The Arabs have done it again. Citigroup, the world’s largest bank, is raising $7.5 billion from the government of Abu Dhabi in an intriguing deal that is raising more questions than answers as to the true extent of the troubles besetting the US financial sector. The Gulf lifeline to Citigroup has come at a price though, with the US giant offering a whopping 11 percent to the Abu Dhabi Investment Authority (ADIA) for a convertible loan stock, which ADIA can convert into a 4.5 percent stake in Citi in 2010 and 2011, at a conversion price slightly above the current share price- now at a five year low. The rate paid by Citigroup is a couple of notches above junk bond rates and must be a humiliation for such a prime financial name. If the conversion takes place as planned, then ADIA will end up with a stake at just above that held by Prince Alwaleed bin Talal, who also came to Citi’s rescue during yet another US mortgage crises in the late 1980’s and early 1990’s. The major question is whether this capital infusion is enough to stop the present banking crises, and if Arab sovereign funds will be asked to ride in and rescue more western financial institutions, given the large oil revenue surpluses now at hand for some Gulf states.

What is bothering about this white knight rescue by ADIA is that analysts have led us to believe that, unlike previous banking crises, this time round the financial institutions most affected by the sub-prime implosion were well capitalized, and have a large cushion to weather any losses. How false this is turning out to be, and it seems that some of the prime US banks are now reaching the bare minimum of their Basel Tier 1 capital requirement of 8 percent levels. Citigroup’s Tier 1 capital ratio, a ratio of financial strength, stood at 7.3 percent in the first quarter 2007, below its target of 7.5 percent, but the ADIA lifeline will take it back above target. This move might stabilize the fall in Citi stock prices, but it is coming at a hefty price, and makes some wonder why the American bank could not raise these funds in its backyard at better terms. It also raises troubling questions on the standards applied for welcoming foreign investments in the US, as it was not too long ago that Abu Dhabi’s neighbor, Dubai, was forced to sell its take in US port operations after furious opposition from some US politicians. And yet, some of the same politicians who had opposed Dubai’s acquisition are now welcoming ADIA’s move in trying to preserve the US financial market as the ‘world’s financial center”.

It could very well be that ADIA had taken comfort from a less vocal US opposition to the Chinese move to put $1 billion into the Wall Street bank Bear Sterns, and some $3 billion into the US equity group Blackstone. However, before more Arab funds rush off to acquire stakes in troubled financial institutions at such mouth-watering rates as ADIA’s deal with Citigroup, one has to ask a simple question — has the bottom been reached in the current banking crises? Some institutions have yet to bite the bullet and bring some of their derivative products and various Structured Investment Vehicles (SIV’s) back on balance sheet. This could change the picture dramatically in terms of possible new loan losses. The giant HSBC has already done this by bringing some $35 billion of SIV loans directly on to its own books. So far Citigroup has resisted doing this, but might be forced to, in which case its capital ratios would have been significantly impaired. The ADIA lifeline gives Citi the ability to do so, but will also force Citi to reconsider its current position to continue paying out a generous dividend policy costing the bank around $11 billion a year. At current share prices, the dividend yield is above 7 percent, which might go some way to explain the high 11 percent coupon rate paid on the new equity loan units to ADIA, or a 4 percent premium. So has Citi come out of the wood yet, or will ADIA be requested to pump in more money? Citigroup’s investment business has been one of the most heavily affected by the ongoing credit crises. Some analysts estimate that excessive betting on sub-prime mortgages could still cost the bank up to $15 billion in sub-prime losses and other collateralized debt obligations. It is the SIV’s, probably amounting to around $80 billion, which are causing the greatest concern, should these be brought on to Citigroup’s books like others and HSBC.

So the spectacle remains that more Gulf Arab white knights will be sought to rescue ailing financial institutions. One of the peculiar characteristics of today’s global markets is that in some sectors, particularly commodities and other strategic assets, there is abundant cash for asset purchases by some companies, but that such acquisitions are blocked on national security or other political arguments. The barriers seem to have come down as far as US financial institutions are concerned, but how long this lasts is only a matter of guesswork, as once again, the specter of foreign takeover of “national” symbols will be hard to accept.

As for Gulf saviors, whether they remain passive investors and bystanders in the operations and strategic policy direction of their newly acquired companies, or try to introduce a little bit more of financial discipline, is another matter. At 11 percent rates, ADIA seems more than happy to remain in the sidelines for the time being, but the situation could change if the extent of potential collateralized debt obligations and structured investment vehicles becomes clearers.

(Dr. Mohamed Ramady is visiting associate professor, Finance and Economics, King Fahd University of Petroleum and Minerals)