In an effort to stave off an exodus of wealthy clients, Citigroup recently pumped $661 million into six troubled hedge funds. The bank also devised a restructuring plan that would potentially enable investors to recoup some of their money. By requiring investors to agree that they will not sue as part of the restructuring plan, the bank is trying to “sweep the mess under the mat,” one securities attorney warned.
Sold under the brand names “ASTA” and “MAT,” the six hedge funds used extensive leverage to buy municipal bonds. Approximately $8 for every $1 raised was borrowed by the fund. When the municipal market collapsed in February, the hedge funds tanked. Despite Citi’s emergency cash infusion, the funds are down 60 to 80 percent.
Citi’s hedge fund demise follows a plunge by another group of highly leveraged funds that it also managed, $1 billion Falcon Strategies. Late last year, the Falcon funds fell more than 30 percent after making a series of bad bets on the mortgage market. Declines have continued into 2008.
These Citigroup problems began earlier this year when the municipal bond market became fearful of the woes big insurers experienced. Prices on bonds tumbled and the volatility wreaked havoc on these funds that sold short-term debt and used the proceeds to buy higher-yielding, longer-term municipal bonds. The funds owned municipal bonds guaranteed by Financial Guaranty Insurance Co. When the insurer lost its AAA rating, the prices on FGIC-backed municipal bonds dropped sharply.
At their peak, Citi’s funds controlled some $15 billion worth of municipal bonds though they only held $1.9 billion of investors’ money. The portfolios may not have been destroyed if it were not for the leverage. The chaos in the municipal market, however, triggered a round of margin calls that forced managers to sell assets to come up with cash to pay fund lenders. Citi moved quickly to shore up the municipal bond funds with a huge cash infusion.
Even though written materials outlined the use of leverage, brokers pitched the products as a “conservative” alternative to traditional bond funds. This prompted some investors to invest a large portion of their net worth in these products.
Some of the bank’s high net worth clients, whose losses in the funds approach $2 billion, are threatening to move their money to Citi’s competitors. The fallout is prompting some of Citi’s top brokers to consider leaving the bank as well. As tension mounts, some brokers have begun referring frustrated clients to lawyers.
We are not describing Citigroup as a “sinking ship,” but one has to wonder just when the bleeding will stop. The headline to Liz Moyer’s April 18th article on Forbes.com was “Bad News Really Is Bad News For Citi.” Moyer observed that the first quarter of 2008 was “a repudiation of the notion that a broadly diversified company can weather financial crises better than more focused companies.” Moyer also quoted Citigroup CFO Gary Crittenden as admitting that “this cycle would be particularly difficult.”