Citigroup 7% Preferred

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Citi Makes an Enticing Offer
Preferred Stock Will Pay 7% Return
January 15, 2008 10:29 p.m.; Page C2

Away from the headlines, Citigroup CEO Vikram Pandit quietly offered the great American public a deal this morning.
Lend the bank some money, he said, and we'll pay you a fat 7% interest rate. The payouts will get the same favorable tax treatment as shareholders' dividends, but will be secure against pretty much anything except a full business meltdown. (In an earlier version of this column, I discussed this in terms of Chapter 11. But while we haven't seen the details of the new convertible preferreds, a full Chapter 11 filing might not be needed for Citigroup to suspend dividends.) Oh, and if Citigroup's fortunes recover you'll get to share in the upside along with ordinary shareholders.
That's quite an offer.
The bank is set to issue $2 billion worth of so-called convertible preferred stock to the public. The prospectus hasn't been issued yet, but the terms should be similar to those offered to a handful of very rich investors in a just-concluded $12.5 billion private placement.
Those investors include the bank's former chairman, Sandy Weill, and Prince Alwaleed bin Talal. So if you buy into the convertible preferreds, you'll be in good company.
The stock will have a 7% yield. These are "preferred" stocks, which means they're a little like bonds. The dividends won't rise: But they are pretty secure, as they should get paid in full before common shareholders get a penny. On the other hand, the dividends should get the same privileged tax treatment as payouts on shares. Oh, and investors will have the ability to swap their preferreds into ordinary shares if the price of the latter recovers 20% from its current depressed situation. In other words, you get a great yield, some pretty good security, and almost all the upside if things improve.
The risk/reward trade-off is compelling. Stay tuned for further details.
As for those already invested in the common stock, they're wondering how much worse it's going to get.
The shares fell another $2 following the kitchen-sink fourth-quarter earnings release1, with its anticipated bloodbath of red ink and job losses.
At around $27, Citigroup stock has now fallen more than 50% from the all-time peak reached barely 12 months ago. The shares literally cannot fall as far as they have already, even if they were to go to zero.
So in a technical sense, the worst is already past. The question remains whether that is also true in a meaningful way, and whether we're near the bottom.
Two things give me pause. The first is that too many people are still asking that question -- the best bottom-fishing is done solo. The second is that we may yet be witnessing, in Citigroup and elsewhere, a monstrous, generational unwinding of financial leverage and excess.
If you think that's a distinct possibility, you probably won't invest in any bank -- in the worst-case scenarios, even the preferred stock would get slammed. But if you assume that U.S. and international capitalism will somehow stagger on reasonably successfully, as usual, then Citigroup's stock is starting to offer attractive risk/reward possibilities.
The first thing to notice is that some big, rich and smart people, such as Mr. Weill and Prince Alwaleed, are pouring in money this morning. Citigroup slashed its dividend -- but, as predicted here, that still leaves the payout looking pretty juicy. (On a $27 share, the yield is 4.7%.) Also, the bank is taking the necessary steps to shore up its balance sheet.
And while the company clearly hasn't been managed well, most of its businesses are in far better shape than the headlines would suggest. It is, after all, the nature of news to write about the airplane that crashed instead of the thousands that landed safely. Even in that disastrous fourth quarter, Citigroup's global consumer revenues rose 13% -- 4% rise in the beleaguered U.S. division, 28% overseas. Transaction-service revenue was up 31%. Revenues from global wealth management, which includes both Smith Barney and the private bank, rose 28%. Total revenues for the quarter were $81.7 billion, even if the bank did earn a mere $3.6 billion in net income.
Citigroup has written down its exposure to subprime mortgages from $54.8 billion to $37.3 billion. It's a lot. But it's a fraction of the $140 billion that has been wiped off the bank's market value since last summer in the growing panic over subprime.
None of this is to downplay the scale of the problems, merely to suggest that at current levels the stock already seems to be pricing in a lot of risk.
The best play, though, may be the new "convertible preferred" stock.
Write to Brett Arends at brett.arends@wsj.com2

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