NEW YORK (Reuters) - Citigroup Inc’s (C.N) plan to sell $12 billion of loans and bonds made to private equity firms is seen as a positive for the bank and the loan market, but the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.
That’s because Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.
Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar.
“The bank still has some of the same risk, but they have a lot of equity in front of them, and it’s not on their balance sheet anymore,” said David Bailin, head of alternative investments at Bank of America, speaking at the Reuters Hedge Funds and Private Equity Summit. Bailin had no direct knowledge of the Citi deal.
After the sale, Citi would no longer have to mark down the original leveraged loans if their value falls further, a real possibility in the currently disrupted credit markets. It also allows the bank to confirm the recorded values of other leveraged loans in its portfolio.
“It demonstrates that there is a market for this paper,” said Marshall Front, Chairman of Front Barnett Associates in Chicago, which owns about 450,000 Citi shares. “This whole process of credit unfreezing, which started with the Federal Reserve opening the discount window to investment banks, is beginning to play out.”
The central bank said last month that it will allow investment banks to borrow from it directly, an unusual move designed to thaw frozen credit markets.
Loan markets greeted the news positively. Risk premiums on leveraged loans, or loans made to finance corporate buyouts, narrowed. One dealer said the news gives market participants comfort that banks may be moving closer to selling off their unsold loans.
That’s crucial for banks to be able to move beyond their current crisis and start to generate profits again, said Bruce Richards, the chief executive of Marathon Asset Management, a hedge fund and private equity group which has been buying some loans from banks.
“The banks and investment banks are dangerously leveraged at this current juncture. So they have to raise capital and offload assets. It’s the prudent thing to do,” Richards told the Reuters Summit.
Reuters LPC estimates that banks have about $113 billion of leveraged loans left to sell, a number that was closer to $154 billion at the end of 2007.
But not all markets were cheering the move.
Corporate bond spreads, or risk premiums, widened on Wednesday and are still at more than three times their levels of April 2007. And the U.S. stock market fell as well, with the Standard & Poor’s 500 falling as much as 1 percent.
The move makes sense for Citi, but also for the private equity firms, which can earn returns of more than 20 percent from the loans, assuming the obligations perform, a loan expert said.
Additional reporting by Tessa Walsh and Faris Khan of Reuters LPC, and Anastasija Johnson; Editing by Gary Hill