Citigroup (C) announced on Friday that it will redeem $3 billion worth of trust preferred securities, or TruPs, next month in an effort to save interest expense. The four TruPs series that are being redeemed are:
- Citigroup Capital VII-7.125%
- Citigroup Capital VIII-6.950%
- Citigroup Capital XIV-6.875%
- Citigroup Capital XV-6.500%
I was critical of Citi's "capital return" plan announced last week wherein the company announced it would repurchase $1.2 billion in common stock this year as approved by the Federal Reserve. I posited that this doesn't amount to a capital return at all as Citi issues that much common stock per year as compensation to its employees. In other words, Citi was just stopping the bleeding that was occurring as a result of constant dilution due to paying its employees.
However, this move to redeem $3 billion in TruPs is terrific for long-term holders of the stock. With the move, Citi will save approximately $200 million pre-tax annually in foregone interest payments on the securities. Given that Citi still owns a massive, unused deferred tax asset, this money should be relatively tax-free until the DTA is used up. After that, even if we assume a full 40% tax rate, which Citi hasn't incurred for a very long time (per the financials), we are still talking about $120 million of after-tax savings that will accrue directly to the bottom line annually.
With Citi's current 3.04 billion shares outstanding, the company is using $1.01 per share in cash that is currently available and will accrue between $0.04 and $0.07 per share in additional earnings, depending on how taxes are allocated. Considering that Citi clearly had no use for the $3 billion currently, as the company is apparently not interested in returning cash to shareholders any time soon, this is the next best thing as it will increase earnings per share every year. If we apply a multiple of 10 times earnings to this move to reduce interest expense, we can assume that Citi should be worth 40 to 70 cents more per share today than it was on Friday on a long-term basis. While this isn't a huge increase, the fact that Citi is being creative in order to find ways to reduce unnecessary expenditures is a positive for shareholders. As a bonus, additional earnings later should allow for higher dividends and share repurchases in the future.
On the other hand, if Citi decides later that it needs the financing again, it can simply reissue TruPs or bonds of the same amount at much lower interest rates. If Citi decides to go this route, of course the interest savings will be diminished but the fact remains that if Citi can find a profitable use for the money later, it should incur the interest expense and issue the securities. If Citi had a profitable use for the money it has decided to use to redeem the TruPs, it wouldn't have decided to redeem them. In a zero interest rate policy environment, it can be quite challenging to earn 7% by investing money and I suspect this played a role in Citi's decision. However, when this environment disappears and some level of normalcy returns, Citi could simply reissue TruPs and invest the money after having accrued hundreds of millions of dollars in interest savings from this move.
Although I was critical of Citi last week with its weak capital return plan, this move to reduce expensive debt is terrific for long-term holders of the stock and I believe that it means Citi is worth about one to two percent more than it was before the announcement, based on the after-tax savings and Citi's unused deferred tax asset. Of course time will tell but right now Citi stands to gain hundreds of millions in interest savings even if it decides to reissue the TruPs at a later date. If not, billions in savings will accrue to Citi shareholders in the coming years, boosting earnings and the stock price.