Investors Buy Citi Preferred, Sell Common In Arb Play (The report "Investors Buy Citi Preferred, Sell Common In Arbitrage Play," published around 3:03 p.m. EST, incorrectly suggested that Citi will redeem publicly traded preferred shares at par value, for 7.7 common shares. Citi will redeem the publicly traded preferred securities at a "premium to market," while Citi will redeem privately placed and government preferred securities "at par." The correct version follows.)
By Marshall Eckblad
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--The government's latest rescue of Citigroup Inc. (C) sent the New York bank's preferred shares soaring in mid-day trading on Friday, even as Citi's common shares fell sharply.
One factor in the move was an arbitrage play in which investors were buying preferred shares of Citi and selling the common stock.
A top Citigroup executive and other investors said many investors were arbitraging that spread between preferred shares' current market price and their intrinsic value after conversion to common shares.
Citigroup announced on Friday that it would stop paying dividends on all preferred shares except trust preferred securities. At the same time, Citi said it would offer to exchange all preferred shares to common stock at $3.25 per share.
That offer, at first blush, seems like a raw deal for preferred shareholders. Not only will most lose their dividend payments, but if they agree to pay, in essence, for common shares at the rate of $3.25 per share, they will in essence pay more than twice the current market value of Citi's common stock.
Citi shares recently traded down sharply, off 38.6% to $1.51 after the U.S. government said on Friday morning that it would assume a 36% stake in the hobbled bank.
Many of Citi's preferred shares initially sold for $25, but the bank hasn't said what value it will use in exchanging publicly traded preferred shares for commons shares. In its announcement on Friday, the bank said only that the redemption price for publicly traded shares would be at a "premium to market."
The bank did, however, say it would convert privately placed preferred shares, as well as government-owned preferred shares, at par.
Since the publicly traded shares had previously fallen to distressed levels, the announcement that Citigroup would redeem them at a yet-to-be-determined premium sent the shares climbing. Most closed around $8 on Friday. (Even so, public investors who purchased the shares at full price when they were issued are still under water.)
"Believe it or not," said Scott Colyer, chief executive of Advisors Asset Management, Inc., the conversion offer has "actually helped the preferred shareholder a bit."
But Colyer also said the situation is sufficiently complicated that analysts are working furiously to understand exactly what Citi's preferred shares are worth.
Since the intrinsic value of the preferred shares falls when Citi's common shares fall in price, some investors have sold the common shares short, while purchasing preferred shares outright. (In a short sale, investors can profit when a security declines in price.) Shorting the common stock would protect preferred shareholders should Citigroup common shares later fall even more.
"There is a lot of arbitrage going on because the natural thing to do is short the stock and buy the preferred," said one executive at a large bank.
Citi Chief Financial Officer Gary Crittenden also acknowledged the strange dynamic in an interview with cable channel CNBC. He said it could take some weeks for prices of the company's common and preferred shares to become aligned.
A number of market observers, in interviews, said rising numbers of investors are short-selling Citi's common shares. That could put even more pressure on the company's stock, since that amount of short-selling in Citi shares was on the rise even before Citi's announcement Friday.
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