U.S. bails out Citi with $20 billion capital, guarantees

NEW YORK (Reuters) - The U.S. government has bailed out Citigroup Inc, agreeing to shoulder most of the potential losses on $306 billion of high-risk assets and inject $20 billion of new capital in its biggest move yet to rescue a bank.

The action marks the latest government effort to contain a widening financial meltdown that has caused the disappearance or bankruptcies of companies including Bear Stearns Cos, Lehman Brothers Holdings Inc and Washington Mutual Inc.

Shares of Citi surged 55 percent to $5.83 in electronic trading before the opening bell in New York. The price of insuring $10 million of Citi bonds through credit-default swaps fell by about half to $257,000 per year.

"Clearly, this will stabilize the (banks) group near term, and the stocks this morning should reflect it," Oppenheimer & Co analyst Meredith Whitney said. "We are still cautious on the potential future dilution from further prospective capital raises for the group as well as continued higher losses related to credit and asset deflation."

Whitney, an early critic of the bank, rates the shares as "underperform." Citigroup's stock is still down from $8.90 a week ago and 87 percent this year.

SECOND EFFORT

The government's $20 billion of new capital comes on top of $25 billion it had put into the bank, and it will receive preferred shares with an 8 percent dividend in return.

Citigroup received the latest infusion after its shares plunged 60 percent last week to $3.77, amid worry it lacked enough capital to survive. The bank estimated $40 billion of capital benefits, partially from the government guarantee.

In return for the bailout, Citigroup's dividend will be effectively wiped out. The bank cannot pay out more than 1 cent per share per quarter over the next three years without government consent. The quarterly dividend is now 16 cents.

"It looks enormous in size and scope," said Tony Morriss, senior currency strategist at ANZ Bank in Sydney. "Does this mean support for other financial institutions will be this big? Does this mean there will be more problems around calculation of so-called toxic assets?"

Citigroup has the farthest international reach of any U.S. bank, with operations in more than 100 countries. The bank was widely perceived to be too big to be allowed to fail, because any collapse could cause financial havoc around the globe.

"To stabilize the equity, we had to put behind us the issue of Citigroup's ability to withstand whatever would come," Chief Financial Officer Gary Crittenden said in an interview.

The New York-based bank will try to modify troubled mortgages in the $306 billion portfolio as the government tries to keep homeowners out of foreclosure.

Chief Executive Vikram Pandit and other top management will keep their jobs, but the government will have the final say on executive pay. More details on compensation may come next week, government officials said.

Not all investors were pleased. "You're seeing an inept management team being rewarded by the U.S. government," said William Smith, chief executive of Smith Asset Management in New York, which owns Citigroup stock.

SPREADING THE EXPOSURE

If it works, the package may become a template for other U.S. banks expected to face growing losses as the economy sinks into recession. Credit losses, once concentrated in mortgages, are already bleeding into other areas such as credit cards and commercial real estate.

The rescue further magnifies the U.S. government's burden, following bailouts of American International Group Inc, Bear, Fannie Mae and Freddie Mac, and the injection of hundreds of billions of dollars into banks and other financial institutions.

Well over $1 trillion of taxpayer money is at risk, and the Big Three automakers in Detroit are seeking billions more to avert bankruptcy.

The administration of President-elect Barack Obama may also propose a $500 billion to $700 billion economic stimulus.

Citigroup agreed to absorb the first $29 billion of losses on the $306 billion portfolio, plus 10 percent of additional losses, for a maximum total exposure of $56.7 billion.

The Treasury Department could end up absorbing $5 billion of losses, the Federal Deposit Insurance Corp $10 billion, and the Federal Reserve the rest.

The Treasury Department will get $24 billion of preferred shares and the FDIC $3 billion. Of the combined amount, $7 billion constitutes a fee for the government guarantees. The government will also receive warrants to buy $2.7 billion of common stock, comprising about 254 million shares at $10.61 each.

Citigroup estimated the injection will give it a Tier-1 capital ratio of 14.8 percent, more than twice what the government requires. The bank said it will also get increased access to the Fed's discount window, adding liquidity.

The Fed, the Treasury Department and the FDIC called the actions "necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy."

The government announced the package less than a week after Pandit set plans to reduce Citigroup's workforce to 300,000 by early next year from 375,000 at the end of 2007.

HIT HARD

Earlier this month, U.S. Treasury Secretary Henry Paulson said the $700 billion industry rescue package would instead be used as a means to provide direct capital injections to banks.

That decision hit Citigroup hard, and the bank's problems were compounded by the tens of billions of dollars of assets that it decided to buy back or move onto its balance sheet.

Citigroup's market value on Friday was just $20.5 billion, down from more than $270 billion two years ago -- and even below the $25 billion initial capital injection.

In Europe, Citi's shares soared on the news of the rescue. In Frankfurt, the bank's shares were up 41.89 percent at 4.2 euros at 0819 GMT.