Conversion of its
Citigroup preferred shares into common stock will pare paper loss
from US$5.5 billion to US$1.67 billion
By CONRAD TAN
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THE Government of Singapore
Investment Corp (GIC) will convert all its preferred shares in
Citigroup into common stock to cut its losses. The swop will
give it an 11.1 per cent stake in the troubled US bank, which
yesterday announced a sweeping plan to boost its common equity
base. The conversion will pare GIC's paper loss on its original
US$6.88 billion investment in Citi from 80 per cent or US$5.5
billion to 24 per cent, or US$1.67 billion, based on Thursday's
closing price of US$2.46 for Citi shares.
BOOSTING TCE
Citi says the share conversion plan
has just one goal - to increase the bank's tangible common
equity
Separately, Citi said yesterday that it plans to swop up to
US$52.5 billion of its preferred stock, including US$25 billion of
the US$45 billion held by the US government, for ordinary
shares.
Citi also recorded a massive US$10 billion charge for impairment
of goodwill and other intangible assets in the fourth quarter,
resulting in an additional net loss of US$9 billion for the final
three months of last year.
For GIC, the decision to convert its shares appears to have been
the lesser of two unpalatable choices. Citi yesterday suspended
dividend payments on its preferred shares as well as common stock,
which means that GIC would lose the 7 per cent annual dividend that
it has been receiving if it chose not to convert its holdings.
The conversion will make GIC the second-biggest shareholder in
Citi with a stake of about 11 per cent, compared to about 4 per
cent at the time of its original investment. The US government will
be Citi's largest shareholder, owning 36-38 per cent of Citi's
common equity. The final stakes will depend on how many investors
in the publicly held tranche of Citi's preferred stock decide to
participate in the share conversion.
Related links:
Click here for
Citi's news release
Citi's goodwill
announcement
Statement from
Citi chairman
GIC's news
release
One thing is certain: Existing ordinary shareholders will suffer
massive dilution of more than 70 per cent. Citi shares plunged 37
per cent to US$1.55 at the start of US trading yesterday after the
bank's announcement. At that price, GIC's unrealised loss on its
Citi investment would be US$3.6 billion. The profitability of US
banks 'is likely to be impaired in the next two years', said Ng Kok
Song, GIC's group chief investment officer in a statement.
'GIC's view is that with this latest move, Citigroup's capacity
to weather the severe economic downturn will be strengthened.'
Before yesterday's announcement, the market value of the
preferred shares held by GIC had already slumped 80 per cent to
just US$1.376 billion since its initial investment in Citi, as
mounting losses made it less likely that the bank would be able to
keep up its dividend payments.
The US government, GIC and other investors that bought Citi
preferred stock alongside GIC in January last year will receive
common stock at a price of US$3.25 a share. Those investors,
including Saudi Arabia's Prince Al-Waleed bin Talal, have agreed to
the exchange, said Citi.
At the conversion price of US$3.25, GIC will get some 2.12
billion common shares in exchange for its US$6.88 billion in
preferred stock. Based on Thursday's closing price of US$2.46 a
share, GIC's stake after conversion is worth US$5.21 billion.
That puts GIC's unrealised loss on its original US$6.88 billion
investment in Citi at US$1.67 billion after the conversion,
compared to US$5.5 billion before.
Under the original terms of GIC's investment in Citi, it would
have had to pay a much higher conversion price of US$26.35 for each
common share, GIC said. That would have translated into a stake of
just 261.1 million shares, worth a mere US$642 million at
Thursday's closing price for Citi shares.
But the conversion also means that GIC will now bear greater
risk than before, as an ordinary shareholder. It also gives up for
good the 7 per cent annual dividend that it previously earned on
its preferred shares.
Citi chief executive Vikram Pandit said that the conversion plan
had just 'one goal' - to increase the bank's tangible common equity
or TCE. Converting its preferred shares into ordinary equity will
boost its TCE ratio - the focus of stress tests by US regulators
starting this week as a key measure of the bank's ability to
withstand further losses if the recession is worse than
expected.
Ordinary shareholders are the first to suffer any losses, so
common equity is seen as the highest quality of capital that a bank
holds, and the size of a bank's common equity base relative to its
assets is considered the purest measure of its buffer against
losses.
The hope is that by raising its TCE ratio, Citi will be able to
weather the worst recession that the US has seen in decades. The
plan is expected to increase its TCE as a proportion of its
risk-weighted assets from less than 3 per cent now to 7.9 per
cent.
Crucially, it does so without the need to inject more money from
the public purse. That makes it unnecessary for the US government
to seek the approval of lawmakers for more funds amid growing
public fury over the use of taxpayers' money to bail out large
banks.
But the US government could still inject more capital into Citi
- in the form of mandatory convertible preferred shares - if the
stress tests show that the bank's capital cushion still needs
bolstering. That would mean further dilution for ordinary
shareholders, including GIC, when the shares are eventually
converted to common stock.
'As a shareholder, GIC supports the initiative by Citigroup and
the US government to strengthen the quality of the bank's capital
base in view of the challenging economic environment,' GIC said in
a statement.
