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New U.S.-Citigroup aid deal is a shocker for shareholders

February 27, 2009 | 10:25 am

Citigroup Inc. shareholders knew the government was planning to boost its ownership stake in the bank. But they evidently weren't prepared for the terms, as announced this morning.

By converting a large chunk of its Citigroup preferred stock to common shares, the government could dilute current shareholders' stake to as little as 26%.

The bank's stock has dived today, and was off 88 cents, or 36%, to $1.58 at about 10:20 a.m. PST.

The U.S. isn’t pouring more money into Citi, but by converting $25 billion of its preferred shares to common stock would raise its ownership of the company to 36% if the deal goes as planned. The move is aimed a bolstering the bank's common equity capital, the first line of defense against further loan losses.

Citiflags The key to the deal is that other preferred holders, including major foreign investors, must agree to convert their shares to common as well.

The government didn’t leave preferred shareholders with much choice but to go along.

The terms of the deal extend a carrot to other preferred holders by offering to exchange up to $27.5 billion of their preferred shares for common shares at a rate of $3.25 each, a 32% premium to Thursday’s closing price.

But there’s also a stick: The financial restructuring will suspend dividends on preferred shares, thus removing the key reason for owning them.

"Citi is essentially forcing non-government preferred shareholders to convert to common,” wrote David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, in a note to clients. “The preferred [dividends] are getting eliminated, leaving the [preferreds] worthless, so holders will choose the stock.”

Common shareholders must approve the restructuring, but there’s arm-twisting going on here, too: If common holders reject the plan, Citigroup will issue securities to the preferred shareholders giving them the right to purchase new common equity at one cent a share -- effectively resulting in the same outcome. . . .

The dividend on common shares also is being suspended, but it already had been slashed to just one cent per quarter.

If all of this wasn't enough for shareholders to absorb, Citi also revealed an additional $10-billion writeoff that it’s tacking onto its fourth-quarter results. That will boost its net loss last year to $27.7 billion, or 48% larger than it estimated six weeks ago.

The news on Citi helped yank down shares of other financial institutions and briefly pulled the Standard & Poor’s 500 to a new bear-market intraday low, surpassing the previous low set on Nov. 21.

The government's move set off a new round of worry that it will take even stronger steps in the future, perhaps requiring Citi or other financial companies to restructure or dismantle themselves.

"It’s known that the government is going to take a stake in these companies. But the question is why,” said Kris Niswander, associate director of financial institutions at SNL Financial. “Is it to create stability in the companies or to create stability in the market so that at a later point the fate of these companies can be determined?”

-- Walter Hamilton

Photo: Sometimes a photo really is worth a thousand words -- or a 36% government stake in your business. Flags outside Citigroup's headquarters today. Credit: Mary Altaffer / Associated Press