Its Citi stake now vulnerable to dilution if the bank decides to sell new shares to redeem part of the US govt stake
By MICHELLE QUAH
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THE Government of Singapore Investment Corporation (GIC) has beaten the odds in profiting from what many considered a risky investment in Citigroup.
At the time, a year and a half ago, GIC's US$6.88 billion investment looked almost like a bailout of the struggling US financial institution.
Instead, the sovereign wealth fund actually succeeded in turning a profit.
Which then begs the question: why not capitalise on its good fortune, hold onto its stake in Citi and ride the group's re-ascent, instead of paring its shareholding?
A year and a half ago, Citi was in desperate need of cash. There were concerns that, despite GIC's cash injection, the group would still need to go to the market to raise more capital, in the future.
Then, when the situation couldn't seem to get any worse, it did. Lehman Brothers collapsed and there were fears it could take the entire financial system down with it.
Yet, therein lay the secret of GIC's success. The fund proved that, sometimes, the best investments are made in the worst of times.
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It was precisely because of Citi's desperate situation then that the bank offered an impossible-to- refuse deal to GIC - convertible perpetual preferred shares with an interest coupon of 7 per cent, set at a fixed share price, which essentially meant that GIC faced no downside risk, unless Citi collapsed.
And, yet again, it was precisely because the danger of Citi's collapse suddenly became very real (after Lehman's demise) that GIC struck its next bit of good fortune.
The US government was determined not to let another major bank go under - it pumped in $45 billion into Citi to keep it afloat.
It also decided to recapitalise Citi by increasing the level of common stock, to ensure that the latter would have enough capital to absorb future losses should things worsen.
This activated the second part of GIC's investment deal with Citi - which allowed it to convert its perpetual preferred securities to common stock at a 20 per cent premium to an agreed share price (the average stock price prevailing at the time).
As Citi's shares had just come off their lows then, it allowed GIC to convert its preferred stock into common stock at $3.25 a share (or $2.95 a share, after accounting for the preferred dividends it received before the exchange).
By the time the exchange was completed, just earlier this month - which left GIC with a 9.4 per cent stake - Citi's share price had climbed to $4.61.
That allowed GIC to make a substantial profit of US$1.6 billion, when it decided to sell off a 4.5 per cent stake. Its remaining 4.9 per cent stake is sitting on paper gains worth an estimated US$1.6 billion.
The turn of events is remarkable given the risks Citi faced and the pummelling its shares have taken - its share price is now just a fraction of what it was a year and a half ago. And the outlook seems good for GIC's remaining investment in Citi.
The bank's shares have held up well in recent months. And Citi CEO Vikram Pandit has talked about reducing the US Treasury's 34 per cent stake in the bank and also about weaning Citi off debt guarantees provided by the Federal Deposit Insurance Corp (FDIC).
The remarks have done well to lift sentiment surrounding the stock.
So, given the optimism surrounding Citi, why didn't GIC just hold onto its entire 9.4 per cent stake in Citi?
One possibility is the new level of risk which GIC now faces with its investment in Citi.
Back then, GIC had invested in Citi, out of all the other banks that possibly came begging for handouts at the time, precisely because the move seemed risk-free.
Its preferred stock investment offered no downside risk, save for Citi's collapse - which GIC gambled was not a possibility, given Citi's systemic importance to the US financial system.
Now, it would take much less to deal a heavy blow to GIC. Its current stake in Citi, held through common stock, no longer offers the protection that came with preferred stock. GIC's investment could easily be wiped out, if Citi shares plunge.
GIC's stake is also now vulnerable to dilution if Citi decides to sell new shares - as some reports suggest it might - to redeem some of the preferred shares that the US Treasury currently holds.
Keeping half a stake would allow GIC to realise a sizable profit now, while it can, while still allowing it to participate in any further upside.
A smaller investment would also be in line with GIC's vision of itself as a portfolio investor. The fund has indicated that it never intended to hold a stake as large as 9 per cent in Citi - which it landed up with.
Its statement yesterday reiterated: 'A stake below 5 per cent reflects GIC's goals and desire to be a portfolio investor.'
But, perhaps, the overriding principle that guided GIC's actions is the fact that it sees itself not merely as an investor, but also as a guardian of Singapore's wealth.
Its deputy chairman and executive director Tony Tan said recently: 'GIC has always given priority to preserving the value of Singapore's foreign reserves in both good times and bad times. Our aim is first to ensure that our portfolios suffer minimal losses rather than try for maximum return.'
That clearly puts GIC's latest move in perspective.
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