When the news came out that Citigroup was acquiring $7.5B in capital in exchange for an 11% piece of commercial paper with mandatory conversion provisions; many (myself included) initially reacted with stunned disbelief. 11% yields are the stuff of junk bonds; and while Citigroup's near-term liquidity is disturbingly constrained, it seemed incredulous to think C would have to pay junk rates. If that were true, was there no end to the potential fallout of this credit crisis?
Hat tip to Andrew Clavell, who seems to have unlocked the puzzle in his post: Citibank, ADIA and that pesky 11% interest rate.
...The dividend enhancement is probably worth 12% of the deal amount of $7.5bn. With sensible assumptions, the net value call spread is around 8% in Citi's favour, so the remaining cost to Citi is around 4% or about 1.5% pa over the weighted average life of the deal. Put another way, Citi has raised tax deductible, upper tier capital funds for 4 years at a cost equivalent to another financing source of Libor+150. Smart business. It may even be that Citi's stock has suffered since the deal was struck in part due to Citi itself hedging out its long callspread position.
The FT and the Wall Street Journal are guilty of sensationalist journalism and have totally missed the point in their quest to find the worst possible slant on any investment bank's activities. I suppose this is in vogue at the moment. Perhaps if they had wanted to batter ADIA instead of Citi, the headline might have been "Unsophisticated Arab financiers write massive put option on US investment bank".
Thanks to Andrew for seeing the forest for the trees here. Let's not pretend these are Halcyon times for Citigroup or that they still don't have a long road ahead of them; but it's nice to have some perspective on the deal from someone who actually understands the structure, versus the deluge of reactionary "The Sky Is Falling" reactions I've been seeing just about everywhere else this week.
Note: This is not a
recommendation to buy or sell C or any other
security, but is
personal analysis to foster discussion for informational purposes only.
At the time of this writing, I and/or funds I maintain discretionary
control over, did not maintain a direct position (long or short) in C. As always, we reserve the right to do so in the future. We also may, at
times, carry derivative options on underlying
positions as a hedge.
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