Citi survives, world can sleep

24 November 2008 By Hugo Dixon Follow @hugodixon

That s the good news in the government s mega bailout. The bad news is that the terms are too lenient, big valuation questions are unanswered and it s not clear that the bank is out of the woods.

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The US government has agreed to provide a mixture of extra capital, guarantees and loans to Citigroup. The multifaceted package includes the following elements:

The provision of $20bn in capital in return for preference shares with an 8% coupon.

The provision of a guarantee and funding in connection with a $306bn pool of mortgage assets that will continue to be held by Citi. The bank will absorb the first $29bn loss on the pool. Thereafter, any losses will be split with the government taking 90% and Citi taking 10%.

The second $5bn loss will be absorbed by the Treasury; the third $10bn loss will be absorbed by the FDIC. The pool will be financed by a nonrecourse loan from the Federal Reserve, so the central bank will face any further losses.

Citi will issue a further $7bn in preference shares to the US government. It will pay an interest rate of 300 basis points over the OIS rate for its loan.

Citi will issue the government with $2.7bn of warrants with a strike price of $10.61, exercisable over 10 years.

The bank will be need government approval to pay quarterly dividends in excess of $0.01 a share for three years. One factor in determining approval will be its ability to issue common equity of appropriate size.

Citi will have to gain Treasury approval for its executive compensation plan, which will have to be designed to reward longterm performance.

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