Thursday, December 17, 2009

A Triple Shot of Citibank: Taxes, the Prince, and the Government

Citibank made news yesterday with three very interesting stories.

First, I woke up to the Washinton Post's: "U.S. Gave Up Billions in Tax Money In Deal For Citigroup's Bailout Repayment."  Here are the details:  Companies, like people, can accumulate tax loss carry forwards.  If you as an individual, lose $100k trading next year, you can carry that loss forward to next year, so that if you make $100k trading next year, you can use your prior loss to offset the gain.  Companies to the same thing, but it's with income too, along with capital gains.  Citi had $38B in tax loss carry forwards, but there is a provision in the tax code that nullifies these future tax benefits when there is a change of control at the company - this provision exists so that companies don't buy the "losses" of other companies just to get tax benefits.

The Treasury's stake in Citi fell under this provision, so Citi was going to lose its tax loss carry forwards, until, that is, the government changed the rules.   Now, Treasury spokeswoman Nayyera Haq makes a reasonable point in saying "This rule was designed to stop corporate raiders from using loss corporations to evade taxes, and was never intended to address the unprecedented situation where the government owned shares in banks."  Also, as a fiscal conservative, I'm aware of hypocrisy - generally, me and my kind are not in favor of higher taxes, and wouldn't really be screaming and yelling about companies being able to keep tax loss carry forwards.   So why is it different here?  Because Citi exists only due to a government  (taxpayer!) bailout, and thus they should not be given any tax breaks at all.  It is important to clarify that the value of this tax break is not $38B - it's the TAXES on $38B, which, assuming a roughly 35% tax rate for Citibank comes to about $13B.  (see Ritholtz and Denninger for more on this story)

The next major Citibank story yesterday was that the Abu Dhabi Investment Authority (ADIA) is suing Citi over some mandatory convertibles (which required ADIA to pay a certain price for Citibank stock) that ADIA bought a few years ago.

"Citigroup said on Tuesday the Abu Dhabi Investment Authority filed an arbitration claim against it, accusing the U.S. lender of misrepresentation over a $7.5 billion investment by the sovereign wealth fund.
The sovereign wealth fund, considered by some the largest in the world, bought securities from the U.S. bank in 2007. In the original deal, the Citigroup bonds must be converted into common stock at a price between $31.83 and $37.24 a share between March 2010 and September 2011."

Obviously, with Citi stock hovering above $3, ADIA is, to put it gently, PEEVED at the prospect of having to pay more than $30 for the stock.  The irony here is palpable - as Citi has been on the lender side of the table many times in similar situations:   as we've seen in the past few years, Citi held many bad mortgages where the borrower (homeowner) misstated their income or the value of the home was incorrectly assessed.  Now, Citi is the borrower, and their lender, ADIA, is asserting that Citi made fraudulent misrepresenations.    Further complicating the matters, ADIA is a huge client of Citi's, and investors from the  Middle East have been instrumental in Citibank's health and survival over the past 15 years (see: The Prince!)

The final story was Citibank issuing shares to raise capital and repay TARP funds.    Never mind that this decision is an absolute disaster for shareholders and seems designed primarily to free up the bank from government compensation restrictions (see James Kwak's take here, and I actually agree with Dick Bove for once!)  - I want to focus on the fact that the government decided not to sell shares on the offering.

The government planned to sell $5B of its Citi stock (a portion of the common stock that the government owns as a result of converting its preferred stock position) alongside Citi's $17B of new issuance.  However, when the price of the deal came in at $3.15, the story was that the government decided not to sell.  Now, let's consider what really happened:  CNBC last night said that they heard that the deal was 17 times oversubscribed.  We can pretty much write that off as total bs, as a deal with massive demand would not price at such a huge discount.  My colleagues this morning confirmed that there is no way the deal was massively oversubscribed.  Then, we must consider, is the government really playing the role of Joe Stocktrader?  Should the government be saying "we think Citibank is worth more - we're going to hold it for the long term?"

The answer to that question may be debatable, but to me the answer is a resounding "no."  Never mind the conflicts of interest present with the largest shareholder being the fiscal policy maker too, it's simply not the Treasury's job to play portfolio manager here. They should be trying to sell their stake in the least impactful way possible.  Which brings us to what I think really happened:  that the government had to pull their share sale because no one wanted to buy the stock!  That explains the steep discount, which was exacerbated by the problems mentioned above with ADIA.    I can only hope that the truth is that the government pulled out because there was no demand, and not because either 1) the government didn't want to sell the stock below its $3.25 cost basis as the Bloomberg article mentioned, or because 2) the government is playing portfolio manager.

Lending further evidence to the theory that there was a dearth of buyers is the fact that the Treasury agreed to a 90 day further lockup on its shares, and their statement that they will be disposing of the shares over the next 12 months.  It seems to me that investors were worried about buying Citi shares and getting steamrolled by the government selling more shares in the near future (you don't want to buy shares if you know there is still a big seller who needs to sell more!) - so the government had to abort its sale and make the lockup concessions just to attract enough buyers for Citi's share issuance.



Anonymous said...

Hey Kid,

it's amazing how self-professed "conservatives" suddenly sound like progressives when they find themselves on the giving end of corporate welfare. Dig a little deeper and come to the dark side, my friend.

Anonymous said...

my friend, my friend I mean to say.