Articolo sull'entrata del Tesoro nel capitale di Citi:
Why Citi Common Shares Crashed, And Why Common Preferred May Be Problematic Too
March 01, 2009
The Volkswagen bandwagon idea du jour was a capital structure arbitrage in Citi (
C) preferred paired with shorting Citi common. As the government's term sheet proposed the conversion of Citi preferred stock into common at a price of $3.25, a huge number of accounts thought there was a significant arbitrage to be held here.
The math is roughly as follows: the face value of Citi preferred stock (C AA on Bloomberg) is $25, implying 7.69 shares of common to be received per preferred share (at $3.25). As C common traded at an average price of $1.60/share during the day on Friday, a preferred share holder would effectively arb into an implied value of $12.30 of common stock per preferred share. Citi preferreds traded down to a low price of $4.5 early in the day, after closing at $5.50 Friday, however they quickly inverted and hit a high of $9.25 as people realized the potential arbitrage, before closing for the day at $8.05 on volume of 46.5 million shares. The trade could be boxed by shorting 7.69 shares of common for every share of preferred purchased, thereby "securing" a roughly 50% return. This (probably among other things) explains the persistent drop in Citi common over the day as hedge funds were locking in what they thought was a certain premium.
The problem that most however may have overlooked is a little footnote in the Citi illustrative example of how preferred to common conversion would take place, where Citi noted that the government will provide
separate treatment for private and public preferred shareholders: "Ownership assumes conversion of publicly issued preferred stock is done at a significant premium to market, while the U.S. Government's and privately placed preferred are done at par."
Investors are now hoping that the premium for their publicly purchased preferred shares will be lower than the "guaranteed" 50% return they would pocket if they executed the trade at the end of the day, as otherwise they face massive losses on the conversion. As the Volkswagen example has taught us, and as the government has shown in its "white glove" treatment of private investors of all kinds, and couple that with some forced repo pulls by Citi common longs who may eventually realize their stock will skyrocket if they cause a forced squeeze, we wait with baited breath to see the carnage as the "Citi Arb Trade" blows up at some point over the next several weeks.
For people who want to dig through the most recent prospectus supplement to the Citi Series AA Preferred stock, you can do so
here.
CreditSights has done an invaluable comparison of the 3 different classes of exchanging securities as part of the transaction, listing out the key terms for each tranche of securities (
click on chart to enlarge). One of the relevant findings is that the gov't will exchange the balance of its existing preferreds (not exchanging to common) into 8% Trust Preferreds. The implication is current TruPS and eTruPS holders will be
pari with the government, which is good from a security protection point, but risky in case the government decides to waive the dividend on the TruPS as all current TruPS holders will also lose dividend payments. The last is unlikely as it is the last form of dividend-paying security that taxpayers have remaining in Citi.
