Citigroup’s Third U.S. Rescue May Not Be Its Last, Analysts Say

Feb. 28 (Bloomberg) -- The U.S. government’s third attempt to help rescue Citigroup Inc. won’t stanch the company’s losses, which will continue to swell and may lead the bank to require more money in coming months, analysts said.

Yesterday’s action didn’t furnish the New York-based bank with new money, although it cuts expenses by eliminating dividends on preferred stock. Instead, it converted preferred shares into common equity, which absorbs the first hit in the event of further losses, at an above-market-value price of $3.25. The stock, which has fallen 78 percent since the beginning of the year, closed in New York trading yesterday at $1.50, its lowest since November 1990.

Vikram Pandit, 52, Citigroup’s chief executive officer, told investors yesterday that increasing tangible common equity to as much as $81 billion from $29.7 billion should “take the confidence issues off the table,” regarding the company’s ability to absorb losses. Still, Citigroup, which lost $27.7 billion in 2008, is expected to lose $1.24 billion in the first six months of 2009, according to the average of analysts’ estimates compiled by Bloomberg.

“There’s no difference here,” said Christopher Whalen, co- founder of Institutional Risk Analytics, a Torrance, California- based risk-advisory firm. “It won’t fix revenue, and you’re still going to see loss rates.”

One immediate change from yesterday’s announcement was that the value of the government’s investment fell by more than half. The government said it would convert as much as $25 billion of its preferred stock to common shares for a 36 percent stake in the bank. At yesterday’s closing price of $1.50, that investment is worth about $11.5 billion. Citigroup has a stock market value of $8.2 billion today.

‘Ripped Off’

“Taxpayers are being ripped off,” Congressman Brad Sherman, a Democrat from California who sits on the House Financial Services Committee, said in a statement. “The only thing worse than nationalizing a bank is to pay for the entire bank and only get one-third of it.”

Goldman Sachs Group Inc.’s analysts, led by Richard Ramsden, recommended that investors avoid Citigroup shares because “it is unclear whether this is the last round of capital restructuring, which means that existing equity may be further diluted in the future.” The analysts also noted that the bank’s new 4.3 percent ratio of tangible common equity to total assets falls to just 2 percent if deferred tax assets are excluded. Those will only become valuable if and when the bank returns to profitability.

Ratings Cut

Rather than boosting confidence, the move led Moody’s Investors Service to cut its senior debt rating for Citigroup to A3 from A2 and prompted Standard & Poor’s to change its outlook on the bank’s debt to “negative” from “stable.”

“Citi will face a tough credit cycle in the next two years, which will likely result in weak and volatile earnings,” S&P analyst Scott Sprinzen wrote in a statement. “We cannot rule out the possibility that further government support may prove necessary.”

Some analysts and investors were more heartened by yesterday’s news. David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York, said the transaction fortifies the bank’s balance sheet, and he expects the stock to rise back to $3 “once the emotion of the moment passes.”

William Isaac, chairman of Secura Group LLC and a former chairman of the Federal Deposit Insurance Corp., said that while he hopes yesterday’s action is enough, the government may need to put in more money if the economy continues to deteriorate.

“If they need more money we should put it in,” Isaac said. “The best approach is to do what you think will work as you go along.”

Preferred Stock

In its first two efforts to rescue Citigroup, the U.S. Treasury provided $45 billion by buying preferred stock and joined the Federal Reserve and FDIC in agreeing to guarantee the bank against all but $29 billion of losses on a $301 billion portfolio of assets. Yesterday, the Treasury, as well as other preferred stockholders including the Government of Singapore Investment Corp. and Saudi Prince Alwaleed bin Talal, gave up their dividends and agreed to take common stock at $3.25 a share.

“The administration and the past administration have tried so many different ways that we can only hope and pray that this time they get it right,” said Charles Rangel, a Democratic congressman from New York who serves as chairman of the House Ways and Means Committee. “It seems like with the banks it is a never-ending thing.”

Conversion Price

The government was in a near-impossible position trying to set a price to convert the stock, said Tony Plath, a finance professor at the University of North Carolina at Charlotte.

“You can’t massively overpay because the taxpayer will scream, but you can’t pay market price because that doesn’t give them enough tangible common equity,” Plath said. “The value of the equity is close to zero, but you can’t let it fall to zero because so much of it is owned by private money outside the U.S.”

Institutional Risk Analytics’ Whalen said the government’s efforts are mainly protecting those who hold Citigroup bonds, which he said are widely held by other financial institutions and foreign governments.

“The taxpayer is funding the operating loss and protecting the bondholders,” Whalen said. “The subsidy for the banks will become one of the biggest lines in Washington’s budget.”

Boon for Bondholders

Citigroup’s $3 billion of senior unsecured bonds that mature in May 2018 rose to 87 cents on the dollar yesterday from 85 cents a day earlier, according to data reported on Trace, the real-time bond-price reporting service of the Financial Industry Regulatory Authority.

Whalen said it would be better if the government organized bondholders in Citigroup and insurer American International Group Inc., which got a $150 billion U.S. bailout, and reach a deal to convert some debt to equity.

Standard & Poor’s, in cutting its outlook on Citigroup’s debt to negative, said even bondholders may be affected.

“Debt holders could eventually be required to participate in further government-led restructuring actions,” S&P said.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

To contact the editor responsible for this story: Alec McCabe at amccabe@bloomberg.net.