Sunday, March 1, 2009

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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Michael Pollak said...

Perhaps being witty and sharp, you may be onto something deep here. If what you say is true, what is really happening is not (pace everybody) the creeping nationalization of Citi, so much as rather the creeping debt-equity swap of Citi.

Which might not be a bad strategy. It's got it's own difficult shoals to navigate, as you point out. But it might be a better route to recapitalizing the banks than any other.