the Citi arb.



As the chart above shows, funds that have put this trade on over the past 2 weeks are now facing a loss of about $7.5 per unit (assuming it was put on when the delta was $1 which was the predominant value of the past 14 business days). If one assumes that a half of the trades in Citi common stock since the government's announcement of the exchange on February 27 were predicated on the arbitrage, then of the roughly 11 billion shares of common changing hands, there are around 700 million arb units in existence and at a $7.5 loss today, this would mean there could be over $5 billion in unrealized losses among hedge funds at market close today! (the assumptions are broad - I welcome any adjustments to this calculation). And let's not forget the funding cost: one year term borrow on Citi shares from broker dealers that still can find a few repoable shares, can be as high as 200%! This means the longer funds wait for this situation to normalize the more they have to pay. If they hold this arb for longer than 6 months, the arb has to return over 100% for the trade to be profitable, and even at today's closing levels, the best possible return is about 70%.

And the short squeeze is not the bulk of funds' worries... If the government really does feel like obliterating the bulk of the fast money HFs (read: most of them), all it has to do is adjust the terms of the Common-Preferred conversion ratio lower. And seeing how pretty soon C common will be trading above the conversion price for the preferred of $3.25, the likelihood of the ratio getting whacked grows by the day... If on top of a short squeeze, the 7.31 ratio is adjusted to say 3, the ridiculous levels reached by VOW stock will be like a walk in the park compared to the destruction that would follow as everyone runs for the Citi arb exits... Can't say Zero Hedge didn't warn them.

Tangentially, for all value investor club readers, isn't it an amusing coincidence how all your highest rated ideas end up being nuclear ICBMs - first VOW GR now Citi arb? Guess the too good to be true maxim applies not only to ponzi schemes...

6 sigma.

Disclaimer: ZH has been long Citi common since Feb 27. Sphere: Related Content

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Financial Companies' Stock Borrow Disappears

Rampant rumors from traders that repo desks are continuing to call in shares used to short financials such as Citi and AIG (look at charts below for lift off). This is causing a forced covering of all financial shorts, and an impossibility to put on new shorts... Interesting how this happens the day before Obama shows up on Leno. This fits in perfectly with Zero Hedge's conspiracy theory of the Volkswagen situation repeating itself in the financial sector in general and Citi in particular .





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Let's See If Citi Runs Again, Shall We

The fourth leg of the trifecta squeeze just came out (to everyone's total lack of surprise): Citi chairman Dick Parsons said "Citigroup does not need any more capital injections from the government and that the bank would remain in private hands." Demonstrating a keen sense of humor, in an interview with Reuters Dick had this to say:

"I think actually, particularly with the latest conversion... Citi is actually one of the better capitalized banks in the world."

Seeing how Citi has received over $45 billion in taxpayer cash and 3 bailouts since October it would be a shame if Citi was one of the worse capitalized banks in the world. Reuters further claims that the regulators have recently begun work on a contingency plan to stabilize Citigroup if problems mount, but no imminent rescue was planned according to an anonymous person familiar with the plan B preparations.

As the three big bad banks are apparently big fans of Douglas Adams, we expect part 5 of the trifecta to surface tomorrow when Citi's janitor provides his resounding endorsements of the non-nationalizeable nature of the financial conglomerate, and the short squeeze hits 1,500 on the S&P. In the meantime, for your amusement, with Bloomerg's kind generosity, we provide the transcript of the update conference call Lehman held on September 10, 4 days before it filed for bankruptcy and particularly draw your attention to where Dick Fuld says "Today's strategic actions, each of which is significant in its own right, taken together as a whole, significantly reduces our remaining risk and greatly improves our ability to create value for our shareholders." Good stuff.

(Disclaimer: Zero Hedge is, to its own dismay, long Citi stock. )

Lehman Transcript

Publish at Scribd or explore others: Creative Writing

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On The Worthless Equity Value Of Banks

If anyone wants empirical proof of the concept Zero Hedge brought up two weeks ago that the "creeping equitiziation" higher and higher into the capital structure of the sick banks is becoming a major issue for existing bondholders, one just needs to look at the price of Citi 7.25% Sub Notes due October 2010 (70) and Bank of America's 7.4% Senior Sub Debt due January 2011 (85).



Why is this chart relevant. David Darst at FTN puts it best:

"The current prices imply that the companies’ equity is worthless, the government’s investment is worthless and subordinated debt holders will lose some of their investment."

Additionally, the security tranche just below the sub notes, the Trust-Preferred Shares, is trading at less than 30 cents and yielding more than 25%. Zero Hedge has discussed the implications of pricing at various levels of the capital structure previously, but in summary as Citi sub bondholders are expecting roughly 70 cents on the dollar recoveries (at least based on the market action), there is, mathematically, zero value left over for any securities below this tranche, which of course includes both the TRUPS and the common stock. In practice this is not exactly the case due to optionality and hedging, but it does serve as a rough estimate of what the value of both Citi and BAC common stock should be.

There is, of course, an opposing view. Tim Band of Barclays had this to say: "The sell-off in senior bank debt is completely baseless [and prices]are reacting to “inchoate, illogical and poorly reasoned fear of political risk. Prices are cheap creating an opportunity to lock in attractive yields on senior bank debt that has been made more creditworthy than a few weeks ago because of the added government support." Then again, Tim's assumption is based that taxpayer cash will be used to fund asset shortfalls at Citi and BAC, which is not what occurred last time Citi was bailed out. It is ZH's belief that the latest model of forced equitization into common stock with no new capital will be the de facto model to be used by the government going forward, which means that more and more of the lower tier securities will end up getting massively haircut as they get converted into increasingly more diluted common stock.

Since most bank debt is held by insurers and foreign investors, and only a small portfio is owned by mutual funds, the negotiations with these bondholders will be very politically charged but the end outcome will likely still be the same, with the likes of sovereign wealth funds and insurance companies facing significantly more pain in the coming months. Ironically, as bond losses drive the cost of capital higher, the banks will be forced to ensure they don't do the same kind of "sloppy" underwriting that set off the credit crisis, according to Thomas Atteberry of First Pacific Advisors, and may be the reason why banks are so unwilling to lend even to legitimate borrowers as they see the writing on the wall. Atteberry, who is a believer in the tenets of capitalism, concludes "investors who choose to lend money to banks like Citigroup, which is poorly run, should share the pain of a business that’s having to write things off."

But at least Vikram is there to assure the market that all is good with the occassional one page memo now and then. Sphere: Related Content

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Citi CDS Hits Record Wide of 640 Bps

Last market was 615/645. This is roughly where Bear Stearns traded days before Jimmy Cayne's rastafarian reign came to an end.

Below is a chart of Citi CDS through yesterday.

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Citi Issues 8K Clarifying Preferred Exchange Terms

Read all about it here. Looks like discount to privates is only 5%

Summary of public preferred terms:

We are perusing the 8K currently.

Seems public preferreds are happy. C AA stock spiking after government announces conversion number of public prefs into common shares will be equal to the privates after all... unless we are reading this totally wrong...

update - odd selloff in preferreds now from highs of $9.75. Nothing to see here...

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Why Citi Will Not Follow In Lehman's Footsteps

Here is something for all those who say we are permadoom sayers... Fresh from gimme credit, and we tend to agree. A full blown implosion of Citi would be the Mutual Assured Destruction to everyone with exposure to Citi, which is... well... everyone, whether it is by 1 or 6 degrees of separation. Betting on Citi's demise is ironically just like buying US Sovereign CDS: you have a high likelihood of being right, but if you are, the money you make (assuming someone honors the contract you are collecting under) will be worth just the paper it is written on.

From GimmeCredit:

Citigroup’s 10-K filing makes it clear why regulators appear committed to (or perhaps are stuck with) a strategy of supporting the full capital structure (including holding company debt), rather than subjecting the bank to the Lehman treatment. Citigroup has a daunting $1.9 trillion of assets on the balance sheet alone (not counting off-balance sheet exposure). The balance sheet is essentially supported by an uneasy alliance between the U.S. government and the company’s depositors and other creditors, since the market value of the equity is so depressed. Deposits totaled $774 billion at year end, including nearly $500 billion outside the U.S. In a liquidation of a U.S. insured depositary institution, the 10-K notes that U.S. deposits would have priority over deposits outside the U.S., as well as over parent company claims. But we can’t imagine the new administration will want to precipitate an international crisis over whose-deposits-get-paid-off-first. There is $360 billion of long-term debt, including about $24 billion of TruPS-related junior subordinated debt and $34 billion of subordinated debt. At year-end, parent company liquidity, including unencumbered cash deposits at the broker-dealer, totaled $67 billion. But no cash hoard would be big enough right now, without the support of Uncle Sam. Investors are worried (with good reason) about the risk for more markdowns of loans, securities and the deferred tax asset ($44.5 billion). Moody’s lowered Citigroup’s senior and subordinated debt ratings last week, but left the short-term rating at P1 (under the assumption that “systemic support” is “most predictable” for short-term debt.) A downgrade in the C.P. rating would trigger an $11 billion funding requirement. As we discussed last week (see report dated 2/24/09), we see value in Citigroup’s senior debt (although the 5.5% notes due 2013 have tightened to T+604 from T+752 a week ago.

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Exclusive: The Creeping Equitization Of Citi's Capital Structure

Much has been written about the staggering losses of Saudi Prince Alwaleed Bin-Talal in Citi's common stock. The amount of money he has dropped on Pandit's titanic may have easily funded GM's operations.... for about a day. Now as preferred shareholders have joined the fray of impaired parties, other investor higher in the capital structure are starting to feel Geithner's flamethrower. Enter the Abu Dhabi Investment Authority or ADIA as it is better known. News just out of Reuters that Abu Dhabi's sovereign wealth fund, which just happens to be the largest of its kind in the world, is nervous about its $7.5 billion 11% Citi convertible bond investment. The bonds begin converting in March 2010, and through September 2011, ADIA is set to receive 235.6 million shares, at a conversion price between $31.83 and $37.24. Seeing how Citi's common closed at $1.50, ADIA managing director Sheikh Ahmed bin Zayed al Nahyan must be depressed about his prospects of breaking even on this investments any time soon if ever. Granted, ADIA will likely not lose too much sleep over this loss - the sovereign wealth fund which recently completed and moved into the tallest skyscaper in Abu Dhabi (insert), had about $850 billion in its portfolio. However with oil dropping from $120 to $30, with or without USO's shennanigans, even the real masters of the petrouniverse must be scratching their beards...

"Nothing has changed from ADIA's perspective at this point. ADIA's convertible bonds are due for conversion in a phased manner between March 2010 and September 2011, and that stands," an Abu Dhabi government official told Reuters. "But it is carefully assessing its options due to the latest events -- although no decision is taken yet," he said, declining to be named.

Ironically, instead of waiting to see the notes thru their conversion, the fund may decide to convert early making a potential full-blown nationalization even more politically charged, due to ADIA's extended web of investments in a plethora of U.S. companies and GSEs. The last thing Geithner can afford is to anger such a huge investing partner as ADIA, and by implication it neighboring sovereign wealth funds of countries such as Kuwait, Qatar, Dubai, and Saudi Arabia (for a list of all the major sovereign wealth funds, click here). The real concern should be for other convertible (and potentially higher up in the capital structure securities), who unlike ADIA can ill afford to lose out on their heretofore considered safe investments.

"We know ADIA is following the recent developments closely, but as a bondholder, ADIA's investments are secure because the U.S. government has left bond holders untouched, unlike other investors such as preferred shareholders," a senior Abu Dhabi-based banker close to ADIA said."

However, it is early days, and we need to wait and see what ramifications the latest events would have and whether there would be pressure on investors in bonds to convert (early)," he said.

Citi, he said, has been urging preferred shareholders and convertible bond holders to convert to common stock to help avoid nationalization by the U.S. government.

Indeed, what is becoming more and more obvious, is that while the government is unlikely to wipe out the common stock tranche in Citi and other banks ever (which would be de facto nationalization and by implication a failure of a "too big to fail" bank, which Geithner will simply not allow per Lehman bankruptcy consequences), it will continue a forced creeping dilution of higher and higher tranches of the balance sheet into Citi common stock. Yesterday the preferred, today the convertible stock, tomorrow unsecured and lastly secured bonds. At some point the common may actually be worth something fundamentally, regardless of squeezes and other contraptions. We can only hope that in the process Geithner does not royally anger someone really important along the way as he forces stakeholders to convert into chunks of more and more diluted common stock. The other implication is that holders of higher tranches of Citi securities will follow in the preferred's footsteps and commence shorting against their long holdings in advance expectations of equitization. This further increases the likelihood that every fund and their grandmother will soon be short Citi common, and while a Volkswagen outcome is never a certainty, six sigma events just happen to occur on a daily basis lately. Sphere: Related Content

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Why Citi Common Crashed And Why The Common-Preferred Arb Could Be The Next Volkswagen

(Please read update 4 for very important additional information)

The Volkswagen bandwagon idea de jour was a capital structure arbitrage in Citi preferred paired with shorting Citi common. As the government's term sheet proposed the conversion of Citi preferred stock into common at a price of $3.25, a huge number of accounts thought there was a significant arbitrage to be held here.

The math is roughly as follows: the face value of Citi preferred stock (C AA on Bloomberg) is $25, implying 7.69 shares of common to be received per preferred share (at $3.25). As C common traded at an average price of $1.60/share during the day, a preferred share holder would effectively arb into 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 yesterday, 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. The trade could be boxed by shorting 7.69 shares of common for every share of preferred purchased, thereby "securing" a roughly 50% return. This (probably among other things) explains the persistent drop in Citi common over the day as hedge funds were locking in what they thought was a certain premium.

The problem that most however may have overlooked is a little 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."

Investors 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. As the Volkswagen example has taught us, and as the government has shown in its "white glove" treatment of private investors of all kinds, and couple that with some forced repo pulls by Citi common longs who may eventually realize their stock will skyrocket if they cause a forced squeeze, we wait with baited breath to see the carnage as the "Citi Arb Trade" blows up at some point over the next several weeks.

For people who want to dig through the most recent prospectus supplement to the Citi Series AA Preferred stock, you can do so here.

CreditSights has done an invaluable comparison of the 3 different classes of exchanging securities as part of the transaction, listing out the key terms for each tranche of securities. One of the relevant findings is that the gov't will exchange the balance of its existing preferreds (not exchanging to common) into 8% Trust Preferreds. The implication is current TruPS and eTruPS holders will be pari with the government, which is good from a security protection point, but risky in case the government decides to waive the dividend on the TruPS as all current TruPS holders will also lose dividend payments. The last is unlikely as it is the last form of dividend-paying security that taxpayers have remaining in Citi.



But what about all those toxic, toxic assets on the left side of the balance sheetreaders ask? Won't they drag the company down anyway regardless of what the government does on the liabilities side? What good is a technical play if the company is an AIG in the making?

The same people at CS put together a good analysis of what the key Stress Test metric of Tangible Common Equity/Risk Weighted Assets will look like in a severe scenario. And by severe Zero Hedge would use the term realistic. This analysis also presumes that all the potential converters in the preferred to common exchange go along for the ride as demonstrated in Citi's presentation:

The "severe" world is one in which:

• unemployment is 10-12%
• GDP is negative for more than 18 months
• credit card receivable portfolios losses reach 15%
• leverage loan marked down by -45%
• losses on mortgage portfolios are:

1. subprime: -40%
2. optionARM: -50%
3. second liens: -30%
4. Alt-A: -20%
5. first liens: -7%
6. commercial real estate: -15%
7. residential and commercial construction: -40%

Presuming things really hit the skids, the incremental equity generated by the exchange may just be sufficient to not let Citi fail, which itself has stated that based on its own internal stress tests the newly generated TCE "will be enough to let the company pass through this period." TCE/RWA will go from a precariously low 3.0% to 4.9% even in the Draconian scenario. Of course, whether it is pessimistic enough is anyone's call and the government may very well may be left with another AIG, however due to the lack of exponentially devaluing assets such as CDS contracts which become worth less and less with time, Citi's toxic assets may really only go down in value so far.

Disclaimer: ZH purchased Citi common at the end of trading Friday.

Update 1: Story is starting to spread... Picked up by Dow Jones at 10:18 PM...

Update 2: More interesting preferred tranches emerge. The spike in Series AA Preferred occurred with Series T 6.5% preferred as well. The stock, whose liquidation preference is $50 and should trade at double the price of AA by implication, closed at $15.75, a slight arbitrage most likely driven by liquidity.

The higher rated Series XV/XVI and other Trust Preferreds (BB-/BB vs CC+), which traded up to a 10% premium over AA/T comparable $25 liquidation parity closing around $8.80 (we are looking at the structural subordination issues regarding regular preferreds vs TruPS).

Update 3: Some legal perspectives on the deal.

Update 4: Some more math on the current equilibrium price for the preferred based on the very crude information provided by Citi in the conversion example slide:

• As the lower right number indicates there would be 21 billion shares of common outstanding pro forma for all participants converting;
• Current common shares out are about 5.5 billion;
• The government's conversion of its total $25 billion worth of preferred shares would add another 7.7 billion shares of common (at $3.25)
• As the slide shows, combined public and private ownership would be 38% of 21 billion or 7.98 billion. As the private preferreds hold 12.5 billion shares, this implies 3.85 billion of common, leaving 4.13 billion shares of common for public preferreds.
• This allows to calculate what an implicit price for the public preferreds would be: taking 14.9 billion public preferreds translating into the 4.13 billion share of common gives a 3.6 conversion ratio, which is 47% of the unadjusted conversion of 7.69 shares pref/common. Assuming the Friday common closing price of $1.50 is used, we get a value of 3.6 x $1.50 Citi common giving a value of $5.40 for the $25 par value of public preferreds.
• The Pref's closed at $8.05 on Friday. They are said to convert to significant premium to market. If one takes Thursday's closing price of $2.50 for Citi common, 3.6 share is equal to $9/share, which is a 9/5.5 = 64% premium to market to the Thursday preferred closing price of $5.50
• The question is: Is 64% considered a significant premium to the government? The end number could be much lower (or higher). There is no definitive information yet. A "mere" 20% premium to Thursday's close is a $6.6 implied preferred price, a 20% discount to the Friday closing price, and an explicit 20% incremental value to the common as the arb has to be repriced.

P.S. We will not respond to individual emails requesting additional mathematical elaboration. All you need to come to the presumed conclusion is here.

Update 5: Next Bank Of America picks up on this theme and in a research note focusing on the Citi exchange cautions that the Public Preferred could be in trouble:

An important difference in exchange terms wording

We note that in the term sheet of Citi’s exchange offer, privately placed and government held preferreds are to be exchanged into common stock at “$3.25/share at par”. However, publicly issued preferreds (including the Series T 6.5% convertible preferred) are to be exchanged into common equity at “$3.25/share at premium to market”. We think this is an important difference for investors of those targeted publicly issued preferreds. In our view, “$3.25/shareat premium to market” opens up the possibility that those publicly issued preferreds are likely to be exchanged into common equity not based on their original par value, but based on their recently-depressed trading prices.

Implication for the Citi 6.5% convertible preferred

We are looking for Citi to provide additional details on the exact definition of the term “at premium to market” regarding the exchange of those publicly issued preferreds. In our view, “at premium to market” could be interpreted as an “adjusted par value” that is based on past trading price of the preferreds plus a certain premium. Here, we offer our scenario analysis based on certain assumptions. The current trading range of the Citi 6.5% convertible preferred of $15 - $17/share (versus $1.50 C common price) implies an “adjusted par value” of about $33-37/share, which is about 65-74% of the original par value of $50/share and is a premium of 145-178% over the 30-trading price of the series T preferred. Assumptions and detailed scenario analysis are on the second page.

Importantly, investors should note that this is only one of the multiple possible interpretations of the exchange terms, and it could be very different from the more precise exchange terms that Citi may announce later. Investors are strongly recommended to look for Citi’s further clarification regarding this exchange announcement.

Additionally BofA present the following hypothetical conversion analysis on the Citi 6.5% Cvt Pfd (which has a liquidation preferrence of $50, so divide all output numbers by 2 to get comparable values for the Straight Preferred AA, E, and F $25 liquidation pref public preferreds). The question is whether the 45-78% implied premium conversion over recent pref trading prices is what the govt has in mind with its cryptic statement.

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"Alanis Morissette Ironic" Category Research Report Nominee: Citi Cuts GM Target Price to $0.50

Not a lot of commentary needed here although the shout out to Gasparino by analyst Itay Michaeli deserves at least 10 brownie points. One can only imagine if GM had a research department what they would have to say about Citi's stock price target. But it would probably look like this, taken verbatim from the GM report:

"Given GM’s [CITI's] complex restructuring and Chapter 11 risk, valuing the stock remains very fluid. We value the shares off an out of court workout simulation consistent with GM’s [CITI's] 2012 plan."


GM Citi - Free Legal Forms Sphere: Related Content

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Vik Bandit To Present In Public New Version of His Resume on January 27

Or, if not that, then something else. Citi has announced Vik will present at Citi's 2009 Financial Services Conference in NY on January 27 at 12.45pm... If anyone cares they can listen to webcast here: http://www.citigroup.com/citigroup/fin Sphere: Related Content

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Semi-Breaking News: Citi Out With Confirmation of Nothing

Citi Statement

Business Wire

NEW YORK -- January 13, 2009

Citi today said that the company is in discussions with Morgan Stanley (NYSE: MS) concerning a possible combination of the retail brokerage business operated under the Smith Barney name and the wealth management business operated by Morgan Stanley. No definitive agreement has been reached, and no assurance can be given that any such agreement will be reached. Beyond this statement, Citi has no further comment at this time.

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