Citigroup Capital Infusion: Junk Terms or Market Rates?

Alphaville takes a closer look at the terms of the $7.5 billion investment stake in Citigroup taken by the Abu Dhabi Investment Authority. The post, entitled Junk Citi, opens with the question:

So how, as the world’s largest bank, do you impart news that you have had to seek an emergency capital injection from a country many of your customers have never heard of, at almost two and a half times the Fed’s target lending rate?

The terms of the investment appear pricey. Citigroup has issued $7.5 billion in mandatory convertible securities paying a yield of 11%. According to the Wall Street Journal:

Citi is paying a higher interest rate than companies that borrow on the high-yield, or junk-bond, market; currently they pay roughly 9% for straight bonds. Typically, convertible bonds pay lower interest rates than straight bonds, although a particular bond’s structure could affect the interest rate paid.

Alphaville takes issue with Citigroup’s positioning of the 11% yield as a “slight premium” to the current 7% dividend yield on Citigroup stock, saying “That’s actually a premium of 57 per cent. Even after the spurious tax argument, it is difficult to see how this funding can be costing much less than 9 per cent.”

CreditSights has a different take. According to analyst David Hendler, the 11% coupon is steep, but is in-line with Citigroup’s cost of equity capital:

This equity cost carries with it an aura of turnaround financing, which could be an accurate description as Citi’s market cap has been nearly cut in half (-47%) year-to-date. However, we would point out that recent volatility has raised the equity risk premium in Citi’s weighted average cost of capital (WACC) calculation. According to Bloomberg, Citi’s current cost of equity stands at about 11.63%, which makes the ADIA investment seem more palatable. The move also shows that Citi can raise equity capital amid a credit crunch and line-up a respected sovereign wealth fund to do so.

Fitch Ratings said it expects to assign an ‘AA-’ rating to the securities and that Citigroup’s Rating Outlook remains Negative. Although the sizable addition of fresh capital alleviates some rating pressure, considerable financial uncertainty remains, Fitch says. “The issue boosts Tier I capital by approximately 60 basis points assuming a steady level of risk-weighted assets. However, the likelihood of depressed earnings or even bottom line losses in 4Q07 could significantly offset this positive capital development. ”

The CreditSights report, Citigroup: Gets $7.5 Billion Middle Eastern Capital Makeover, is available for purchase, as is Fitch Expects to Assign ‘AA-’ to Citigroup’s $7.5B Convertible Securities.

Technorati Tags: (c), Abu-Dhabi-Investment-Authority, banking, Citigroup

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Wednesday, November 28th, 2007 : Credit Research, Equity Research : No Comments

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