(WSJ) The federal government agreed Sunday to take unprecedented steps to stabilize Citigroup Inc. by moving to guarantee close to $300 billion in troubled assets weighing on the bank's books, according to people familiar with details of the plan.
Treasury has agreed to inject an additional $20 billion in capital into Citigroup under terms of the deal hashed out between the bank, the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corp. Treasury officials will charge a higher interest rate for the capital injection -- 8% for the first few years -- than it has charged to dozens of other banks now borrowing money under the government's the $700 billion rescue package approved by Congress last month.
In addition to the capital, Citigroup will have an extremely unusual arrangement in which the government agrees to backstop a roughly $300 billion pool of its assets, containing mortgage-backed securities among other things. Citigroup must absorb the first $37 billion to $40 billion in losses from these assets. If losses extend beyond that level, Treasury will absorb the next $5 billion in losses, followed by the FDIC taking on the next $10 billion in losses. Any losses on these assets beyond that level would be taken by the Fed.
Citigroup would also agree to work to modify -- if possible -- troubled mortgages held in the $300 billion pool, using standards created by the FDIC after the collapse of IndyMac Bank.
The government is not expected to require any management changes, as that was seen as potentially being too destabilizing.
Citigroup is one of the world's best-known banking brands, with more than 200 million customer accounts in 106 countries. Its plunging stock price threatened to spook customers and imperil the bank.
If the government devises a successful rescue plan, it could help bring stability to the entire financial system. If it doesn't, even deeper doubts about the industry's future could spread.
The plan would essentially put the government in the position of insuring a slice of Citigroup's balance sheet.
Another possibility on the table was the creation of what is sometimes called a "bad bank" -- an outside entity designed to hold some of a financial firm's worst assets. That structure would help Citigroup cleanse itself of billions of dollars in weak assets, these people said.
In either case, taxpayers could be on the hook if Citigroup's massive portfolios of mortgage, credit cards, commercial real-estate and big corporate loans continue to sour.
The government also is considering injecting more capital into Citigroup, according to a person familiar with the government's plans.
The government and Citigroup had hoped to unveil the plan Sunday evening, but the negotiations appeared to drag on longer than expected. Treasury Secretary Henry Paulson briefed a few Congressional leaders about the plan late Sunday. A Citigroup spokeswoman declined to comment on the discussions.
Asian markets were mostly lower in early Monday trading as news of the discussions surfaced. Japan's markets were closed for a holiday.
While Citigroup's recent woes don't appear to be as severe as the problems that ultimately felled Bear Stearns Cos. and Lehman Brothers Holdings Inc., the U.S. government seems to have decided it can't afford to gamble on whether Citigroup will weather the storm.
At the same time, the Treasury Department is already facing a political backlash over the use of taxpayer funds to stabilize the banking sector, and has nearly exhausted the $350 billion that Congress allotted to the first phase of the industry rescue.
The planned arrangement with Citigroup appears to be an attempt to thread that needle by giving the company some breathing room until markets calm.
It was unclear Sunday night whether the government would take an additional equity stake in Citigroup in return for the support. Citigroup previously agreed to issue the government preferred shares in return for the $25 billion the bank received as one of the first nine companies to get capital infusions.
If the government sets up the bad-bank structure, the amount of financial support will be a key variable. If there is too little, investors might conclude that the bad assets will wipe it out, leaving the bank right where it was before.
A bad-bank structure was used successfully in the late 1980s, with funding from private investors, to rescue Mellon Bank, now called Bank of New York Mellon Corp., from a pile of bad debts.
Behind the push is a broad effort to shore up faith in Citigroup, which saw its stock price fall 60% last week to a 16-year low. Citigroup has been pounded by mortgage-related losses and growing anxiety about future losses.
In addition to $2 trillion in assets Citigroup has on its balance sheet, it has another $1.23 trillion in entities that aren't reflected there. Some of those assets are tied to mortgages, and investors have worried they could cause heavy losses if they are brought back on the company's books.
Even as they assured employees and investors last week that the company was on sound financial footing, Citigroup executives and directors knew they needed to do something fast to stabilize their company. Top government officials, including the heads of the Treasury Department and the Fed, also have been scrambling to draw up contingency plans in case Citigroup's troubles intensified.
On Sunday evening, government officials were locked in meetings to hammer out the final terms of an arrangement that will leave the government deeply enmeshed in the inner workings of one of the world's largest financial institutions.
It wasn't known late Sunday if Citigroup will have to make changes to its executive ranks, board or elsewhere inside the company in return for government assistance.
As Citigroup shares fell last week, Chief Executive Vikram Pandit and other top executives insisted that the decline wasn't a threat because the company has plenty of capital. By Friday, bank officials were hoping for a public expression of confidence from the government, believing that would help reassure clients and customers.
One rescue structure under consideration would resemble aspects of the $150 billion bailout plan the government struck with American International Group Inc. in November. Two vehicles, funded largely by as much as $52.5 billion in government money, were created to take on risks from some of AIG's souring assets, including exposure to credit derivatives. That deal also reduced interest costs on AIG's previously arranged $60 billion loan from the government.
In Citigroup's case, the government's arrangement likely will be able to accommodate only a sliver of the company's more than $3 trillion in assets, including its holdings in off-balance-sheet entities. Jitters about such "hidden" assets helped trigger the nose-dive in Citigroup's stock last week. Among the off-balance-sheet assets are $667 billion in mortgage-related securities.
Citigroup has tried repeatedly to rid itself of its exposure to those assets. In late September, the company reached an agreement for a government-financed acquisition of Wachovia Corp. Under that planned deal, Citigroup and the government were going to divvy up the losses on $312 billion of assets, with Citigroup absorbing the first $30 billion in losses and the government shouldering the remainder.
Citigroup described that arrangement as intended to insulate it from Wachovia's risky mortgage assets. But Citigroup also would have been able to unload some of its own assets, according to people familiar with the matter.
That deal unraveled in less than a week, after Wells Fargo & Co. emerged with a higher bid that didn't require direct government backing.
Shortly afterwards, Citigroup pitched the bad-bank idea to the government, arguing that the government should help the company after Wachovia slipped away, according to a person familiar with the matter. But federal officials balked at the idea.
As recently as one month ago, Citigroup had hoped to be able to unload some of those assets to the U.S. government through its Troubled Asset Relief Program, or TARP, according to people familiar with the bank's plans. But when Treasury Secretary Paulson earlier this month shelved plans to use TARP to purchase banks' bad assets, that option vanished.
Last Monday, Mr. Pandit said an a meeting with employees that Citigroup was scrapping plans to try to sell about $80 billion in risky assets. Investors and analysts interpreted the move as a sign that Citigroup either was unable to sell the assets, or would have had to incur hefty losses in the process.
Two days later, Citigroup announced it was buying $17.4 billion in assets from its structured-investment vehicles -- complex entities whose holdings included risky mortgage-linked securities -- and faced a $1.1 billion loss due to their diminished values.
The back-to-back moves, coupled with existing fears about Citigroup's massive off-balance-sheet holdings, stoked investor fears that Citigroup could be swamped by toxic assets flooding back onto its books. That helped launch the current panic, which was exacerbated by bleak economic news.
Depending on the structure of Citigroup's deal, government officials could face requests from other banks for similar help shoring up their balance sheets. Banks, hedge funds, and private equity firms have urged Capitol Hill and government officials to restart the asset-purchase program in recent weeks.
"The problem is that other banks would want to get in line" for such government support, says Thomas B. Michaud, a vice chairman of investment bank Keefe, Bruyette & Woods Inc. "Is there enough money to do that?"