By Alvin Foo

THE Government of Singapore Investment Corporation (GIC) has increased its stake in US banking giant Citigroup from what was potentially 4 per cent to 11.1 per cent.

The increase, which makes GIC the second largest shareholder in the bank after the United States government, came after it decided last night to convert its US$6.88 billion (S$10.6 billion) investment in preferred shares of the bank to common shares.

The closely watched move followed a day of dramatic developments for the beleagured bank which began when the US government made the first move to convert up to US$25 billion of its own preferred shares to common shares, raising its stake to as much as 36 per cent.

The US government's move was conditional on Citigroup getting other major preferred shareholders to do the same. The bank also agreed to reconstitute its board. CEO Vikram Pandit will stay on.

This precipitated investors like GIC, Saudi Arabia's Prince Alwaleed Talal, Capital Research Global Investors and Capital World Investors into also converting their preferred shares.

The exchange of preferred shares for common shares is aimed at raising what is known as the bank's 'tangible common equity' - a key capital adequacy measurement. It also saves money by cutting dividend payments on the preferred shares, estimated at US$5.5 billion a year in total.

Preferred shares come with a fixed yearly dividend and are usually convertible to common stock at a certain price.

Common shares are the shares that most retail investors buy on stock markets. They pay fluctuating dividends declared yearly by companies.

For GIC, the conversion will mean exchanging its preferred shares for ordinary shares at a much lower price of US$3.25 per share than its original investment in January last year.

The preferred shares were then convertible at US$26.35 per share. This translated roughly to a 4 per cent stake at the time, if the shares were fully converted.

The conversion will also enable GIC to pare the paper losses from its Citigroup investment from 80 per cent to about 24 per cent, or US$1.67 billion. That is based on Thursday's closing price of US$2.46 for Citi shares.

The downside is that GIC will lose the yearly dividend of 7 per cent. It had already started to receive that dividend, estimated to be US$482 million a year.

As a normal shareholder with common shares, GIC will also take on more market risk, becoming fully exposed to movements in Citigroup's share price, which fell over 90 per cent in the past year.

Mr Ng Kok Song, GIC's group chief investment officer, said the conversion will boost Citigroup's capacity to weather the severe economic downturn.

'The plan will also enable Citigroup to exploit the earnings power of its unique business franchise when the world economy recovers,' he added.

Analysts said this latest move could turn out to be a win-win situation for Citigroup and GIC.

Mr Wong Kok Hoi, APS Asset Management's chief investment officer, said: 'If Citigroup manages to turn around its operations, then its share price will rebound and GIC will also be a winner.'

It was a different story for other Citigroup shareholders, who now face massive dilution from the US government and other investors taking on additional common shares.

Citigroup shares slumped more than 36 per cent when US markets opened yesterday to US$1.56.

Stake in Citigroup

JANUARY 2008

Investment: US$6.88 billion in preferred notes, with a 7 per cent dividend per year.

Terms: Option to convert into ordinary shares at US$26.35 for a 4 per cent stake - Less risky than ordinary shares

Market value of notes: US$1.38 billion (Feb26 prices)

FEBRUARY 2009

Investment: No new cash injected

Terms: Convert into ordinary shares at a lower price, to own 11.1 per cent and become second-largest shareholder - Not entitled to preference dividend

Market value of shares: US$5.21 billion (Feb 26 prices)

This article was first published in The Straits Times.