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Tuesday, January 15, 2008 10:54 AM

Cost of Capital "Ratchets Up" at Citigroup and Merrill

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Bleeding capital badly, Citigroup Swings to a Loss, Plans to Raise More Capital

Citigroup Inc. posted a huge fourth-quarter net loss, hit by $17.4 billion in subprime-related write-downs.

The bank announced plans to sell another $14.5 billion in preferred stock and said it will cut its dividend 41%. The company also plans to sell noncore assets. After initially trading higher in premarket trading, shares were recently down to $28.15 from Monday's closing price of $29.06.

New York-based Citigroup posted a net loss of $9.83 billion, or a loss of $1.99 a share, compared with a profit of $5.13 billion, or $1.03 a year earlier.
Bloomberg is reporting Merrill Lynch Gets $6.6 Billion From Kuwait, Mizuho.
Merrill Lynch & Co. raised $6.6 billion by selling preferred shares to a group including the Kuwait Investment Authority and Japan's Mizuho Financial Group Inc. after being battered by losses from subprime mortgages.

The investors also include the Korea Investment Corp. and clients of U.S. money managers TPG-Axon Capital and T. Rowe Price Associates Inc., Merrill said in a statement today.

The bank will pay a 9 percent annual dividend on the securities until they automatically convert into shares in 2 3/4 years' time. The group will get fewer shares if Merrill's stock price climbs above $61.31 and more if it drops below $52.40.
Ratchet Provisions

Minyan Peter was talking about "Ratchet Provisions" in Citigroup and Merrill Lynch convertibles.
In the terms for both the Merrill (MER) and Citigroup (C), convertible transactions are "ratchet" provisions. For those not familiar with the term, when an issuer agrees to a ratchet, it gives the security holder the right obtain better terms in the future under certain conditions.

Specifically, (and in a nutshell) should Merrill issue more than $1.0 of additional convertible equity, or Citigroup $5.0 billion in the next year at a lower conversion price, the holders of the deals announced this morning can get the new price.

For existing Citigroup/Merrill shareholders, should such a further capital raise occur at a lower stock price, their dilution will be significantly compounded because of the ratchet.

At least to me, the inclusion of a "ratchet" for both of these companies suggests that, while still available, the true price for incremental capital has gone up significantly.

Shareholders in troubled financial services companies should not take this lightly.
Citigroup Underpins Consumer Struggles

Professor Andrew Jeffery is noting that Citi Underpins Consumer Struggles.
In many ways, Citigroup is representative of the American consumer, lulled to sleep by years of unprecedented prosperity while it ignored a ballooning balance sheet supported by fewer and fewer real dollars of income. Though its subprime losses were certainly the catalyst for the recent management shakeup and capital restructuring, Citigroup and the consumer’s current struggles underpin something much more fundamental about the sustainability of debt-induced expansion.
Citigroup 4th Quarter 2007 Presentation

Following are a few charts from Citigroup's 4th Quarter 2007 Presentation. Click on any chart to see a sharper image.

Income Statement Summary

Major Profit and Loss Items

Cost Of Credit

The above charts tell a sad story. Citi had losses on Subprime, consumer credit, and headcount reductions. Cost of capital is going up with ratchet provisions.

Just as Bernanke Reached a Point of Recognition, so it seems has Citigroup, with a dividend cut and expected massive headcount reductions in the works.

But the market has reached a point of recognition as well. This can be seen in the ratchet provisions. Those provisions are going to make it difficult for Citi to raise more capital down the road. Yet it is clear that more housing related losses are coming, and more consumer credit losses are coming as well. A Credit Card Time Bomb Is Ticking Away.

Like it or not, Citigroup is going to have to start selling off business units to raise more capital. By the time all is said and done, Citigroup is likely to be a mere shadow of its former self.

Mike "Mish" Shedlock
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