What’s Up with Citigroup?

On Monday, Citigroup received permission from its regulators to buy back the remaining $20 billion in preferred shares held by Treasury because of its investments under TARP. (Treasury invested $25 billion in October 2008 and another $20 billion November 2008; however, $25 billion worth of preferred shares were converted into common shares earlier this year, giving the government about a 34% ownership stake in the bank.) The stock then fell by 6%. What’s going on?

This is another example of a bank doing something stupid in order to say that it is no longer receiving TARP money, and probably more importantly so it can escape executive compensation restrictions. As Citigroup CEO Vikram Pandit himself said last October, TARP capital is really cheap (quoted in David Wessel, In Fed We Trust). Instead of paying an 8% interest rate* on $20 billion in preferred shares, Citigroup chose to issue $17 billion of new common shares while its share price is below $4/share. Citigroup’s cost of equity is certainly more than 8%, so it just increased its overall cost of capital. The stock price fell because existing shareholders are guessing that the dilution they suffered (because new shares were issued) will more than compensate for the fact that Citi no longer has to pay dividends to Treasury.

Paying back the TARP money also makes Citigroup weaker. That’s $20 billion less in cash it has to withstand any potential problems in its asset portfolio. Now, you can say that it compensated by issuing new equity. But those are two separate transactions; Citi could have issued the common shares whether or not it paid back its TARP money. Standing on its own, paying back TARP money is unequivocally bad for the balance sheet.

So this is bad for Citigroup shareholders and bad for Citigroup–except for the potentially important fact that Citi can now pay more money to its employees, which matters if you believe that pay is correlated with future performance (it doesn’t matter if it’s only correlated with past performance). So why are the regulators letting Citigroup do it? I think there are two reasons. The first is that they’re on a slippery slope. Once they let Bank of America pay back its TARP money, they couldn’t say no to Citigroup without confirming what everyone has always believed but that the government has scrupulously avoided saying: that Citi really is in worse shape than the other banks. The second reason is that it enables the government to declare victory and put TARP behind it, which is certainly valuable for political reasons.

What about for the taxpayer? I may differ from some people here, but I actually think it’s good for the taxpayer. We are getting our money back. The risk that Citigroup will come back for a future bailout has gone up, which is bad; but I believe that if such a bailout ever happens, it will have to be on draconian terms–a government takeover in which management is fired, shareholders are wiped out, and the company is broken into pieces and sold off. I doubt that any administration will be able to engineer another Citigroup-friendly bailout in the future.

Of course, on the way out the door, Citigroup did get one parting gift to reduce the chances that it will have to come back: an Internal Revenue Service exemption worth $38 billion. Arguably 34% of that is the government dealing with itself (since it owns 34% of Citigroup), but if the Times is right that still leaves $25 billion (about $1/share) of subsidy to Citi’s other shareholders. $13 billion of the $38 billion counts as capital for regulatory purposes, so this enables Citi to boost its capital ratio by a full percentage point (Citi’s risk-weighted assets were around $1 trillion at the time of the stress tests).

Finally, the FDIC is keeping $5.4 billion of the $7 billion in preferred shares it got from Citigroup in exchange for guaranteeing about $300 billion of assets in November 2008. More on that later.

* The interest rate on the first $25 billion was 5%; the rate on the next $20 billion was 8%. After the preferred-to-common conversion, I don’t know which rate applies.

By James Kwak

19 responses to “What’s Up with Citigroup?

  1. The government is also selling some of its shares in the public offering. (The ones “we” converted from preferred.)

    Perhaps the stock is also falling because the market was expecting those shares to be held permanently and/or dissolved eventually?

    I agree this is good for taxpayers. Let Citi raise private capital while it can, at inflated prices, to repay the Treasury. Now, about those FDIC guarantees…

  2. CBS from the West

    “…I believe that if such a bailout ever happens, it will have to be on draconian terms–a government takeover in which management is fired, shareholders are wiped out, and the company is broken into pieces and sold off. I doubt that any administration will be able to engineer another Citigroup-friendly bailout in the future.”

    I hope you are right about this, but I wonder why you believe it. Neither the administration nor Congress has shown any inclination to hold any bank’s feet to the fire up to now. Why will they start?

  3. I believe it because I don’t think public and the Congress will stand for it. Just like the administration would have liked to bail out Lehman in September 2008 but decided it didn’t have the political capital, I don’t think there is the political capital left to be nice to Citigroup again. I could be wrong.

  4. The public will not stand for it, but will that change anything?
    The public voted for change, but the only change we the people got was a changed Mr Obama.
    Same in Europe: the people did NOT want the Euro, NOR the constitution, but ended up with both.

    The Congress will not stand for it?
    Why not, when this blog and others have detailed these ´reforms´ Congress has come up with. Remember, they are paid by the financial ´services´ firms.

    ¨Just like the admin would have liked to bail out Lehman…¨
    Based on articles about that weekend, the admin did NOT want to bail out Lehman. There was bad blood on Wall Street re Lehman and Fuld and co. Goldman like having a competitor removed. And also, Paulson, Bernanke and Geithner did not understand the fall out impact. That´s why, only a couple of days later, they bailout AIG, and City, with much more dollars than would have been required for bailing out Lehman.

    And with this incredible tax exemption to the tune of $ 25 billion, what good are we to expect from this admin?

  5. i have seen stories that Citi is also getting a tax breadk of 38 billion to pay TARP back. and maybe just maybe they got the money to pay it back by borrowing from a Fed program to boot?
    as for any body in Congress wanting to do the right thing? nope. some Dems may have been captured. but all of the GOP have been. can’t have any controls on the market to make sure it operates right, that way when it breaks (and it will) they won’t be responsible for it,

  6. dw: the $ 38 billion tax break is also mentioned by James in the post. As taxpayers are 34% owners of City it is a net $ 25 billion tax break (which I refered to above).

    City repays TARP to Geithner. Geithner can spend this money without Congress input. The tax break of $ 25 billion is at the discretion of IRS (no doubt by heavy input from Geithner and others of the admin), hence no Congress input.
    Because even if in the end Congress will always vote for the best interests of Wall street, they sometimes like making a lot of distracting theater.

    So Geithner has some extra money to spend, and City gets a $ 25 billion taxpayers’ gift. That’s what the admin calls a win-win situation. That’s what we the people call wealth transfer from the middle class to the upper-rich banksters.

  7. Isn’t the transaction is really just an additional subsidy disguised as a TARP repayment.

    The way I’ve read this is CITI gets a +25B tax benefit for paying off the 20b by raising 17B+ in new common. Net cost to CITI Negative 22B.

    Pure smoke and mirrors

  8. As bad as things are, even I think it’s doubtful that they’ll be able to carry out any kind of big bailout again, draconian or not. Especially after how they’re hyping how these banks are “paying the money back”.

    Maybe I’m just being too optimistic for once, but if they can’t do the looting in smaller backdoor increments (like the recent AIG conversion), I’d be surprised to see them try to get big and brazen about it again.

  9. It seems like Citi paying back TARP money is a good idea but if this puts them in a worse situation how is this helpful. It doesn’t make much sense for them to do this.

  10. The press is tying the entire tax asset to booking of carry forwards. A hefty portion is foreign taxes. There are also a lot of other revenue recognitions for GAAP purposes not recognized for tax purposes. Finally, a major portion of the prepaid tax for GAAP purposes is providing for repatriation of foreign earnings. That is the profits of foreign units have not been included in US parent tax returns in full. Consequently Citi’s domestic tax loss carry forwards could have been extinguished to the extent of electing to deem all needed foreign earnings as repatriated and reinvested. Thus, the taxes provided for these deemed repatriated earnings would be credited out in the tax provision. Given Citi’s non US business this must be a huge number. Citi anticipating the loss of carry forwards would have lowered them to the extent of deeming foreign earnings repatriated.

    The net operating loss gift being trotted out here comes under Section 382 IRC and change of ownership problems must have been anticipated by the Citi tax people.

    Either way, I suspect whatever net operating loss carry forwards based on returns as filed for 2008 and prior carrybacks would be relatively minimal unless the bonus issue redemption of the Treasury stock were not anticipated. Citi would have made the foreign earnings election in the 2008 return which was filed in the last several months. Extensions are, after all, a planning tool.

    On the other hand, deliberately sacrificing the tax benefit for employee bonuses must surely be actionable by the shareholder’s including the Treasury.

    It would be very interesting to see all the details of the Citi Tax Provision for the last few years including 2008. Then 2009 is still underway and if the tax benefit were really at issue to get the bonus, CIOti could make as many deliberate inclusions in income as possible to kill current year losses. Obviously, Citi would trigger all possible tax losses already provided for in the financial statements to offset the deliberate income recognition items. Citi certainly has plenty of this kind of loss residing in non deductible reserve liabilities. Sell the junk to get the loss in other words. I do not think the Treasury or Fed would like dumping right now.

    Hence what they did was sound policy. But it surely was anticipated or am I giving too much credit to Citi ?

    The most basic tax competence involving net operating loss questions is to substitute all possible income recognitions and transference of what would be lost to increasing tax hard basis in assets of the parent and subsidiaries. In short, you get the deduction when you sell or liquidate the asset rather than simply letting it fall through the cracks as a waste.

  11. Simply put in the above post. If necessary, a loss carry forward asset is reduced by prior inclusion in the tax return of discretionary income inclusions, especially the electable types. That is why elections are included in the tax code.

    The effect of the above actions on specific temporary differences being triggered would be . Debit Current and Non Current Deferred Income Taxes. The Credit would be Current and Non current Deferred Tax Assets. Thus , if the Tax Asset were $38 bn and $37 bn of the above discretionary actions were taken, the write off of the Tax asset if that were the issue post actions is a write off of $1 bn instead. In this case, using the items I refer to, assets within the consolidated group would get future deductions to the extent of $37 bn instead of a gross loss.

    If none of the foregoing were considered all through 2008 and 2009 before the 2008 tax return were filed and 2009 too, Citi would be simply wasting assets to be able to pay bonuses to their employees.

  12. I went into the Citi 2008 tax provision note. Citi shows a refundable Current Federal tax of $4.582 bn . There was a refundable Current Federal tax of $2.560 bn for 2007. Subsequently, the carry back changed to five years and the provisions would have to be recalculated to record refunds of taxes to years 2003. This would be a refund due and a reduction of tax asset recorded for carry forwards of losses and tax credits of $18.424 bn in the tax footnote detail. Foreign Tax Credits are $10.500 bn . Thus maximum carry back loss values would be $ 7.924 bn The detail is not shown for years before 2007 but it is safe to assume the entire $7.924 bn carry forward will be turned into a refundable carry back. That leaves the Foreign Tax Credit Carry Forward as the issue. The expirations are mostly quite far out.

    In another vein, Citi has paid US taxes way in advance of recognition of income on it’s books. As of 2008 the tax asset was $52.079 bn which at the Federal Statutory rate of 35 % that Citi uses means that Citi income tax returns cumulatively did not deduct expenses on its books or included income on the tax return not on the books of $97 bn. Citi did take some deductions or not included income on it’s tax return of $$22 bn. That means the governments were paid taxes on advance recognition of taxable income over books of $75 bn. That means Citi gets a deduction of $75 bn against future years income of a like amount. The single biggest item is non deduction of credit loss reserves of $32 bn. Yup, the wrote off $32 bn more on the books than they took on the tax return.

    The government is not losing out here at all. Citi might be losing if they cannot offset all of their Foreign Tax Credit Carry Forwards. The government collected tax they should not have collected.

    In my first two posts I tried, probably poorly, to use a general case to show that Citi would be very incompetent to not anticipate an ignorant populist hue and cry over tax stealing by Citi when that is
    simply not the case. If the tax return were filed the same as GAAP, Citi would be entitled to a tax refund of a net of $44.469 bn as of the end of 2008.

    In a sense, the ” bailout” was the governments making good on it’s windfall.

  13. Russ: one word – HUBRIS

  14. Based on the real economic factors at work globally, the economy is not actually out of recession, and considering that the toxicity of the assets will rise next year (read commercial and new Alt-A defaults) greatly, there is every chance that this IS 1930, and the market run up is a myth caused by the churning on Wall Street and the cheer leading from the Administration. Where does this leave the big financial companies. Well, I think that they will be sucking for air (and more bailouts) sometime next year, and they won’t get them, because the FED can’t print enough money, and the populace is becoming more aware daily of the gaming it’s gotten from the oligarchy, AND because there another bailout would equal political suicide for anyone voting to do it.

    Oh well, I guess all sinners have to pay the piper eventually. That is, of course, if Jamie, Vikram, Dick, and the others can somehow avoid assassination until then!!

  15. I agree. It’s not “good for the taxpayer,” it is another “taxpayer” bailout.

  16. Mr. Kwak,
    Don’t forget all those CitiGroup people that are in the Obama administration.

  17. i think you’ll find the european public actually did vote for both the euro and the lisbon treaty. those countries that didn’t want the euro (eg britain) opted out.

  18. The people may not like it, but what choice will they have? Unless new procedures have been put in place in secret (I, at least, have seen nothing about them), the choice will be the same – bailout or economic collapse. However, as Jerry J points out below, note the hue and cry over the Citi tax break, which is really nothing more than letting them have what really should be theirs – it is more in the way of preventing a tax ripoff by the IRS than providing a windfall to Citi. So, the hue and cry over the tax issue makes me wonder if, next time, we may find what would have happened without the bailouts we gave in the first round.