Inside the Citi Bailout

Guess what? Citi isn’t just raising their credit card interest rates. They’re also cashing in on a substantial bailout. For those that are curious, I just ran across an interesting article that answers some questions about the bailout. Here’s a synopsis…

1. What is Citi getting?

Specifically, the government will back a $306 billion pool of troubled loans and securities… After Citi absorbs the first $29 billion in losses on these securities, the government… will step in and bear 90% of any further losses. In return, the government gets up to $7 billion in preferred Citi stock and the right to buy more shares at $10.61… On top of that, $20 billion from the Treasury’s Troubled Asset Relief Program (TARP) will be injected into the company in exchange for preferred shares that come with an 8% dividend.

Yikes. That leaves the government on the hook for roughly $249 billion in troubled loans. In return, they’re getting $7 billion in preferred stock and the right to buy more shares at nearly double the current market value.

2. Didn’t the government already rescue Citigroup?

On Oct. 13, [the] Treasury told Citi and eight other large banks that it would be buying billions of dollars worth of stock in their institutions… Citi got $25 billion in exchange for preferred shares on which it is to pay 5% interest for five years and then 9%.

But last week, events took a turn for the worse. Negative reports on consumer default rates and troubling statistics on commercial loans unnerved investors… On Nov. 18, the company announced that it would be laying off about 50,000 of its employees, or 20% of its global workforce…

Citi stock plummeted, dropping 60% over the course of the week… Bankruptcy rumors circulated, and fears grew that people doing business with Citi — including its retail banking customers — would pull their money. At that point, regulators felt they had no other option but to step in.

Okay, we’ve saved them twice now. Is that enough to get them over the hump? This is actually the subject of question #4, below.

3. Why save Citi when other banks are going under?

Citigroup, with $160 billion in revenue last year, more than 300,000 employees and tendrils in every corner of finance, both domestically and abroad, is the poster child for an institution that is allegedly “too big to fail.” A much smaller financial institution, Lehman Brothers, was allowed to go down — and shock waves hit corners of the financial world, like money-market mutual funds, that no one had anticipated. The fear is not only of pain inflicted but also of unpredictability.

Citi is not the first bank to hit the wall. When Washington Mutual, which had a balance sheet less than a third the size of Citi’s, went down, the FDIC immediately flipped the company to JPMorgan Chase. But marrying off Citi was not a viable option. “There isn’t anyone to hand Citi to,” says Roy Smith, a professor of finance at New York University’s Stern School. “This is the King Kong of banks.”

Hmmm… Seems like that “too big to fail” moniker is kinda dangerous. Going forward, it seems like companies that fall into this category will be all the more willing to take risks, as we now know that the government will step in and protect them. Privatize the profits and socialize the losses, right?

4. What are the chances we’ll have to save Citi yet again?

There are still plenty of questions about Citi’s long-term health. The government’s rescue addresses $306 billion worth of troubled assets from Citi’s $2 trillion balance sheet. The bank, though, has roughly another trillion dollars in assets that aren’t on its balance sheet but kept in entities somewhat removed from the company. These assets could be problematic if the economy grows worse… Put simply, there’s room for more to go wrong.

Lovely. So this be just the tip of the proverbial iceberg.

5. Does this rescue mean Citi’s stock is a buy?

With the government injecting a total of $27 billion into Citi and getting warrants to buy more shares, existing shareholders will be diluted… On the upside, the government’s involvement has already sent the stock on a mini tear, to $5.95 at Friday’s close, up from last week’s low of $3.77…

One other immediate effect: common stockholders can say goodbye to their dividend, which was 16 cents last quarter… [T]he deal prohibits Citi from paying dividends of more than a penny per share for three years without [government] approval…

So there you have it. Everything you wanted to know about the Citi bailout, but were afraid to ask.

Source: Time.com