Citigroup Injecting Hedge Funds with $1 Billion

Citigroup is committing $1 billion to shore up hedge funds pressured by the tightening in the municipal bond market. The money will be spread across six highly leveraged municipal bond funds with $15 billion in assets, which were sold under the names ASTA and MAT, depending on how severely the assets have dropped in value. About $600 million had been provided in the first week of March after lenders issued a margin call in response to falling securities values.

ASTA and MAT funds were first offered in 2002 to Smith Barney clients and private bank customers with more than $5 million in liquid assets. This has been the bank's fund trading strategy for years.

Trusts run by Citigroup and other financial institutions borrowed money by issuing tax-exempt commercial paper. They then used the cash to buy municipal bonds that have slightly higher yields and pocketed the difference. Using taxable securities, the trusts then hedged against big swings in interest rates by reversing that trade and they piled on leverage to boost returns. The cycle ends with Citigroup fund managers buying the riskiest bonds issued by the trust. The ASTA and MAT funds have total assets worth about $15 billion and about $2 billion in capital.

This trading scheme was failing by the end of last year and it is barely alive now. The market downturn decimated municipal bond yields while the yield on taxable bonds rallied substantially. With the hedges on the trades hemorrhaging money, Citigroup issued margin calls and is now making this $1 billion equity commitment.

Other Citigroup investments have also been hit hard this year.

In Feb., Citigroup suspended redemptions in a large corporate debt fund, CSO Partners, after investors tried to withdraw more than a third of its $500 million assets. In Jan., Citigroup injected $100 million into the fund, which suffered heavy losses last year.

Citigroup rescued seven affiliated investment funds by shifting more than $49 billion in securities onto its already strained balance sheet.

Falcon Strategies, a big fixed income hedge fund, fell more than 30 percent last year after miscalculating that last summer's market turmoil was over.

Old Lane Partners, the investment fund founded by Citigroup's chief executive, Vikram S. Pandit, has also posted dismal results.