The Hindu Business Line : Citi rescue package terms ‘lenient’

Global banking giant Citigroup, with roots dating back to 1812, was rescued by the US Government last week with a billion-dollar package. The action aimed to strengthen its capital base and increase liquidity. The bank had earlier received a $25-billion capital injection via preferred stock by the US Treasury.

Package terms

This time around, the US Treasury will infuse $20 billion in 8 per cent preferred stock under the Troubled Asset Relief Program. The next step is a Government guarantee on a portfolio of $306 billion of securities, loans, and commitments, which are backed by residential and commercial real estate and other assets as agreed by the US Government.

Citi will issue an additional $7 billion in preferred stock to the Treasury ($4 billion) and the Federal Deposit Insurance Corp (FDIC, $3 billion), bringing the total equity infusion to $27 billion.

The guarantee is for 10 years on residential assets and for 5 years on non-residential assets.

Beyond this threshold, 90 per cent of the losses will be covered by the Government; the Treasury takes up the first $5 billion, the FDIC the next $10 billion and the remaining will be funded by the Federal Reserve.

The balance 10 per cent will again be assumed by Citi. Cash flows from these assets will still accrue to Citi.

Citi has agreed to limit quarterly common stock dividend payouts to one cent ($0.10) per share for the next three years, effective from the next quarter payment.

The FDIC and the Treasury have also been issued warrants worth 10 per cent of the total equity infusion or about 254 million shares at a strike price of $10.61 per share. A template for the management of the guaranteed assets has been provided, including mortgage modification procedures. Appropriate compensation plans for executives, including bonuses, should be submitted to, and approved by the Government.

Restoring confidence

In the past few weeks, worries were mounting over Citi’s ability to pull through the recession intact; its risky assets and announced job cuts exacerbated negative sentiments.

Citi’s shares witnessed massive declines, sliding 60 per cent in a week to touch $3.05 per share, lowest since 1992. The cost of credit default swaps that protect investors from losses on Citi’s bonds were also escalating.

The rescue package served as a confidence booster and shares reacted positively, rising almost 58 per cent on November 24, following the announcement of the package. Costs of credit default swaps also almost halved.

The capital injection measure is estimated to pull the Tier I capital adequacy ratio to 14.8 per cent, more than twice the requirement.

It is also expected to allow more time for Citi to shed assets, control costs and streamline its business to rein in its huge losses stemming from toxic debt.

Criticism

While economists agree that Citigroup was too important to go under, and that a rescue was necessary, they deem it to be inadequate and badly designed. They have slammed the package as it puts taxpayers at risk of huge losses for a relatively small stake in the bank in return.

It does not require rationalisation of the management, accountability is not defined and it contains only a vague clause on compensation limitations.

It also does not back non-residential consumer loans such as credit card loans, student loans, small business and auto loans.

The bailout of Citigroup has also raised questions about the health of other banking majors. That it is Citi’s second bailout in as many months despite its assurances to the contrary has left many still uneasy about its future and that of the other institutions.

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