Citi Compensates Bondholders For Pain And Suffering Of Worrying That Citi Might Default

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Back in the pre-Lehman days Citigroup owned a lot of things that, in hindsight, turned out to be awful. Everyone knows that now but various people didn't know it then, including (1) the people who bought some of those awful things from Citi, (2) the people who bought stock in Citi while it hung on to the bulk of those awful things, (3) the people who bought bonds in Citi while it hung on to the bulk of those awful things, (4) the people who bought preferred stock in Citi ... you get the idea. The world being as it is - full of lawyers1 - each of those groups of people is slowly making its separate peace with Citi. We've talked about some of them before, including a rather controversial $285mm SEC settlement on behalf of the awful-thing-buyers and a $590mm private settlement on behalf of the stock-buyers. Today brings the biggest settlement yet, $730mm on behalf of the bond- and preferred-stock and TRUPS-buyers, who lost billions when Citi defaulted on its bonds.

Hahahaha no I'm kidding, Citi never defaulted on its bonds. Here's the Journal:

In the case settled Monday, plaintiffs alleged the New York company misled them about Citigroup's possible exposure to losses on securities backed by home loans, understated its loss reserves and said some assets were of higher credit quality than they actually were. The pact covers 48 preferred-stock and bond deals between May 2006 and November 2008.

Those possible exposures became real exposures, and Citi incurred plenty of unpleasantness. But these bonds mostly didn't. You can find a list of the bonds included in the settlement in the exhibits to the settlement, or in this footnote,2 but picking a few at random there are for instance Citi's 5.85% Notes due 2016, now trading at 113.75, its 6.125% Notes due 2036, now trading at 115, and its 5.5% Subordinated Notes due 2017, now trading at 112.5. There are also its Floating Rate Notes due 2011, which were ... due in 2011, and paid off at par. And the 5.3% and 5.5% Notes due 2012, which again paid off at par in 2012.3

There's some bad news too - Citi's Floating Rate Subordinated Notes due 2036, for instance, now seem to trade (infrequently) at 81. More notably various flavors of trust preferreds and preferred stock, convertible and otherwise, suffered various outrages during the financial crisis including having their dividends turned off and being exchanged for common stock in a "voluntary" 2009 exchange offer that offered holders considerably less value than they'd paid for their preferred shares originally.

Still for most of the bondholders this is rather different from the typical CDO cases, where the buyers were hurt because of actual defaults due to credit problems that Citi (allegedly) concealed from them. It's different from the stock-drop cases too: stockholders are the residual claimants on Citi, so any drop in Citi's value - or any dispelling of illusions they previously had about Citi's inflated value - directly affects stockholders: they're a residual claimant on less stuff. Bondholders just want their money back. They got their money back. The losses that Citi suffered, which were real and giant enough, didn't eat through the equity cushion and impact the bondholders. So why should they get $730mm extra?4

I know it doesn't work that way, of course: the plaintiffs here lost money because they bought high (based on supposedly fraudulently optimistic financials) and sold low (in November 2008 when things weren't looking good for our Citi). You might think "well that's their call, selling in November '08 instead of waiting to be paid off at par," but the law doesn't think that way. The legal questions are whether Citi hid stuff from the bondholders, whether that stuff would have been material to their investment decision, and whether they lost money because of it. The judge in this case seemed to think there was at least a possibility that the answer to those questions was yes, so: juicy settlement. The fact that Citi didn't default on its bonds - though it arguably sort of did, à la grecque, on its preferreds - doesn't enter into it.

Still it seems weird. In the above I've ignored a pretty pretty pretty pretty big fact, which is that the bondholders didn't survive unimpaired just because Citi didn't lose all that much money. Citi lost all that much money, and then lost some more money. The bondholders survived unimpaired because Citi got an "extraordinary"bailout that squashed the stockholders pretty hard, and at least strong-armed the pref holders. But the bailout was intended to, and did, add to the equity cushion to protect Citi's creditors, even at the cost of moral hazard and too-big-to-failness and all the rest. Seems a little odd that Citi's shareholders - who of course will ultimately pay this $730 million - should have to pay them again.

You could put that another way too. Treasury stopped being a Citi common shareholder in late 2010. This lawsuit was filed in September 2008. Citi says the settlement will "be covered by existing litigation reserves." So when Treasury sold its Citi shares it was, in a sense, already paying for this settlement: the buyers of its shares were effectively getting a discount for the expected price of this settlement. The bondholders were getting bailed out by Treasury again.

Citi Settles Case for $730 Million [WSJ]
Citigroup to Pay $730 Million in Bond-Lawsuit Settlement [Bloomberg]
In re Citigroup, Inc. Bond Action Litigation [Bernstein Litowitz Berger & Grossmann LLP]

1.I was tickled by this passage from the plaintiffs' lawyers motion to get the settlement approved, filed yesterday:

As discussed in more detail below, in September 2008, Bond Counsel recognized that, although purchasers of Citigroup’s bonds and preferred securities potentially could assert under claims arising under the Securities Act of 1933 (the “Securities Act”), these claims had not been asserted by any other plaintiff. Accordingly, in September and October 2008, Bond Counsel and certain of the Bond Plaintiffs filed two separate complaints in New York State Supreme Court asserting claims on behalf of (i) purchasers of Citigroup’s bonds; and (ii) purchasers of Citigroup’s preferred securities.

The context further down makes it clear that this is after Citi stockholders had sued for basically the same securities violations (that's the case Citi settled for $590mm last August). Basically the lawyers here noticed that someone on earth wasn't suing Citi, and rectified that. For that they're expecting 20% of $730mm, or $146mm. I've wasted my life.

2.Though I don't recommend it because it's weeeeeeee:

3.Prices Bloomberg HP rounded to the nearest quarter of dollar price.

4.Oh though don't get too excited by that:

Based on Bond Plaintiffs’ damages expert’s estimates of the number of Bond Class Securities purchased during the Settlement Class Period that may have been affected by the conduct at issue in the Action and assuming that all Bond Class Members elect to participate in the Settlement, the estimated average recovery (before the deduction of any Court-approved fees, expenses and costs as described herein) per eligible share of Citigroup Preferred Securities is $0.63; per eligible Citigroup Note is $3.25; and per share of eligible Citigroup Capital E-TRUPS is $0.55.


Appellate Court Willing to Entertain the Possibility that Citi Was Not Committing Fraud

I've had some fun these last few days proposing counterintuitive theories for why Citi might not suck as much as you probably think it does and it's nice to see others joining in the pastime, even if this sounds a little far-fetched: The district court’s logic appears to overlook the possibilities (i) that Citigroup might well not consent to settle on a basis that requires it to admit liability, (ii) that the S.E.C. might fail to win a judgment at trial, and (iii) that Citigroup perhaps did not mislead investors. That piece of rank conjecture is from the Second Circuit's opinion on an appeal* of Judge Rakoff's rejection of the settlement between the SEC and Citi over some mortgage-backed securities. Here's DealBook: