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Plan Gives Government A Big Stake In Citigroup

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The Associated Press

Published: February 28, 2009

WASHINGTON - The U.S. government will exchange up to $25 billion in emergency bailout money that it provided Citigroup Inc. for as much as a 36 percent equity stake in the struggling bank, greatly increasing the risks to taxpayers as voter unhappiness about the broader bailout program rises.

The deal announced Friday by the company and the Treasury Department represents the third rescue attempt for Citigroup in the past five months. It's contingent on private investors agreeing to a similar swap.

The administration decided to restructure the bailout package for Citigroup again in the hopes that converting $25 billion of preferred shares into common stock would give investors more confidence the bank has sufficient capital reserves to withstand mounting losses on its holdings of mortgages and other loans. While the conversion to common stock will dilute current shareholders' investments, a wider equity base could calm investors since there would be more reserves in place to guard against further losses as the economy sours.

Besides a stronger capital base, the company is getting a critical boost to its cash flow as it forgoes its 4 cent annual dividend on its common shares. That is giving Citi an additional $2.18 billion a year. The bank will also no longer pay the 5 percent dividend it owed on the government's preferred shares that have converted to common stock.

But the deal doesn't affect one of Citi's greatest problems, the billions of dollars in failed mortgage-backed securities that still sit on its books. As those investments have fallen in value, they have exacerbated Citi's losses.

The aim of the government's rescue effort is to keep the New York bank holding company alive and bolster its capital as it faces growing losses amid the intensifying global recession. Existing Citi shareholders would see their ownership stake shrink to as little as 26 percent.

Underscoring its precarious nature, the company also disclosed that it recorded a goodwill impairment charge of about $9.6 billion because of the deterioration in the financial markets.

The Treasury Department said the transaction requires no new federal funds, though it left the door open for Citigroup to seek additional government funding. For now, the remaining $20 billion of the government's investment will be converted into a new class of preferred shares that will pay an 8 percent annual dividend.

The conversion will make the government the largest shareholder in Citigroup, but company officials said they still expect to call the shots.

Citi will offer to exchange up to $27.5 billion of its existing preferred stock held by private investors at a conversion price of $3.25 per share. That's a 32 percent premium over Thursday's closing price of $2.46.

The preferred shares are similar to debt and the banks were under pressure to essentially pay back the government in five years. Preferred shares also get paid back before common shareholders in the event of a bankruptcy.

Neither of those conditions accompany common shares. Still, owning such shares means taxpayers will share in future gains or losses from any drops or increases in the company's share price.

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