Citigroup $2.42 Billion Issue Erases Bailout: Corporate Finance

Citigroup Inc. is removing the last traces of its government bailout by persuading investors to buy almost three times the subordinated debt it issued seven months ago as it restores profitability after the financial crisis.

Citigroup, which took more rescue assistance than any other U.S. lender after the 2008 collapse of Lehman Brothers Holdings Inc., gave the Federal Deposit Insurance Corp. $2.42 billion of subordinated notes in exchange for preferred securities yesterday after a similar $894 million deal in February. The FDIC resold the new bonds today, eliminating a $7 billion stake the government acquired in exchange for guaranteeing $301 billion of Citigroup holdings including mortgage- and other asset-backed debt against losses.

“It closes a multistage saga that was a sad tale of mismanagement stretching back to before the crisis,” said David Knutson, a credit analyst in Chicago at Legal & General Investment Management America Inc., which oversees $32 billion. “Today the franchise is much more stable and the bank is back on steady ground.”

The lender that lost $29.3 billion in 2008 and 2009 combined has restored profitability and repaid other bailout funds by selling off assets and boosting lending in emerging markets. New York-based Citigroup also is convincing regulators that it can weather a future economic crisis, passing a set of Federal Reserve stress tests earlier this year that measure banks’ safety.

Sale Today

A $1 billion portion of notes sold by the FDIC and due in 30 years yielded 6.675 percent, and $1.42 billion of 12-year securities paid 5.5 percent, according to data compiled by Bloomberg. Citigroup won’t receive proceeds from the resale to the public, similar to a transaction in February that provided the U.S. Treasury with $894 million.

“When the transaction concludes, no U.S. government entity will continue to hold any securities in Citi issued as a result of the financial crisis,” Mark Costiglio, a spokesman at the bank, said by e-mail yesterday. “We remain very appreciative of the support provided by the U.S. Treasury, FDIC and American taxpayer during the financial crisis and are pleased that their investment realized a return of more than $13 billion.”

David Barr, a spokesman at the FDIC, declined to comment on the transaction.

Improving Finances

The 6.675 percent bonds increased to 102.77 cents on the dollar to yield 6.47 percent at 10:56 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The 5.5 percent securities increased to 100.22 cents to yield 5.48 percent.

Finances have improved with unwanted assets in the bank’s Citi Holdings division tumbling 31 percent to $131 billion for the year through June. The unit once held more than $600 billion of assets tagged for sale and wind-down, including a student-lending business, distressed U.S. mortgages, and a stake in the Smith Barney brokerage business.

Its tier-1 capital ratio, a measure of a bank’s cushion against losses, has increased to 13.24 percent on June 30 from a decade-low of 7.12 percent at the end of 2007, Bloomberg data show. The gauge exceeds the measure at each U.S. bank with market values bigger than $100 billion, which include Bank of America Corp. and JPMorgan Chase & Co.

Moody’s Review

“Citi, like most large U.S.-based banks, have greatly increased their capital base and improved their risk exposure,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York.

While Moody’s Investors Service said last month that it may cut the credit grades of Goldman Sachs Group Inc., JPMorgan, Morgan Stanley and Wells Fargo & Co., it put Citigroup on review with the direction of any change uncertain, according to an Aug. 22 statement.

Citigroup’s subordinated debt is ranked Baa3, one level above speculative grade.

“The risk of downgrade for Citigroup seems to be materially less than it was,” Don Jones, an analyst at Sterne Agee & Leach Inc., said in a telephone interview. Eliminating the government’s stake with the bond sale is “without a doubt a positive step for becoming more capable of improving returns to shareholders,” he said.

2 Bailouts

The bank’s market capitalization has surged by about $150 billion since March 2009, when its value tumbled to $5.59 billion, or a split-adjusted $10.20 per share. Yields on its 6.125 percent senior unsecured bonds due May 2018 surged above 9 percent in October 2008 before declining over the next five years to 2.91 percent yesterday.

Regulators sought to prevent Citigroup’s collapse during the financial crisis as the bank’s losses from soured mortgage investments ballooned. An initial $25 billion bailout in October 2008 failed to prevent a further plunge in the stock as customers withdrew deposits and counterparties demanded collateral.

The Treasury and FDIC arranged a second bailout in November, receiving a combined $7 billion in preferred stock in return for guaranteeing some of the bank’s riskiest assets.

Regulators also provided a further $20 billion in cash to rescue Citigroup, once the biggest lender in the world.

‘Gut Instinct’

“While there was consensus that Citigroup was too systemically significant to be allowed to fail, that consensus appeared to be based as much on gut instinct and fear of the unknown as on objective criteria,” according to a January 2011 report from the special inspector general for the Troubled Asset Relief Program. “The conclusion of the various government actors that Citigroup had to be saved was strikingly ad hoc.”

The bank has recovered as former Chief Executive Officer Vikram Pandit pursued profit in emerging markets including Mexico and India with U.S. and European growth slumping in the wake of the crisis. Profit from the bank’s businesses in Asia climbed 5 percent to $2.18 billion for the six months through June, compared with the similar period last year, and net income rose 3 percent to $1.77 billion in Latin America.

As the U.S. economy heals with housing and consumer spending aiding a recovery, the asset quality of the country’s banks should improve further, according to Dorian Garay, a New York-based money manager at ING Investment Management. Relative yields on bank debt are also approaching spreads on industrial bonds, according to Bank of America Merrill Lynch index data.

Bank bonds paid 157 basis points more than Treasuries last yesterday. That’s 3 basis points more than industrial borrowers, a gap that has declined from 46 a year ago.

“U.S. banks are on a much better ground today than a couple of years ago after the financial crisis,” Garay said. “We expect concerns about the financial system to continue to ease going forward.”

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