Citi’s annual report came out on Friday, along with the news that the US government would convert its preferred shares into common shares.
The reasoning behind the deal was described thusly :
Citi Chief Executive Officer Vikram Pandit said, “This securities exchange has one goal — to increase our tangible common equity. While we believe Tier 1 capital remains the most important measure of the financial strength of banks, we recognize that the markets also view Tangible Common Equity as an important measure. This transaction — which requires no additional investment from U.S. taxpayers — does not change Citi’s strategy, operations or governance. Our clients and partners will not be affected and will continue to receive the high level of service they expect from Citi around the world.”
So, while Tier 1 will remain the same under the new plan (at something like 11.9 per cent), the bank’s tangible common equity will rise to as much as $81bn from $29.7bn.
That’s a big deal for Citi, which has been criticised by investors, or, um, non-investors, for the fluffiness of its capital calculations, especially its preponderance of deferred tax assets. As per its latest annual report, deferred tax assets make up 11.8 per cent of its Tier 1 capital ($14bn of Tier 1 capital of 118.76bn), up from 11.3 per cent in the third-quarter; proving fluffiness is still very much there.
A new focus on tangible common equity should help strip out some of that fluffiness — intangibles like deferred tax credits aren’t included in the calculation of tangible common equity ratios. However, simply converting preferred shares to common shares, without additional capital, doesn’t actually do much for Citi besides lower its costs (it saves on dividend payments) and move losses further away from bondholders, at the expense of the value of the US government’s stake.
Indeed, Bloomberg noted on Saturday that as a result of the conversion, the value of the US government’s Citi investment fell by more than half.
That’s a perfect example of the bank rescue dilemma faced by the current adminstration.
The US wants to inject enough capital into the banks to jumpstart lending — but not at the expense of taxpayers. At the same time it’s trying to avoid taking overt control of the banks. But, as a Deutsche Bank’s US economics team notes today, this may not be possible:
For example, if the government were intent for political reasons not to overpay for stock or troubled assets, and it wanted to achieve its goal of having the banks healthy enough to increasing loan volumes, it would have to buy a sufficient number of shares that would dilute current equity holders substantially, and leave the government with a majority stake. Similarly, if the government wants its ownership to be confined to a minority stake, it cannot then inject enough capital to revive lending, unless it buys stock at above-market prices that would subsidize current stock holders. There is no way around this dilemma.
Related links:
US U-turn on tangible common equity – FT Alphaville
Bondholders breathe sigh of relief but fears over preferred shares remain – FT
Citigroup’s third US rescue may not be its last, analysts say – Bloomberg