Vitaliy’s Contrarian Edge

Citigroup - As Good As it Gets?

November 28th, 2007

By Vitaliy Katsenelson 

Who would have thought that an almighty Citigroup (C ), a diversified financial giant that should have benefited from the sub-prime mess by scooping up weaker competition at pennies on the dollar, would be taking out a sub-prime no-income verification $7.5 billion convertible preferred loan from Abu Dhabi - a country that most of us can hardly find on the map?I don’t use the word sub-prime lightly, but the 11% coupon on the cost of the Citigroup (C) deal exceeds the 7.5% coupon that Countrywide (CFC) (the US’ largest mortgage originator which is fighting for its existence and supposedly doesn’t have the diversity of Citi’s financial empire) promised to pay Bank of America ( BAC) in the similar convertible preferred deal. And it is no-income verification loan as Citi’s exposure to the alphabet soup problems (SIV, ABS, CDO, CMO, MTV, VH1 – oops I went too far), or in other words everything that went wrong in financial markets over last six months, is very difficult to identify.

Unfortunately it takes years not months for all problem loans to surface from the balance sheet to the income statement. For example, in late 1980s CIti found itself in the center of a Latin American default crisis. It took close to four years for the company to work through the troubled loans.

This is not just another investment from a sovereign foreign entity that should “shore up investor confidence in Citi,” as PR would spin the deal. At 11% interest rate this loan is an act of desperation. Remember, the bank is in the business of making a spread between its borrowing and lending rates.

Unless Citi will be lending at a rate in excess of 11% - a highly unlikely scenario - the purpose of this loan was to fund its dividend for next three quarters. Citi’s management saw what happened to Freddie Mac’s ( FRE) stock – it took a dive – when it announced a 50% dividend cut and decided to take the expensive route instead.

The fallout in financial stocks will create a lot of buying opportunities as lot of great regional banks that were not smart enough to do dumb things are getting lumped in the same bad apple basket as Citi and the like.

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Entry Filed under: Analysis & Research