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Emac's Bottom Line

Citigroup and Treasury's Sticking Points

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FOX Business has confirmed that Citigroup is in talks with the government over a $15 billion equity offering to pay back $20 billion of its Troubled Asset Relief Programobligations, possibly as early as this week. It is aiming to close out the TARP funding before year-end.

Citigroup chief executive Vikram Panditcancelled a scheduled trip to San Antonio and Dallas Monday, where he was going to talk to 10,000 Citi workers and promote a micro-lending program. Instead, he stayed to negotiate with Treasury Secretary Timothy Geithner and his team.

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A Citi spokesman declined comment.

A number of serious sticking points are hanging up the negotiations between Citi and the government, however.

Among them:  the dilutive stock offering that would be required to pay back TARP; whether paying back the TARP would effectively cancel Citi's $306 billion government backstop to its balance sheet; and how a TARP payback would affect the regulatory cushion needed to support its operations.

Citigroup received $45 billion in TARP money. According to sources, Citi has offered to pay back $20 billion via a $15 billion equity raise, with the remainder paid in cash. Yet another hurdle is the government's ownership of $25 billion worth of common equity in Citigroup.

Letting the government unwind this massive 34% stake is part of the ongoing negotiations, a stake now worth about $31 billion.

Another issue is whether “the government will let us pay it back,” says one Citi insider, since the government doesn't want to risk having to turn around and bail out Citigroup once again. (Citi has had four government rescues over the last eight decades.)

Federal Deposit Insurance Corp. chairman Sheila Bair recently warned that the government should be careful about letting big banks pay back TARP, since such funds may not be available in the future.

That view is especially notable if $200 billion in TARP money is used for a new government jobs bank, as the Obama Administration plans. In addition, Bair has reportedly expressed little faith in Citigroup's management in the past.

What Pushed Citigroup to Act

"Bank of America's capital raise triggered it on our end...we've been negotiating throughout the week and will continue to do so," a Citi executive says. Bank of Americaannounced earlier this week that it would raise capital and use cash on hand to pay back $45 billion in TARP funds that the bank and Merrill Lynch have received.

Exiting TARP means exiting the pay czar's executive compensation restrictions. Citigroup officials for months have raised red flags that competitors have been poaching their talent. With BofA exiting TARP, yet another bank could cherrypick Citi's executives, now chafing under the pay caps set by the pay czar.

Also prodding Citigroup is the fact that the bank wants to move on an equity offering before it begins its year-end financial reviews, because the equity raise and use of cash to pay back TARP will change the numbers it reports. Once Citi begins that review process, any TARP payback would be pushed back until the bank publishes its results in mid-January.

If Citigroup pays back TARP, Wells Fargo (WFC) would be the biggest remaining bank that has yet to repay taxpayers. Wells owes $25 billion.

Citi on the Brink

Citi's near insolvency was prevented by a massive government bailout in which Citi received $45 billion in taxpayer dollars and a $306 billion government backstop to bad assets, including auto, commercial and mortgage assets, on its damaged balance sheet. Citi takes the first hit on about $56 billion in potential write-downs, with the government taking on about $250 billion.

The FDIC has also guaranteed $54.6 billion in Citi debt, letting the bank borrow more cheaply to fund its operations.

One key  sticking point between Citi and the Treasury is both yet another dilutive stock offering, plus the size of the potential equity offering, which some insiders peg at just north of $15 billion.

Although Citi has $244 billion in cash on the balance sheet, the government has forced TARP recipients to issue stock to pay back taxpayers as a show of confidence by the markets in their operations.

Another issue is whether paying back TARP would affect the $306 billion government guaranty to Citi's tattered balance sheet. The government backstop is a point of the Treasury negotiations now underway, since it is part of Citi's TARP rescue, sources say.

When Citi received $20 billion in TARP funds it came with the $306 billion government backstop to its balance sheet. To pay for that government backstop, Citi paid the government an additional $7 billion in preferred shares as a fee.

The negotiations with the Treasury now center around whether Citi should pay back that $7 billion fee for the backstop, Citi insiders say, as paying it back would essentially nullify the backstop. Another question is the length of time that Citi will need the backstop, Citi insiders say.

A Treasury official says talks with Citi have been "constructive" and believes the deal was close to being done several times in the last three weeks.

Citi is "anxious to resolve this," the official said, adding that "there are bunch of different pieces" in the Citi TARP repayment and "it doesn't have to be done all at once."

The BofA TARP repayment deal "set up the parameters" for Citi and other banks to repay, the official said. "There are some discussions" with Wells Fargo too, but Citi is moving faster.

Also under consideration is whether paying back TARP would hurt Citi's Tier 1 capital, the regulatory cushion that is its backstop to its risk-weighted assets. That cushion took a battering during the downturn, and some analysts worry that may continue to need bolstering. It sits at around $126 billion, or 12.8%, of risk-weighted assets. However, included in that cushion is about $22 billion in what's called deferred tax assets, a sum that analysts have questioned whether Citi can rely on in the future.

Deferred tax assets are typically a basket of tax losses that are used to reduce the amount of tax that a company will have to pay the IRS in a later tax period. Because the tax bill owed is cut, that bolsters profits.

But deferred tax assets can only be used as future write-offs so long as the company reports positive earnings. Citi has been reporting massive quarterly losses, seven in the last eight periods.

Citi also folds into its regulatory cushion about $36 billion in goodwill and intangible assets, ephemeral amounts that the company can price tag on its own. Goodwill and intangible assets are assets which provide a competitive advantage, such as the markup a company pays to buy a target, or a strong brand, reputation, or high employee morale.

Pandit's “100-Year Flood”

Citigroup is still reeling from the credit crisis, a downturn that put it on the brink of collapse.

Pandit has said that the bank is dealing with the equivalent of a “100-year flood,” a crisis in which its market value had dropped below that of Home Depot (HD) and UPS (UPS) as it has suffered $48.4 billion in losses and $57.4 billion in write-downs since the crisis began.

Citi has also booked a record $35.9 billion in loan-loss provisions to take care of souring loans.

Pandit and his team have won praise internally for moving swiftly and aggressively to split Citigroup into a two-part “core, non-core” structure (Citicorp and Citi Holdings). Pandit has been racing to pare down its $1.9 trillion balance sheet by selling assets that are just about the equivalent in size of GE Capital, General Electric's (GE) finance unit.

And Pandit has moved towards greater transparency, with a detailed presentation to a Barclays Capital investor meeting on Wall Street earlier this year showing Citi's strengths and weaknesses.

Citi's Problems Remain

Citi still has about $200 billion in problem and toxic assets, plus more than $1 trillion in off balance sheet assets, in addition to its $1.9 trillion balance sheet.

Citi officials estimate that a new accounting rule would force it bring back on to its financials about $155 billion in off balance sheet assets next year.

Pandit has also moved to pare back Citi's overhead and cut expenses. The bank has already begun laying off 75,000 workers, and with attrition and asset sales its headcount is down to 276,000 from 375,000. That figure is now well below Citi's initial 300,000 target.

Shares of Citi are up 1% at $3.90 early Thursday.

(Fox Business News senior Washington correspondent Peter Barnes contributed to this story.)

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