Monday, March 2, 2009

some preferred shares, it turns out, are more preferred than others.

From Felix Salmon:

What's Happening to Citigroup?

Tyler Durden has a vision for Citigroup which seems to conform quite well to reality. First, the share price plunges; second, preferred stock is swapped for common stock. And that's just the beginning:

What is becoming more and more obvious, is that while the government is unlikely to wipe out the common stock tranche in Citi and other banks ever, it will continue a forced creeping dilution of higher and higher tranches of the balance sheet into Citi common stock. Yesterday the preferred, today the convertible stock, tomorrow unsecured and lastly secured bonds. At some point the common may actually be worth something.

I'm with him all the way to secured bonds: that's not going to happen, because secured bondholders are senior to depositors, and Geithner's going to make sure that depositors are untouched. It's entirely logical, however, that if the preferred-for-common stock doesn't work (and I have yet to see an independent observer who thinks it is going to work), then the senior unsecured is next in line for conversion into some kind of equity.

Meanwhile, the debate over Citigroup's Mexican subsidiary, Banamex, rumbles on. Under Mexican law, no government can own more than 10% of a Mexican bank, which is obviously a problem if the US government takes a 36% stake in Citigroup. The Mexican SEC is investigating, while Banamex is unconvincingly saying that Nafta somehow overrides Mexican law and makes the stake fine.

Otto over at Inca Kola reckons this story is a very big deal, and from what I know about Mexican politics I'm inclined to agree: no government can allow an illegal partial takeover of Banco National de México without kicking up an almighty political storm.

Finally, Tyler has a theory that Monday is going to see a huge short squeeze in Citigroup shares, as the preferred-common arb turns out not to be possible after all. If you own Citi preferred, you can't convert that stock into common shares at the government's rate: some preferred shares, it turns out, are more preferred than others.

Citi stock is so volatile and trades at such a low price that I'm not sure how you'd even notice a short squeeze among all the usual noise. But the company is definitely a short-term speculative trading vehicle now, rather than a long-term store of value."


In November, on another blog, on the weekend before Citi was bailed out, I argued that Citi would be saved if it was failing, and that there was an implicit guarantee to save foreign investors as well. Several poster claimed that I was insane. Under no circumstances would the US Government be stupid enough to guarantee foreign investors. They would have to take their losses. In fact, one poster claimed that the foreign losses would be made clear in the deal. That turned out to be wrong.

Now, today, on Zero Hedge, we read the following:

"The balance sheet is essentially supported by an uneasy alliance between the U.S. government and the company’s depositors and other creditors, since the market value of the equity is so depressed. Deposits totaled $774 billion at year end, including nearly $500 billion outside the U.S. In a liquidation of a U.S. insured depositary institution, the 10-K notes that U.S. deposits would have priority over deposits outside the U.S., as well as over parent company claims. But we can’t imagine the new administration will want to precipitate an international crisis over whose-deposits-get-paid-off-first."

It turns out that they are implicitly guaranteed. Not only that, some people seem to be arguing that this implicit guarantee is one of the main reasons Citi can't be seized. I wonder what these skeptics think now.

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