INTERNATIONAL FINANCIAL MANAGEMENT

CASE ANALYSIS ON CITICORP (1985)

Submitted to:

Dr. Gajavelli V.S

SUBMITTED BY:

NAME ROLL NUMBERSAURABH KUMAR 2010209SAURABH SINGH 2010210SHANTANU PANDEY 2010212SUNAL KAPOOR 2010235ANSHUL JAIN 2010297

CASE ANALYSIS

The case is based on Citicorp which is a largest bank holding company in the United States and

was the parent corporation for Citibank and other subsidiaries. Citicorp wants to raise medium

or long term funding and is considering floating rate versus fixed rate system. It is also thinking

of raising the funds in domestic market or through Eurodollar bonds. Case focuses on

advantages and disadvantages of these different markets and discusses many of the innovative

Floating Rate Notes issued in Eurodollar market. Citicorp had already issued considerable

amount of debt in the past 12 months in the U.S. and Eurodollar market. Hence it was thinking

that it was the right time to launch Eurodollar floating rate note. Citicorp was aware of the need

to satisfy bank regulatory capital requirements and was not sure if this particular issue could be

designed to improve the statutory capital ratios. It was constantly viewing the recent

developments in the Eurodollar debt market and was searching for a structure that could serve

its purpose at the lowest possible cost.

Citicorp had grouped its business in three core business units: the Institutional bank, individual

bank and the Investment bank. Institutional bank provided both traditional lending and

innovative financial services. Individual bank provided consumer services like checking and

savings account. Citibank was the largest issuer of credit cards in the U.S. and also the largest

marketer of student loan. Investment bank was involved in a broad range of capital markets

fund raising and consultation services, merger and acquisition services, and global securities

trading.

With the large and sustained growth in assets over the past few year Citicorp had been

constantly searching for funding and within the growing pool of domestic deposits , the relative

size of interest bearing deposits to non interest bearing deposits had increased from 1 to 1 to

over 4 to 1 in 1984. About one third of total domestic interest bearing deposits were short term

deposits and certificate of deposits paying market rates of interest. The parent corporation

Citicorp had issued equity and debt in the capital markets in order to inject capital into its

banking and nonbanking subsidiaries. Funds raised by banking subsidiaries in the deposit and

capital markets could not be used to fund nonbanking subsidiaries. Medium and long term debt

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other sources of committed funding totaled $14.6 billion. Stockholder’s equity was $6.4 billion

of which only 4% was consolidated assets.

The decision of Citicorp was based on three alternatives i.e.

Fixed Rate Alternative

Floating Rate Alternative

Subordination

Fixed Rate Alternative

Citicorp had been active in the domestic and Eurodollar debt market and over past 12 months.

Recently Citicorp had also launched $150 million of 10 year subordinated notes of 10.5% in the

domestic debt market. Hence the domestic debt market would not be receptive to another

fixed rate issue at that time.

Citicorp has two alternatives:

1. Issue a 10-year fixed rate subordinated Eurodollar bond at par with an annual coupon of

10.875% and front end fee of 2.0%.

The “all-in” cost in this case would be-

Coupon Capital in $ maturity Upfront fee(2%)

10.875 500,000,000 10 10000000

10-Year Cash Flow

year coupon Present value of coupon

Discount rate

1 108.75 97.78 1.11222 108.75 87.92 1.11223 108.75 79.05 1.11224 108.75 71.08 1.11225 108.75 63.91 1.11226 108.75 57.46 1.11227 108.75 51.67 1.11228 108.75 46.46 1.11229 108.75 41.77 1.1122

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10 1108.75 382.91 1.1122980

Total Cost = (980/1000)*500,000,000+10,000,000= $500,000,000

2. Issue a 10-year U.S. domestic fixed-rate bond at par with a semi-annual coupon of

10.875% and front end fee of 2.0%.

The “all-in” cost in this case would be-

Semiannual coupon of 10.875% = 10.594% annual coupon payment

Coupon Capital in $ maturity Upfront fee(0.75%)

10.594 500,000,000 10 10000000

10-Year Cash Flow

1 105.94 95.44 1.11002 105.94 85.98 1.11003 105.94 77.46 1.11004 105.94 69.78 1.11005 105.94 62.86 1.11006 105.94 56.63 1.11007 105.94 51.01 1.11008 105.94 45.95 1.11009 105.94 41.39 1.110010

1105.94 389.49 1.1100

975.99

Total Cost = (976/1000)*500,000,000+3,750,000 = $491,750,000

It is within the target of 70-80 basis points above the 10.1% 10-year T-bond rate.

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Floating Rate Alternative

If a floating rate debt was issued Citicorp could obtain better terms in the Eurodollar market

than in the domestic market and could easily issue Eurodollar with a coupon of 1/16% over

three month LIBOR. With three month LIBOR at around 7.80%, the current coupon on a

Eurodollar FRN would be 7.86%.

Subordination

Recent regulations seemed to favor increases in capital ratios through specially qualifying debt

as a means of increasing market discipline of banks but also of providing additional protection

to depositors. The expected growth of assets through 1985 would decrease the primary capital

ratio to a level uncomfortably close to the regulation.

In Eurodollar bond market Citicorp can issue debt at floating rate in two ways-

1. Issue a Eurodollar bond FRN with a coupon of LIBOR + 1/16% with .30-.50% fees or

LIBID + 3/16% with the same fees.

3-month LIBOR + 1/16% = 7.80% + 1/16% = 7.86%

Spread between LIBOR-LIBID is 1/8%. So,

3-momth LIBID + 3/16% = 7.675% + 3/16% = 7.86%

So, there is no difference between using LIBOR and LIBID because the yield is same for

both. The difference between the two is LIBOR does not worry about the spread getting

wider.

2. Issue a long-term FRN with a coupon of LIBID + 3/16% with .30-.50% fees, in which the

bank gets to choose whether it uses 1, 3 or 6 months LIBID in determining coupon

payments.

The Bank has more options by choosing 1, 3, or 6 months for coupon payments, hence it is

not relatively priced as compared to the previous option.

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Conclusion:

Since fixed rate options are relatively costly as compared to floating rate options. In floating rate options coupon payment (7.86%) and upfront fee (.30-.50%) is relatively lower, so it will reduce the cost of funding the debt.

Therefore, we would suggest Citicorp to go for the Eurodollar FRN's with 10 year maturity with coupon of LIBID+3/16%, with an option to choose between 1, 3, and 6 month LIBID at beginning of each coupon period and an upfront fee of 0.3-0.5%.

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