US government still has room to manoeuvre, analysts say

The US Treasury announced on November 23 that it would guarantee $306 billion of troubled assets on the bank's balance sheet and provide a $20 billion direct capital injection. The assets consist primarily of residential and commercial real estate loans and securities.

Under the guarantee, Citigroup will shoulder the first $29 billion of losses in the portfolio. Beyond that, the bank will absorb 10% of further losses, with the government assuming responsibility for the remaining 90%. In return, the bank will issue $4 billion in preferred stock to the Treasury and $3 billion to the Federal Deposit Insurance Corporation.

"We don't know how much [the guarantee] will cost. It depends on what happens to the price of these assets, and that is very difficult to predict," said Steve Hess, New York-based senior credit analyst at Moody's.

With the $20 billion capital injection, the US government will hold a total of $27 billion in preferred shares, paying an 8% dividend. Hess noted government cashflow will benefit from the arrangement: "The yield on the Treasuries it issues is much less than [8%,] so the transaction is positive for the government's cashflow during the period it holds these assets."

Analysts believe the US government's balance sheet will be able to absorb any potential loss from the Citi bail-out. According to Brian Coulton, UK-based global head of economics at Fitch Ratings: "At around 2% of GDP, the maximum loss, if crystallised on the government's balance sheet, would not alter the conclusion drawn in Fitch's early October report that the costs can be absorbed within the tolerances of the US's AAA sovereign rating."

Citigroup has already received $25 billion in state funds, as part of the $700 billion Capital Purchase Programme bail-out package passed by Congress in October.

According to a report published by research analysts Mike Mayo and Chris Spahr at Deutsche Bank, "the best benefit we see to the new Citi plan is that the other large banks should now have an incrementally stronger counterparty". They continued: "Citi gets $40 billion in new capital, a cap for some losses, less extreme tail risk, and likely more confidence with depositors and debt holders that should protect against a downward spiral."

Citigroup, which has $3.3 trillion in assets, has seen its problems mount in recent months. The bank posted a third-quarter loss of $2.8 billion, resulting primarily from $4.4 billion in writedowns in the securities and banking division, $4.9 billion in net credit losses, and a $3.9 billion charge to boost its loan loss reserves. The bank also engaged in a tussle with Wells Fargo after a bid to acquire Wachovia soured in September.

See also: $20 billion bail-out for Citi
Treasury to take $125bn equity in nine US banks, says Paulson
Contenders queue up for Tarp funds

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