Citi Bank: Oh the tangled web they weave!
Tags: Citi Bank + Citi Group + Federal Reserve + Fortune + investing + Stocks
Fortune Magazine, the May 26th issue just out, has a story on Private Equity behemoths written by Alliston Sloan and Katie Benner entitled: “The Year of the
Vulture.” The article is an interesting read about deals private equity leaders have made and recounts their winning and troubled deals highlighting a list of market
leaders which include Carlyle Group, Blackstone, Texas Pacific Group, KKR, and Cerberus among others. David Rubenstein, co-founder of Carlyle Group is interviewed about the outlook for private equity at the bust end of a market cycle to which he croons about how he has new money flowing into his funds and they are rummaging through banks to find value. He goes on to say: “The flavor of the day is buying your own debt at below face value.” He continues: “I,m buying bank debt in my deal with leverage from the bank that made me that deal.” The Fortune authors remark: ” You have to love it. First, the banks provide lavish financing for the takeovers, making it possible for LBO firms to show double-digit returns to investors even if the properties themselves produced gains in the single digits. (Example: Borrow $5 billion at 6% to buy a $6 billion company that’s growing at 9%, and you make 24% on your $1 billion investment.) Now the banks are lending their borrowers money to cart off the loans at a discount, giving them another bite at the buy-side apple.”
According to the article, Citi “sort of unloaded” because they didn’t sell the paper to buyout groups as was reported. Instead Citi did “total return swaps,”
a financial maneuver that has important legal and financial implications. The Fortune article continues: “The (buyout) firms forked over $3 billion of cash and agreed to pay Citi interest (at a low 1% over the London Interbank Offered Rate) on $7.8 billion. In return Citi will pay the firms the interest and principal repayments generated by the $12 billion portfolio.” Continuing the
authors write: “Doing a swap rather than a sale avoids various complex financial and legal problems. It also means that the buyout firms are on the hook for only the cash they’ve put up, unless they choose to put up more. So if the loans prove to be truly disastrous, they will be Citi’s problem all over again.”
The point of this takeoff is that it is hardly possible for public investors to make reasonable evaluations of the soundness of Citi Bank and indeed Citi Group, with this lack of transparency in its dealings that have recourse liablities. Regulators are ill-equipped to evaluate and assess the coverage ratios for investment banks
unless they read the deal terms themselves and require extensive footnotes to disclose all the intricacies of the deals that can potentially become a liability. This
recourse, counter-party risk liability issue is a big deal. It accounts for how we got into this situation with the collapse of reserve capital and subsequent mistrust of
financial statements. Regulators need to rethink their methods, proceedures and models. The Congress
needs to understand the potential peril and economic effects to the US if such conduct continues. Glass-Steagall needs to be revisited so that public tax dollars are not gambled away and paid back with FDIC and SIPC dollars.
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