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Capital conundrum

15 November 2007 By Antony Currie

Add high borrowing costs to Citigroup s growing list of problems. The US financial giant had to fork over about 60% more in interest premium on its new $4bn bond than on its last deal and that was done in the midst of the August liquidity crisis. But it s not the only financial firm that will have to stump up to get cash.

Any bank tapping the longer-term bond markets will have to pay more now than earlier this year. Credit fears have caused the price of their outstanding paper to drop, forcing the spread, or premium, over government bonds to widen. They may cling to the hope that spreads will return to normal in a month or two. And in any event, isn t Citi a bit of a special case? After all it has booked $17bn of write-downs, its capital ratios are among the lowest of its peers, and it has just parted company with its boss.

But these hopes look misguided. First, there s little to suggest that spreads for the financial sector will improve in the new year. It s likely there will be more write-downs of subprime and CDO holdings at the end of the year, and possibly beyond. And bondholders aren t as confident as shareholders that the worst would be over, even then.

Second, bond investors are already stuffed to the gills with bank debt, which accounts for about two-thirds of high-grade bond issuance in Europe and the US. As long as they remain unsure of the outlook for the economy and credit quality, they ll demand big premiums. What s more, there s a lot more existing paper that could be up for grabs on the cheap: struggling structured investment vehicles own some $150bn, and could have to sell it to pay their own debts.

But the pain won t stop there. Citi isn t the only one whose capital ratios have fallen. Many will come under further pressure if the credit crunch broadens beyond mortgages and leveraged loans. If that happens, a number of banks on both sides of the Atlantic could be forced to issue more equity corporate financiers are already drawing up their lists. With many bank stocks plumbing lows, that ll make life even more expensive.


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