GIC's Conversion from Preferred to Common Marks the Beginning of the End

In news just out, GIC has agreed to convert its preferred stake in Citigroup to Common Equity, to go along with the US government's continued bailout plan for the company.

GIC converts preferred notes in Citigroup to common shares
By May Wong, Channel NewsAsia | Posted: 27 February 2009 2026 hrs

SINGAPORE: The Government of Singapore Investment Corp (GIC) has said it will convert its convertible preferred notes in the US lender Citigroup to common stock in a bid to help shore up the troubled US lender.

The exchange price is US$3.25 a share – a 32 per cent premium to Citigroup's closing price on Thursday. The price is way under the conversion price of US$26.35 a share under the original terms of the investment.

Vikram Pandit is a Loser; Berkshire Hathaway 2 - GIC 0

In the latest development of what must be the most eventful year in the history of banking, Warren Buffett's Wells Fargo has snatched Wachovia bank from Vikram Pandit's Citigroup. In what must be the most humiliating and daring bank acquisition to date, Wells bid and closed a $16b deal for Wachovia, an offer that trumped Citi's pathetic $2.1b and that has Pandit and his minions crying foul, or whining, rather.

But Pandit seriously doesn't have much of a chance. Wells Fargo is paying much more and is not requiring any assistance from FDIC, in contrast to Citigroup's relatively pathetic bid which involved "FDIC agreeing to absorb up to $42 billion in losses should Wachovia's $312 billion pool of loans later turn sour." The withdrawal of FDIC involvement will surely mean a goodbye to Citi's bid for Wachovia, but Pandit must have known better than to expect that his paltry offer would have been the best in the market.

Singapore's SWFs and the 3 Behemoths of Mass Implosion

What do UBS AG, Merrill Lynch and Citigroup have in common?

A. They're all banks which have received significant cash infusions from Singapore's Sovereign Wealth Funds, GIC and Temasek.

B. They're the 3 largest casualties of the ongoing credit crisis.

Behemoths of Mass Implosion

Meredith Whitney, one of the most prominent Wall Street bank stock analysts, recently put out research notes either downgrading or cutting financial estimates for the three banks:

Merrill, rated “underperform,” faces “headwinds of deleveraging and the next disruptive step of restructuring.” ...

Ms. Whitney says she continues to “be negative in our outlook on Citigroup due simply to the fact that the company has seriously constrained earnings power, in addition to the writedowns seen in 2Q08,” which she estimates will hit $12.2-billion. ...

UBS is rated “underperform” by Oppenheimer because the Swiss bank “faces a difficult task of navigating through its risk exposures from the investment bank and rebuilding its damaged wealth management franchise.”

Whitney's pessimisim is not without good reason. UBS AG, Citigroup and Merrill Lynch, have been the banks with the largest total bank writedowns to date, far and ahead of the rest of their peers:

Citigroup leads the pack, with UBS and Merrill trailing close behind. But the gap between these three banks and the rest is extremely large - HSBC is the next closest with about half of Merrill's damage.

The same three banks lead in another key statistical metric: writedowns/market cap ratio:

This time, Merrill leads the charge. UBS and Citigroup fare better on this ratio, but still are way higher than the rest of the pack.

The stock markets have, in turn responded to the financial carnage the banks have inflicted on themselves: Merrill, Citigroup and UBS are amongst the top 5 % decliners in stock price:

Meanwhile, the 1-year performance of the stocks have indeed been nothing to envy:


The Dubious Wisdom of Lee Kuan Yew

Lee Kuan Yew just a month ago made some comments about GIC's splendid investments in Citigroup and UBS:

"The franchise of the banks, the expertise that they have, under proper leadership, they will be able to recover and rise again ... Will there be another Swiss bank like UBS for wealth management? I doubt it, we doubt it, that is why we invested in it." Citigroup, he added, had "an enormous spread worldwide as a retail bank".

These statements have indeed turned out to be questionable, if not downright wrong. UBS' 'unparalleled' wealth management franchise appears to be undergoing an unparalleled tax evasion investigation:

UBS shares hit by talk of further losses, tax evasion case
Jun 23, 2008

ZURICH (AFP) — Shares in Swiss banking giant UBS plunged on Monday amid talk of further losses and as investors worried that a US tax evasion case around a former employee could widen to the bank itself.

At the close, UBS shares showed a fall of 4.42 percent to 22.06 Swiss francs on the Zurich stock exchange, after a loss of 3.27 percent on Friday. The overall market was down 0.60 percent.

In a note to investors, an analyst at Credit Suisse warned that UBS's wealth management could come under "significant pressure" if the tax evasion investigations broadens to a case directly impacting the bank.

"In a worst case scenario, UBS could lose its banking license which could have adverse effects on the global private banking franchise," she wrote.

On Sunday, Swiss newspaper Sonntag reported that US law enforcement officials had made a formal request to come to Switzerland to investigate a tax evasion case involving UBS.

The move has been sparked by the confession of former UBS banker Bradley Birkenfeld to a Florida court last week that he conspired to help US clients dodge millions of dollars in taxes.

Swiss officials from the justice and finance ministries have already travelled to Washington for talks with their US counterparts amid concern the case could damage the overall reputation of Switzerland's financial industry.

The subprime damage and the suspected tax evasion has had severe consequences for the top leadership of the bank:

UBS AG (UBS) was at the center of a tornado of crushing news Tuesday, as it announced major changes to its board amidst pressure from the U.S. Department of Justice to reveal the names of top clients taking advantage of the bank’s tax breaks.

Four of the No. 1 Swiss bank’s board members - Stephan Haeringer, Rolf Meyer, Peter Spuhler and Lawrence Weinbach - will step down at the bank’s Oct. 2 shareholder meeting.

...

The bank has been the biggest European casualty to the U.S. subprime-mortgage crisis. It has written down more than $38 billion in the last three quarters, and its stock has dropped more than 57% year-to-date.

Continuing that trend, the bank will likely post a second-quarter loss with another markdown of about $4.9 billion, according to Bloomberg News estimates.

UBS said it will immediately submit board-member recommendations to the governance committee and will explore redefining directors’ and management’s responsibilities.

So, not only has UBS taken a severe beating in the subprime mortgage crisis, its wealth management business is undergoing severe pressures as well.

How about Citigroup's "enormous spread worldwide as a retail bank"? Well, it seems that is turning out to be a liability, rather than an asset.

Citigroup plans to sell $400 billion in assets
International Herald Tribune
By Eric Dash; Friday, May 9, 2008

Vikram Pandit is doing some serious spring cleaning at Citigroup.

Since becoming chief executive in December, Pandit has been clearing out the corporate attic of weak businesses and unloading worrisome assets at bargain-basement prices.

In an effort to streamline the sprawling company and placate restive shareholders, Pandit has sold or closed more than 45 branches in eight states. He has also disposed of Citigroup's headquarters building in Tokyo and its investment-banking base in New York and ditched more than $12.5 billion in loans used to finance corporate buyouts. And he has jettisoned the Diners Club credit card franchise, Citi's commercial leasing divisions and a big pension administration unit.

Pandit is not done yet. After months of false starts, Citigroup is now trying to sell Primerica Financial, a life insurance and mutual fund company, according to people close to the situation. He is also looking to sell its back-office outsourcing unit in India and its Smith Barney brokerage firm in Australia. Some speculate he also may try to sell 340 bank branches in Germany, possibly to Deutsche Bank.

On Friday, at Pandit's first major presentation to investors and analysts, Citigroup said that it planned to sell about $400 billion in assets in the next two to three years.

As it turns out, Vikram Pandit is trying to get rid of many of Citigroup's assets. Citigroup's worldwide sprawl made it a giant behemoth to big to manage. On top of that, Vikram Pandit has absolutely no experience running a consumer bank. Does Lee Kuan Yew really like such a person managing Citigroup's wide retail sprawl?

Suffering the Consequences

Who is taking the brunt of all this financial damage? Ultimately, it is the shareholders of these banks. And although GIC and Temasek have incorporated some sort of short term guaranteed returns for their investments in the banks, ultimately, these investments will convert into equity and suffer the effects of dilution:

Shareholders take brunt of banks' capital raising
Saturday June 21, 7:26 am ET
By Joe Bel Bruno, AP Business Writer
Banks cutting dividends, diluting shares to raise badly needed capital

NEW YORK (AP) -- America's banks and brokerages are scrambling to raise badly needed cash, but it may be at the expense of shareholders.

Since the subprime mortgage market imploded, financial companies caught in the fallout have been raising capital in two major ways -- cutting dividends and issuing more shares. Both methods erode shareholder value; analysts believe the industry is poised for more.

"The market is now seeing a substantial increase in financial companies issuing common and convertible instruments in an effort to shore up liquidity," said Standard & Poor's senior index analyst Howard Silverblatt. "The additional financing gives them immediate breathing room, with the payback being longer term dilution."

Put plainly, their gain is your pain.

Just this past week, Fifth Third Bancorp Chief Executive Kevin Kabat needed a cash infusion of $2 billion to bail out his struggling regional bank, while KeyCorp CEO Henry Meyer needed $1.5 billion. Both will issue stock to boost their balance sheets.

Banks have raised more than $60 billion this year by selling common and preferred shares.

The issuance of new stock acts to dilute the value of current shareholders because profit gets split among more shares. It's like having the family over for a turkey dinner and at the last minute grandpa invites the neighbors, too. There'll be less for everybody.

The end of the credit crisis is no where in sight, and the banks have yet to see the light at the end of the tunnel. And from how things are going right now, that light seems quite far away.

The writedowns at the banks have resulted in corresponding losses in stock price. And dilution of shareholders returns due to capital raisings only add to these woes. These are real losses that Singapore's SWFs will suffer; the supposed downside protection they built into their investments are but a short-term illusion.

Were these investments a good idea? We will only know for sure in a few years time when we have the benefit of 20/20 hindsight.

But the way things are going, the prospects for these investments simply don't look good at all.

Lee Kuan Yew Ain't No Warren Buffett

GIC a few months ago took significant stakes in global banking giants UBS and Citigroup. The share prices of these companies have since taken a tumble due to the impact of the credit crisis, but according to GIC, that's no worry, since GIC has taken these investments with a 'long term view.' In addition to GIC's existing investments in those banks, Lee Kuan Yew, Chairman of GIC and Minister Mentor of Singapore, has gone on the record as saying:

Singapore's GIC may invest in more banks
Reuters, April 30

The Government of Singapore Investment Corp may invest in more banks in Europe and the United States if it gets the chance, adding to its stakes in beleaguered bank UBS and Citigroup, its chairman told Bloomberg TV.

"If there are other banks of the quality of the two that we bought into, with the promise and the capabilities and inherent capabilities to recover, we have got the liquidity to meet it, to make such an investment," Lee, 84, said in a Bloomberg Television interview late yesterday. "We will not rule it out."

"We are buying something that we intend to keep for the next two to three decades and grow with them", he said, adding that GIC was a long-term investor.

After throwing in billions of dollars into credit-crunch battered financial institutions, Lee Kuan Yew is prepared to deploy more capital into this area. Ever confident about GIC's investments, the octogenarian further defended GIC's decisions:

"The franchise of the banks, the expertise that they have, under proper leadership, they will be able to recover and rise again ... Will there be another Swiss bank like UBS for wealth management? I doubt it, we doubt it, that is why we invested in it." Citigroup, he added, had "an enormous spread worldwide as a retail bank".

Interesting rationale. According to Lee Kuan Yew, UBS and Citigroup have "inherent capabilities to recover" from the credit crisis. Well, this is quite a debatable statement.

Just a few months after GIC's investments, recovery of the banking sector is far from sight. Instead, the banks are scrambling to raise more capital to deal with the damage the credit crunch has dealt them:

Citigroup, Merrill Lead Record Week of Bond Offerings
By Bryan Keogh and Gabrielle Coppola

April 25 (Bloomberg) -- Citigroup Inc. and Merrill Lynch & Co. led $45.3 billion of U.S. corporate bond offerings, the busiest week on record, as financial companies sold debt at the highest yields since April 2001.

Sales compare with $31.2 billion last week and an average this year of $18 billion, according to data compiled by Bloomberg. Citigroup, the biggest U.S. bank by assets, sold $6 billion of hybrid bonds in the company's largest public debt offering, while New York-based securities firm Merrill Lynch raised $9.55 billion by issuing debt and preferred securities.

Bond offerings soared as investors grew more optimistic financial companies can recover from $309 billion of writedowns and credit losses tied to the collapse of the subprime-mortgage market. Banks and securities firms sold 85 percent of investment- grade debt this week, Bloomberg data show. High-yield bond issuance swelled to the most since November.

An inherent ability to recover from the crisis? Not without a lot of additional capital - extra capital which is going to dilute your existing stakes.

The debt issuance is not the end of the story. Citigroup is issuing equity as well:

Citigroup Sells $3 Billion of Stock to Boost Capital
By Bradley Keoun

April 29 (Bloomberg) -- Citigroup Inc., the U.S. bank hit with writedowns on subprime mortgages and bonds, is selling $3 billion of stock two weeks after reporting its second straight quarterly loss.

The shares are being sold in a public offering, New York- based Citigroup said today in a statement. Citigroup already has raised more than $30 billion of capital since December. A weakening U.S. economy and rising consumer delinquencies forced Chief Executive Officer Vikram Pandit to rescind assurances earlier this year that the bank didn't need to raise more funds.

"This was extremely disappointing," William Fitzpatrick, an equity analyst at Optique Capital Management in Racine, Wisconsin, said in a Bloomberg Television interview. "We were hoping they wouldn't have to go the equity markets like this."

Citigroup's issuance of equity financing is implicit acknowledgement that it won't be able to deal with the upcoming problems in the credit markets without substantial help. Add to that a weakening US economy and a looming recession, the clouds on the horizon are only getting darker.

Morgan Stanley realised this in its latest research report on the banking sector, painting a very bleak picture of the road ahead. This is in stark contrast to investors (including GIC) who have been calling an end to the banks' credit woes:

Morgan Stanley sees big bank woes just beginning
Monday April 28, By Joseph A. Giannone

NEW YORK (Reuters) - Morgan Stanley analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

Just for the record, a baseball game usually has nine(9) innings. Morgan Stanley's declaration that we are only in the third inning of the credit cycle, simply says we're not even a third of the way through the game. A Seeking Alpha contributor has also observed:

The credit markets have improved, in terms of increased liquidity, with the Fed opening up the discount window for investment banks. However, the real economy, which has had only a minimal impact on the financial markets thus far, is deteriorating rapidly. Home prices are continuing to decline, costs of living are continuing to increase (look at the price of oil and food for examples), and the job market is reeling. The real economy will come back around and hit the financial institutions far harder than the freeze in the credit markets did. The Fed put out one fire, but threw gasoline on the other - through massive inflation - and we have not even begun to witness the effects this will have on our economy.

Well, well, it appears Lee Kuan Yew doesn't seem so wise any more. Certainly not as wise as Warren Buffett, whose Berkshire Hathaway has stayed away from picking up stakes in these big banks. And its just as well that we clearly see the difference here, as GIC and Temasek have been repeatedly using slogans to "invest for the long term," to parade themselves as value investors of the Buffett kind.

But Lee Kuan Yew doesn't really understand Warren Buffett. He also said in the interview with Bloomberg:

'[Buffett] has a different view. He has to give returns to his investors year by year. We don't have to. We have to think in terms of the next 10, 20, 30 years. We are buying into something which we intend to keep for the next two, three decades and grow with them.'

But I think anybody who knows Warren Buffett knows that Buffett's favourite investment horizon is forever, and that the investment legend has repeatedly stressed that Berkshire's focus is not on the quarter-to-quarter or year-to-year earnings. In all his writings to shareholders, one can clearly discern that Buffett has his eye on the long term future. Furthermore, Buffett's track record of consistently outperforming the market spans a good 50 years... Thus, for Lee to say the Buffett is narrowly focused on the year-to-year performance of his company, is to demonstrate a gross and fundamental misunderstanding of Buffett's investment philosophy - and thus it was ridiculous for Lee Kuan Yew to claim that GIC has significantly different obligations to its shareholders compared to Berkshire.

Finally, let's not forget Jim Rogers' warning to Singapore's Sovereign Wealth Funds earlier this year:

"It grieves me to see what Singapore is doing. They are going to lose money," he added, referring to investments by Government of Singapore Investment Corp and Temasek in Citigroup, Switzerland's UBS and Merrill Lynch.

I think that just about sums up what is going to happen.