Citigroup: Hoping for a Thaw

A deal was reported this morning that will take $12 billion of leveraged loans off of the balance sheet of Citigroup (C) and move them to private equity investors. Citi had originated the loans in order to facilitate the leveraged buyout boom, with the intention of selling the loans to investors shortly after, but when the credit crunch took hold last summer these assets became unsellable and remained with Citi.

Citi was at the forefront of lending for the leveraged buyouts boom, and thus had a lot of LBO debt. Citigroup has been systematically trying to lessen their exposure to the risky assets, and as of the beginning of the year Citi had $43 billion of exposure.

The loans were very illiquid and the value of the loans themselves continued to fall. They reached a low in February of about 86 cents on the dollar, and still that was not cheap enough to generate substantial interest. Citi had previously written these loans to 70 cents on the dollar for their own books. The price of these loans have rebounded some, as the most liquid of the loans were sold for an average price of 90.47 cents on the dollar.

Citigroup is trying to get the deal finalized before they report quarterly results on April 18. They could report another large write-down related to bad loans, but they have at least further reduced their exposure to the credit market. The greater hope is that this will provide a catalyst to increase the credit market liquidity, and that would imply that the worst is behind us.

Thus far, it has been very difficult for banks such as Citigroup to find buyers for their loans even at discounts to face value. because investors were convinced that the credit markets would continue to drop. The private equity groups involved in this deal are not stupid and they want to make a profit on the deal. They are speculating that at least the market for commercial paper has seen the bottom, but notably most have not started looking into mortgage-related debt.

The deal is a step in the right direction to warm up credit markets, but at the end of the day Citigroup is selling assets at a discount while the hazardous subprime debt is still on Citi’s books. In an attempt to clean up the books they are getting rid of the less harmful LBO debt, and the bottom will not come until someone is willing to buy the most perilous debt, surely for a substantial discount. We will know more about Citigroup’s remaining exposure to risky assets after quarterly reporting.

From a long-term value investing perspective, Citigroup is slightly undervalued based on historical valuation ranges. Our math demonstrates that given Citigroup’s cash flow and sales, it would likely fetch a price in the mid-30’s given normal conditions. However, our methodology attempts to identify companies that have unjustly fallen out of favor with the market, and Citi group does not fit that criteria. So, while it may be rated a BUY, it is necessary to understand that it may be quite some time before Citi fully recovers.

This deal in and of itself does not inspire a great deal of confidence in Citi. It seems more like a frantic attempt to make their books look a little prettier before they make them public.

Comments

[freakdog:]

You should mention the pertinent factor that Citigroup is fronting the money for these entities to purchase this debt, plus they are indemnifying the purchasers on the first 20% of loss. Sounds like financial engineering to me.

2008 Apr 09 09:28 PM

[freakdog:]

OK, got it. Citigroup borrows money from the Fed window to lend to a group of LBO artists in order for them to purchase their own bad debts back from Citigroup (who also is throwing in a free PUT option on the asset so that Citigroup doesn't have to hold the asset on their books and write it down this quarter). This way they get to write down the debt at a later point when it goes bad, artificially inflating revenue for this quarter's earnings. It looks like another form of an off-books vehicle that caused all this mess in the first place. This is moving the chairs from the deck of the Titanic to the top of the iceberg with which it's going to collide. And then they'll rearrange them next quarter. And win the Nobel prize in economics.

2008 Apr 09 09:38 PM

[loonsong:]

Also, the mark to market number for similar debt doesn't take a hit
since the put isn't included in the pricing.
Smoke and mirrors as usual.
loonsong

2008 Apr 09 10:03 PM

[Andrew:]

Essentially C upgraded the $12B from junk to BB by selling directly to the top tier PE firms. Of course, they're paying a hefty price to reposition themselves???

freakdog, I don't think the LBO debt or new IOU's from the PE's would qualify at the Fed discount window, at least I hope not.

2008 Apr 09 11:58 PM

[bearfund:]

@Andrew: You *hope* not? Everything's good at the discount window these days. An IOU from my cousin Bob is fine at face value if I'm an investment bank. Forget haircuts, it's Rogaine time at the discount window. Would you like $130 at 2.5% for as long as you like for your $100 IOU from an out of work carmaker with no savings and $30k in credit card debt living in Michigan, written against his house that's worth $50k? No problem Mr. Banker, the taxpayer and saver are here to help!

2008 Apr 10 12:28 AM

[helplessobs...:]

Seems like the commenters here know more about this transaction than the author.

2008 Apr 11 12:55 AM

[Voice of Re...:]

The BS here (entire site) always seems to run deep. Don't wade in without hip boots. I see little serious or factual anything. Just one self appointed "expert" after another grinding his ax and doing a bad job of faking he knows what he/she is talking about. Damn funny but useful, no freaking way.

2008 Apr 14 11:30 PM