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Wednesday, April 09, 2008 8:13 PM

Ponzi Financing At Citigroup

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Citigroup is cash strapped. To raise cash it has agreed to sell $12 billion worth of leveraged loans it was holding at a reported 90 cents on the dollar. Earlier today in Less Than Meets The Eye at Citigroup, Goldman I noted that in order for Citigroup to get a price of $12 billion for the loan portfolio it sold, it had to agree to indemnify the buyers of the first 20% of losses. Tonight more details are emerging.

Reuters is reporting Citi financing its $12 bln sale of loans.

Citigroup Inc's (C) plan to sell $12 billion of loans and bonds made to private equity firms is seen as a positive for the bank and the loan market, but the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.

That's because Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.

Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar.

After the sale, Citi would no longer have to mark down the original leveraged loans if their value falls further, a real possibility in the currently disrupted credit markets. It also allows the bank to confirm the recorded values of other leveraged loans in its portfolio.
My Comment: Exactly how does this confirm the value of anything? What this did was muddy the waters. Citi had to indemnify the buyers from the first 20% of the loss so Citi effectively got somewhere between 70 and 90 cents on the dollar for those loans. We will not know the exact amount until a later date.

The deal was made in this manner specifically to muddy the waters. It appears that Citi is setting up a con game in which they may pretend they got 90 cents on the dollar when they really didn't. That 20% indemnification clause in the sale is like a PUT option. That option has a value and it's a huge mistake to pretend otherwise.
"It demonstrates that there is a market for this paper," said Marshall Front, Chairman of Front Barnett Associates in Chicago, which owns about 450,000 Citi shares. "This whole process of credit unfreezing, which started with the Federal Reserve opening the discount window to investment banks, is beginning to play out."
My Comment: Yes there is a market, at the right price. There's a market for anything, anytime, at the right price. And the price in this case was a 10% guaranteed markdown plus a free PUT option that has the potential to make the total markdown as high as 30%. And Citi had to agree to finance that! That's quite a market. If I was Marshall Front I would not be talking up that market too loudly. This whole setup smacks of desperation. Citi's dividend can't last long at this rate.

Mike "Mish" Shedlock
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