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Citigroup’s (NYSE:C) preferred share exchange offer may constrain the bank’s ability to raise new common equity from new investors over the next three years, industry sources told Dealreporter.
That could have big implications for the New York-based bank down the road when it may want to raise equity in order to exit the Treasury Department’s TARP program. A spokesperson declined to comment, except to say the exchange offer will make Citi one of the world’s best capitalized banks.
Under the US tax code, if holders with 5% or higher Citigroup stakes increase their ownership by more than a cumulative 50 percentage points within three years, the bank will have to give up many of the USD 44bn in deferred tax assets it has accumulated. Citigroup relies on deferred tax assets for a portion of its Tier 1 capital, according to regulatory filings.
Citi disclosed in an S-4 filing it projects its cumulative change in ownership will be approximately 44 percentage points following the exchange of over USD 58bn preferred and trust preferred shares held by private investors and the US Treasury Department.
Robert Willens, a tax and accounting expert, said tax rules consider a new common equity issuance to be a 5% holder in a company. This means if Citigroup raises additional common equity it would be limited to roughly a 6 to 9 percentage point increase in ownership if it does not want to trip the cumulative ownership change limit, Willens explained.
An industry lawyer said banks planning equity raises or exchanges are taking into account how these rules will impact their ability to raise future capital. Though, he said the change in ownership impacts deferred tax assets differently for each company depending on the types of deferred tax assets a firm holds and whether the company has taken advantage of them yet.
If a bank plans additional equity issuances in the future, the lawyer said the institution will need to weigh the amount of new capital it can raise, versus capital from deferred tax assets it will lose if the change of control clause is triggered.
In an SEC filing, Citi warns that the exchange offer ”materially increases the risk that we could experience an ownership change in the future.” The filing adds: ”future stock issuances or transactions in our stock that may not be within our control, including dispositions of our stock by the [US government], may cause us to experience an ownership change.”
In an effort to protect the deferred tax assets, Citigroup has created what it calls a ”tax benefit preservation plan” that severely penalizes current shareholders with 5% or more holdings in the company if they increase their stakes. This plan does not limit new equity issuances.
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