Citi to slash lending to buyout funds as new capital rules bite | Financia... https://www.ft.

com/content/e594087e-126b-4376-90ad-2a245c8313f3

Citigroup Inc
Citi to slash lending to buyout funds as new capital rules bite
Bank preparing to reduce size of ‘subscription line’ book from $65bn to $20bn

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Citi to slash lending to buyout funds as new capital rules bite | Financia... https://www.ft.com/content/e594087e-126b-4376-90ad-2a245c8313f3

The move comes in the middle of a restructuring of the bank under chief executive Jane Fraser © Lauren Justice/Bloomberg

Joshua Franklin and Antoine Gara in New York SEPTEMBER 24 2022

Citigroup is dramatically scaling back the amount it lends to asset managers, including private
equity firms, as the US bank races to meet tough new capital rules, according to people familiar
with the matter.

The type of lending that Citi is backing away from is known as subscription-line financing, a niche
but important business for Wall Street banks that want to develop deep ties with dealmaking
clients, especially private equity groups.

Citi’s existing book totals roughly $65bn and the bank is preparing to slash that to about $20bn in
the coming months, one of the people said.

There is high demand for the lending from buyout groups in particular, which use money pledged
by fund investors as collateral for the short-term bank loans to close deals in advance of receiving
cash from their backers.

Citi declined to comment.

Citi’s move underscores the impact of new capital requirements implemented by the Federal
Reserve that threaten to curtail lending by large US banks. This week Jamie Dimon, chief executive
of JPMorgan, warned the rules posed a “significant economic risk” that would restrict the flow of
credit to American companies and consumers.

Citi, like JPMorgan and Bank of America, is being forced to increase its buffers this year because it

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Citi to slash lending to buyout funds as new capital rules bite | Financia... https://www.ft.com/content/e594087e-126b-4376-90ad-2a245c8313f3
Citi, like JPMorgan and Bank of America, is being forced to increase its buffers this year because it
has been designated as a global systemically important bank, requiring it to hold more capital
relative to its risk-weighted assets.

Banks can meet the requirements by retaining more profits or raising new equity, but most are
opting to reduce the amount of assets on their balance sheet.

It comes in the middle of a restructuring of the bank under chief executive Jane Fraser, who is also
exiting many of the bank’s retail operations overseas. The lender is grappling with a 2020 consent
order with US banking regulators under which it agreed to upgrade its processes and technology.

Citi has started to alert some of its biggest private equity clients about the impending changes,
according to people briefed on the conversations.

One top private equity said that most large Wall Street banks are still committed to subscription-
line financing but that Citi — which has been a top-three player in the business — is scaling back.

Another buyout executive interpreted the move as a sign that Citi may be embarking on a broader
reconsideration of its role in the lucrative but risky market for providing credit to private equity
groups.

Subscription lines carry minimal risk but do not tend to generate high returns. Instead, they are
offered by banks to cultivate relationships with buyout firms in the hopes of winning more
lucrative business later, the executive said.

“Citi was an outlier,” they said, adding the bank had a big subscription line business but a smaller
presence in financing buyouts.

“As a ‘loss leader’ or low-profitability safe business to establish relationships, it’s a great business.
But as a standalone with no follow-up business, it’s mediocre,” they said.

Copyright The Financial Times Limited 2022. All rights reserved.

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At least Citi is trying to anticipate increasing risk, though blaming the regulatory
requirements for capital is convenient scapegoating ...
blaming the regulatory requirements for capital is convenient scapegoating ...
+1
Is all the fuss necessary, even from a regulatory point of view? Subscription line financing
seems fairly bland, as in low risk
Good that regulation works so quickly. Buyout funds must not be funded via deposits, but via
long/term market funding of capital and debt.
Have citi explained why they are cutting this type of lending and not others? Why should we
particularly care? Is this type of lending economically significant? Seems like it exists to
allow M&A transactions to happen on a faster timescale.
And boost IRR for LPs
(Edited)
And then boost bubles and pyramid schemes in the PE market, especially in TMT
Well done Citi.
I think the next is we are going to see the collapse of pyramid / Ponzi scheme like Private
Equity markets. Especially the ones operating in Technology (TMT).
Snore
Happy dreams???
Rational thinking and back to fundamentals - at least she sees the high risk in this kind of
lending - and taking steps towards some self preservation.
(Edited)
If its money borrowed from the bank how can it also be ‘private equity’ at the same time?
‘Subscription line financing’ sounds more like releasing capital to entities that are designed to
avoid scrutiny. A good business to get out of, I’d have thought. Citi has done well for arriving
at that conclusion, albeit with a bit or prompting from the regulators, and after all that’s what
the regulators are there for.
When a PE group wants to do a deal. They Can draw cash from the sub line to pay, while
they wait for the capital calls to come on into the fund.
Often also use to juice the IRR, by using the line and calling the LP capital a few months
down the line.
Seen as low risk as the LP are legally bound to answer the capital call, with severe
consequences if they don’t.
Thank you Miller1, it sounds like some kind of revolving credit facility to PE. These capital
calls may start to fail during a credit meltdown, just the time when banks need cash not IOUs
on their balance sheet.
Citi and other banks need to become more efficient as tough times ahead. This means getting
out of low margin, high risk business lines.
This business is a freebie designed to get more sponsor deals - if the sponsors aren’t
rewarding Citi with biz it makes a lot of sense for Citi to pull back
Internally this is classified as a low risk business though it is also low margin.

With larger capital requirements, big banks have to focus on business with higher margins
Sounds like the stupidest form of lending. If a deal goes south and fund investors fail to meet
their cash calls Citi is left holding the bag. Fraser is right to scale down this business which
only serves to subsidize the bonuses of the banksters which count on the fees from the
advising and public debt offerings.
I have to disagree. The recourse is legally effective to a diverse group of, generally insto,
investors. Diverse, over collateralised exposure to investment grade institutions is good risk.
That is why it only pays ~160bps.
(Edited)
"Sounds like the stupidest form of lending. If a deal goes south and fund investors fail to
meet their cash calls Citi is left holding the bag"

Lol, no, this comment and all the people who liked it are the 'stupidest'. This type of lending
has nothing to do with "deals" in reality, every single investment made by the fund could turn
out to be worthless and Citi will still get paid back in full. Banks are lending against the legal
commitments made by investors ("limited partners" in industry jargon) to pay money into the
fund in the future, which in the case of established funds are basically all of the world's
largest institutions (think CPPIB, Sovereign Wealth Funds, large insurance companies,
Harvard University endowment, etc.). If any of them default on their legal obligations to a
fund then the world economy is already complete toast (none did in the GFC) and Citi/the
banking system has much bigger problems. Arguably for small PE firms with family office
style investors it's riskier but the bank will charge a higher rate of interest accordingly and
these are not the kind of the funds Citi and similar are lending to anyway.

Also, yes Citi is left holding the bag if it goes wrong theoretically, that's true in every lending
deal - what do you think they are being paid for as a lender?

Can't believe this drivel is the second most liked comment, but I guess it's critical of both
banking and PE so it successfully hits both of the current FT reader bête noires...
(Edited)
Out of the several explanations in the comment section, I think yours is the easiest to
understand.
Thank you.

Can't believe this drivel is the second most liked comment, but I guess it's critical of both
banking and PE
Welcome to the internet... �
From the article:
“Citi may be embarking on a broader reconsideration of its role in the lucrative but risky
market for providing credit to private equity groups.
Subscription lines carry minimal risk”

Risky market, but it carried minimal risk.

2
FT/Joshua: come on.
FT
The subscription lines business carries minimal risk but is a gateway product to the riskier
business of financing the buyouts
Miller1: come on
Why doesn't the article explain anything about subscription lines except that it is "...a niche
but important business"? Subscription paying readers expect more details before telling us to
take your word that it has "minimal risk".
(Edited)
Let’s say I make a commitment to invest $1 million in private equity. I don’t wire the money
to KKR (or whomever) immediately - they make a capital call for my money as/when
needed.

The risk to a bank in bridging capital calls (subscriptions) is that I will back out (KKR will
sue me, though in practice they usually have plenty of excess demand to make up my
shortfall) but everyone else also backs out because aliens have invaded or the market has
tanked or Liz Warren has been elected Prez and has seized all the wealth
(Edited)
You made me smile at coffee time, thank you.
Liz Warren would be about as successful in seizing all the wealth as The Don in building that
wall, but aliens may do a better job a governing than any of them…
FT
Thank you Loan Regulator for your comment as it provides me with a reason to post links to
my articles about subscription lines. I particularly enjoyed writing the Harry Potter
"wizardry" story.

Financial wizardry breathes magic into private equity returns

https://www.ft.com/content/b49985c8-71d5-40b3-bfe4-3f7c23c59460

The SEC has proposed important changes to reporting and disclosure standards which will
require GPs to report IRRs with and without subscription lines.

Investment industry welcomes SEC efforts to reform private equity fees

https://www.ft.com/content/ec661f96-4c71-4361-a823-00bb69ba0fc0

Howard Marks of Oaktree has criticised subscription lines (he knows more than little a bit
about how the finance industry works!)

Private equity’s dirty finance secret

https://www.ft.com/content/48d107b2-5fed-11e7-91a7-502f7ee26895

3
I remember having quite a job explaining subscription lines to my editor back in 2016 when I
first wrote about the issue - and I'm glad to see that 8 years later US regulators want to
address it!

Financing ‘trick’ boosts lucrative private equity fees

https://www.ft.com/content/c5c24c58-953c-11e6-a80e-bcd69f323a8b

Very happy to discuss further if you want. My email is chris.flood@ft.com

(Edited)
Outstanding, Chris, thank you.

I think that among the problems here is the fact that literally nobody in the chain of agents
managing the LP pools (pensions, endowments, sovereign wealth, family office) doesn’t love
the sub lines despite the questionable value to the end beneficiaries.

The high reported IRRs lead to more fees for the PE managers whilst the investment
consultants and in-house investment offices get to justify their jobs, get high job satisfaction,
and game their own employment contracts without having to consider the drag on returns of
cash reserves (collateral) earning (until recently) zero.

An interesting study, if one doesn’t already exist, would be of the actual returns of all-in
private equity programs, considering the cash drag (money reserved for commitments/cap
calls), investment consulting fees, staff expenses (salaries, travel, bonuses for beating
benchmarks, etc.), and adjustments for risk which I think we may soon be reading about in
future Chris Flood articles as the low rate curtain gets pulled back and PE deals default.
(Edited)
I work for an LP making private equity investments and this is completely wrong, many LPs
do not like subscription lines and express this view to GPs frequently, as well as trying to
unpack returns without the use of leverage wherever possible. Unfortunately, many LPs do
like them as you say and in particular one group of LPs that is very large and important does
love these lines - Fund of Funds who themselves are reporting to their own LPs...
If it was “completely wrong” the “many LPs” would instead be “all LPs”. Further, you would
know it was “completely wrong” based on a universal rejection of them and a refusal to
invest unless PE swore off the practice. But of course the opposite is true as evidenced by the
many, massive (ubiquitous) funds raised. Surely not all of that money going these funds is
coming through the Fund of Funds channel.
@FT David - interesting article, real news, but are they cutting volume or duration? if they
are shortening the duration of sub lines, good for them it's disguised fund leverage. If they are
just pulling back scale across the board, it is interesting but not as important
(Edited)
They are cutting volume. Duration is largely defined by the LPA (LPs). The banks, including
Citi, simply live within it. Typically 12 month duration limit.
(Edited)

4
No. You are confusing the term of the fund and the term of the facility. They are not the
same. Most funds have some form of RCF to avoid calling and repaying capital (which is
what a subscription line is) - the date on which that is cleared down is the question. If it is
cleared quarterly, so what? If it is cleared every three years, it's going to do all the IRR
jiggery-pokery that Chris Flood is talking about.

So, my question to @FT is: Are Citi reducing the amount of 3 month RCFs by $Xbn (Shrug,
so what?), or are they reducing the availability of, say, three-year RCFs to, say, 3 months, and
reducing the size accordingly, (Wow! that's a big deal). It is a big deal how it is distributed
amongst GPs too: If one GP can get a three year + line for LPs in their funds, and others can
only get a 3 month line, that is a huge and enduring competitive advantage in an industry
where carry is calculated using IRRs. It also impacts liquidity in the LPs.
(Edited)
Im not confusing anything. I’m answering the question. Citi I know for a fact are off boarding
clients and reducing volume. I’ve heard nothing re duration bar the above quite strange
speculation.

95% of market must clean down subline, be it a 1, 2 or 3 year RCF, every 12 months to
comply with LPA.

Fund life is typically 10 years and a wholly different topic.

(Edited)
Do any of you actually invest in Private Equity? Credit lines benefit both GPs and LPs. Sure
it boosts IRRs a little, but it won't transmute a crap investment into a great one. But it greatly
reduces the numbers of wires and capital calls flying around. Try dealing with several capital
calls coming in every day when you're running an institutional business. And yes this is a
very low risk business because if the LPs default on their commitments they lose the entirety
of their investment and an event of default can damage the entire franchise of the LP. Even in
the depths of 2008 no one defaulted.
« There is high demand for the lending from buyout groups in particular, which use money
pledged by fund investors as collateral for the short-term bank loans to close deals in advance
of receiving cash from their backers.«

Not very clear to me… If money is « pledged » it’s a mere promise so how can it be counted
as collateral ?…
Looks like a risky business where basically the banks will provide bridge financing and is at
the mercy of backers not supporting and financing the deal.

Another article where the quotes of insiders are taken at face value and where it doesn’t seem
the journalist tried to get a critical understanding of the issue…
Banks also provide liquidity lines to mutual funds All of the above is picking up nickels for
“zero risk” until the steamroller hits you
The article is pretty clear given the author's word constraint.
Citi are reducing the scale of a working capital facility provided to funds that hold committed
but not drawn capital. you are asking about security of that facility. there are variations, but
5
broadly, the LP commitment requires them to provide cash to fund the deal the GP/Manager
is sponsoring (in the jargon). If they do not provide cash they are in breach of the partnership
agreement and can be sued by any or all of the other partners (not just the GP, but they would
lead the action). They also lose the value of any existing investments in the fund (there are
variations on how, but that's the principle) which pass to the other partners. The bank
advances a maximum %ge of commitments guaranteed by the LP (and the other LPs using
the facility collectively). so the bank has security from the beneficiary and the other LPs
using the scheme, whereas the LPs have security over the funds assets if they have to step
into an LPs shoes.

you can boost IRRs (but not profit, which falls) by having long subscription lines. This is the
questionable practice under inspection. a short term line is nothing to get excited about. A
long term line is gearing in a fund that is a worrying trend. so back to the article - are they
cutting volume or term/duration is the key unanswered question.
FT
Hello Big in Japan - please take a look at my response to Loan Regulator
(Edited)
Rachel Maddow’s mother is the head of Citi?!!
Friends in high places...
This is akin to supplier financing: on paper low risk and short-term but hard to back out of
and under-remunerated.

In practice, this is permanent leverage in an active fund notwithstanding that in principle it

relates to discrete drawdowns from LPs. So backing out of it requires LPs to "catch up with
themselves" reducing IRRs
Now that it’s raining it’s time to take the Umbrella away. Don’t worry, they’ll give it back
when the sun is shining again.
Not really a difficult decision to exit a business they aren’t in. Pointless bank
This week Jamie Dimon, chief executive of JPMorgan, warned the rules posed a “significant
economic risk” that would restrict the flow of credit to American companies and consumers.
Yes Jamie. That is what the fed is doing to consumers and the entire economy with the
interest rate hikes to cool down the market? Ya missed the memo choom? J-pow is trying to
tame the inflation genie now that it’s no longer transitory.
(Edited)
This is such a typical Citi story. I do not know the details but, having worked for Citi, I bet I
can guess. It goes something as follows.
(i) Former CEM (Chief Executive Muppet) is convinced this is a great opportunity for Citi.
The reason it is a great idea is that it allows the bank to use a ton of capital as a battering ram.
The balance sheet will buy a place at high table which can then be exploited by a yet-to-be-
built world-beating team.
(ii) Bunch of people on obscene salaries are hired to lead the effort. Internally, they are billed
as the industry A-team, the best of the best. Surprisingly, the institutions from which these
giants of banking have come seem remarkably unperturbed.
(iii) The market hoovers up Citi's capital but is less keen on giving back the higher-margin
business. Internally, every minor success is hailed as epoch making. Bonuses flow while the
6
CEM's patronage continues. Questioning the business is potentially career-threatening while
the executives are invested in the project. The Emperors clothes are of the highest quality.
(iv) There is a change of CEM. The new Chief Executive Muppet needs to put clear blue sky
between him or herself and the last muppet and fast. The old muppet's failing initiatives are
cut to the bone.
(v) At some later date, the CEM needs to show an ability to grow the business, not just cut.
S/he identifies opportunities in which capital can be used as a battering ram and the cycle
repeats itself .......
Haha wonderfully accurate
Dear Koba, that is a great story! I’ve been through that cycle myself so many times!
Dear Koba
Spot on. Jane has possibly put a spin on something enforced by the regulators. Btw, how is
she going to sell down $45bn of these loans. It will take a couple of years.

Jane Fraser has been selling the Citi silverware but not shown where she is investing the
money. Meanwhile, the stock keeps sliding. Berkshire seems to have plucked a lemon that
they thought was an apple!
Spot-on!
Couldn’t agree more!
You really did work there
This is brilliant. And explains why banks are uninvestable. They're a wealth transfer scheme
from shareholders to insiders.

Your return as of today is 0% if you bought Citi's stock on August 1st 1995. The S&P
500 returned 969% over the same period.
Quite close. This lending was actually done in the Private Bank out of all places and driven
by a growth-at-all-costs PB CEO (subsequently fired for other reasons). The Private Bankers
on the accounts were more or less paid (a lot) based on lending revenues and cross sell was
very low in most cases. High risk ratings on the deals allowed for low capital so happy days.
All good things have to come to an end…
Chuck Prince 111 the Chief Muppet Master:
“When the music stops, in terms of liquidity, things will be complicated. But as long as the
music is playing, you’ve got to get up and dance. We’re still dancing,” July 2007.
What on earth is that creature wearing
beats a Citi-logo bro-vest.
Who knows the arrogant Chris hunt will only report to a partner
@FT, so what are the new capital rules? Would help to actually get numerical comparisons.
WSJ reports private equity investors expecting losses.
One wonders if causing the losses was behind the “new rules.” The Stalinist law prof did not
get appointed, but one wonders what odd ideas become “tough new rules” that few
understand, or even notice?