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Will Citi Sell its Stake in India's HDFC?

Troubled US banking giant Citigroup, under pressure from US regulators to raise fresh capital and change its leadership, has a potentially-ready source of capital, its 11.73% stake in India's largest mortgage company, HDFC. At current share prices, the beleaguered American lender's stake is worth Rs 8,070 crore or $1.71 billion, which is nearly 9% of Citigroup's market capitalisation. Speculation on Citigroup's intentions is not new, but ongoing public travails have provided some legs for the current round of rumours. In early May, the stress test ordered by the US regulators on 19 major financial institutions indicated that Citigroup needed to raise $5.5 billion by way of fresh capital, a shortfall which the New York-based lender bridged by converting preferred stock owned by the US government to common stock. Last week, a report in The Wall Street Journal indicated that the Federal Deposit Insurance Corporation (FDIC) was pushing for a change of leadership at Citi. "Whenever we have spoken to Citi, they have told us that they were not selling," said Keki Mistry, MD and VC, HDFC. He acknowledged that the current bout of speculation had raised hopes of several potential buyers who have said they were interested. In the past, some sovereign wealth funds have also shown interest in buying Citi's stake. Citigroup, though, continues to deny any intention of selling. As recently as May 27, Ajay Banga, Citi's Asia-Pacific CEO, told international media that Citi will not sell its stake in HDFC and a couple of other Chinese banks. However, the markets will keep a close watch on these investments against the backdrop of Citi's dire need for fresh capital. The sharp rise in HDFC's valuation in recent weeks has coincided with FDIC reportedly pushing for a change in leadership at Citi. Moreover, the rationale for a strategic stake has weakened. Though this has never been explicitly spelt out by Citi, most analysts believe that the medium-term logic was that the New York-based lender would get an equity stake in HDFC Bank in case of a merger between HDFC and HDFC Bank, which many consider a likely occurrence on a five-year time horizon. But after the RBI said last month it would not open up the Indian banking sector for foreign competition in 2009 as originally envisaged, a strategic stake in HDFC makes even less sense. Moreover, it is implausible that the RBI would allow a weakened and troubled Citigroup, which is effectively owned by the US government, a substantial stake in a major Indian bank like HDFC Bank. The combined market capitalisations of HDFC and HDFC Bank, at over $27 billion, are way higher than Citigroup's $19.07 billion. While analysts do not rule out a stake sale, they say it will not make any difference to HDFC's share price. "Citi does need capital badly. But even if they do sell their stake, it will not make any difference to the share price as long as the shares do not enter the open market," said Hemendra Hazari of Karvy Stock Broking. He added that in such deals, shares seldom enter the open market. "There have always been rumours that Citi might sell its stake. It will be an opportune time for Citi as it needs funds. If it happens, it will be a pre-negotiated deal and will not have any impact on the market price. Many long-term institutional investors would be willing to acquire a slice of the HDFC stake," said Mehraboon Irani, V-P (PMS), Centrum Broking. Citi had acquired a 9.27% stake in HDFC in May 2006 by buying out UK insurer Standard Life. At the time of purchase, the stake was worth around Rs 3,100 crore. Three years since, the value of the stake has more than doubled. According to HDFC's latest filing with the BSE, Citigroup Strategic Holdings Mauritius is its largest shareholder, with a 9.10% stake. In addition, Citigroup Holdings Mauritius has a 2.63% stake. HDFC shares have bounced back with interest rates softening. Recently, the mortgage company has borrowed five-year funds at 7.25% to 7.5%, augmenting its ability to compete with banks in the mortgage market. There are some who feel Citi may try to hold on to HDFC for as long as it can because Asia is the only growth engine in the group's portfolio. Besides, Citi is not in as dire a position as bankrupt insurance giant AIG which has no choice but to sell its various businesses.

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