Abu Dhabi's lifeline for Citigroup

Citigroup sees the arrival of Middle Eastern benefactors as a vote of confidence. But most people see it as a sign of the desperate state of affairs at the world's largest bank. By Stephen Foley
Published: 28 November 2007

If a bank was offering an interest rate of 11 per cent on your money, you would bite their hand and most of their arm off to get it. Not even junk bonds, the riskiest investments in the world of fin-ance, offer a double-figure percentage yield, usually. Yet here we have Citigroup, the largest bank in the United States, offering to pay 11 per cent, guaranteed, for the next three years.

Before you pick up the phone, Citigroup is not offering this rate to its customers. This is the figure it has agreed to pay to the government of Abu Dhabi, the oil-rich emirate, in return for a $7.5bn cash infusion. Citigroup was yesterday characterising the arrival of its Middle Eastern benefactor as a significant vote of confidence in the com-pany; outsiders thought only that the startling interest rate proves how desperate Citigroup is to shore up its crumbling balance sheet.

That there is some serious shoring up to be done is not in doubt. Citigroup's investment banking arm has been one of the most heavily affected by the credit crisis and is still totting up billions of dollars in losses from bets on sub-prime mortgages and mortgage-backed collateralised debt obligations (CDOs), which could reach $15bn or more. Worse, lurking on the sidelines, the bank has set up off-balance-sheet vehicles with more than $80bn in assets, which are feeling the pain, too. These might have to be bailed out or, following the example of HSBC this week, brought on to Citigroup's books.

Meanwhile, in the retail bank, customers are defaulting on Citi mortgages in increasing numbers and there are worrying signs of problems among its credit card customers. All of which would be tough for any financial institution, but for one that has long had a weaker balance sheet than almost any other, and which is fighting to reduce its bloated cost base, these are tough times indeed. With hindsight, it seems a shame that Citigroup folded its longstanding logo, the bright red umbrella, at the start of this year – just before the sky fell in.

The Abu Dhabi Investment Authority (ADIA) is paying $7.5bn for equity units that pay the 11 per cent coupon until they convert into Citigroup shares in 2010 and 2011 at a conversion price slightly above the current share price, which is languishing at a five-year low. The emirate will end up with a stake of up to 5 per cent in Citigroup, overtaking its current largest shareholder, the Saudi prince Alwaleed bin Talal, who snapped up his holding during the last US mortgage crisis in the early Nineties.

Citigroup's tier one capital ratio, a measure of fin-ancial strength, was at 7.3 per cent in the first quarter, below its target of 7.5 per cent, but the latest cash infusion will push it back above target. Mike Mayo, the bearish analyst at Deutsche Bank, agreed it is a move towards stability, but at a price.

"The move gives Citigroup additional capital flexibility to take on $100bn of assets on its balance sheet (such as the structured investment vehicle assets, if required), incur additional CDO writedowns (if necessary) above and beyond the estimated $8bn-$11bn announced for the fourth quarter, and to improve its reserve for loan losses," Mr Mayo said. "Yet it probably does not provide enough flexibility to do all three, any or all of which may ultimately be required."

Citigroup continues to insist it is committed to its current dividend, costing $11bn a year, even though many analysts now believe it should be cut to conserve cash. Mr Mayo suggested it would be unseemly to carry on sending $11bn a year out of one door while having to haul new cash in through another. At the current share price, the dividend yield is above 7 per cent – explaining the 11 per cent coupon on the new equity units, which is at a typical premium. Sir Win Bischoff, Citigroup's acting chief executive, said: "The investment from ADIA enables us to access capital in an efficient manner, and is consistent with our strategy of maintaining a balance sheet that benefits from highly diverse sources of funding in terms of both geography and type of security. Coming from one of the world's leading and most sophisticated equity investors, it provides further capital to allow Citi to pursue attractive opportunities to grow its business."

The deal sparked a rally on Wall Street and traders hailed Abu Dhabi's move as evidence that financial stocks have been oversold. Jeff Harte, financial sector analyst at Sandler O'Neill, said the capital infusion may not solve Citigroup's specific problems, but he kept his buy rating on the stock. "The question is whether investors are approaching Citigroup [ie, this is a buying opportunity] or whether Citigroup is approaching investors [ie, in desperate need of capital]. We suspect the former."

ADIA's managing director, Sheikh Ahmed bin Zayed Al Nahyan, said that Citigroup possesses a unique position in the financial markets throughout the world. "We see in Citi a highly respected company with a premier brand and with tremendous opportunities for growth. This investment reflects our confidence in Citi's potential to build shareholder value."

Shares in Citigroup have lost two-fifths of their value over the last four months as losses from the credit crisis have spiralled. At the start of this month, Chuck Prince, the chief executive for the past four years, bowed to the increasingly shrill calls for his resignation, and investors worry that the scale of the problems will deter talented executives from seeking the post.

Any new leader faces significant challenges, from the big picture – should the company abandon its conglomerate structure and split the investment banking and brokerage businesses from the retail bank? – to the nitty gritty, such as how to extend the current round of cost-cutting beyond existing plans for 17,000 job losses. Employees are braced for still more blood-letting, amid reports that middle managers have been told to seek additional job cuts.

What the new man, or woman, at the helm won't have is any input from Abu Dhabi. The emirate has committed to being a passive shareholder, with no role in the management or governance of the bank and no representation on the board. In doing so, it is acknowledging sensitivities in the US about the growing influence of so-called "sovereign wealth funds", investment vehicles controlled by the increasingly rich governments of emerging markets and oil-rich nations. Charles Schumer, the New York senator whose bellicose opposition to the takeover of US port operations by a Dubai company scuppered that deal last year, said yesterday that he welcomed Abu Dhabi's investment in Citigroup. "It will help preserve New York's status as the world's financial centre," he said.

Citigroup executives must have breathed a giant sigh of relief.

The rise of sovereign wealth funds

Fox Business, the new Rupert Murdoch-owned US business channel, may take a while to recover its credibility after the hilarious blooper when an arm of the Abu Dhabi government snapped up a $622m stake in Advanced Micro Devices, the chip maker, this month. After initially announcing the buyer was Apple, and having a spirited debate about what a brilliant deal it was for the iPod manufacturer, the anchors clutched their squawking earpieces and backpedalled: "It's not Apple, we're hearing... it's Apple Dubai... no, Abu Dubai... oh, OK, the Arabs."

Fox may still be catching up, but Wall Street has come to know well the purchasing power of the governments of the Middle East, reinvesting their soaring income from oil across different industries and across the globe. The general public are also increasingly aware – and wary. Abu Dhabi, Qatar and Dubai all have longstanding investment arms – the Abu Dhabi Investment Authority which has just bailed out Citigroup is the world's largest, with $650bn at least in assets – and in recent years they have been joined by funds controlled by the governments of China, Singapore and others.

Dubai has accumulated a string of New York landmarks, plus a large chunk of the London Stock Exchange, and this week added a stake in Sony. China has put $1bn into the Wall Street bank Bear Stearns and three times that into the private equity giant Blackstone.

For now, these so-called "sovereign wealth funds" are operating as traditional investors. But the Group of Seven nations, prompted by the US, has called for more transparency from the funds and for them to promise that they will not use their investments for political ends.