Washington faces hard choices on US lenders

Bloomberg

The Obama administration, which says it doesn’t want to nationalize U.S. banks, may find itself taking a step in that direction if it converts the government’s preferred shares in Citigroup Inc. into common equity to help the firm withstand losses.

Citigroup and rival Bank of America Corp., beaten down in New York trading last week on U.S.-takeover speculation, are among more than 20 lenders that could wind up majority-owned by the government if such conversions took place. Executives at New York-based Citigroup have discussed the change as a way to quell concerns about capital adequacy while heading off all-out nationalization, according to a person familiar with the matter.

The bank is talking to regulators about expanding the U.S. stake to as much as 40 percent, the Wall Street Journal reported.

"Conversion would make a lot of sense for the banks that are struggling with their tangible common equity ratio, because they cannot go out today and raise common," said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine, referring to a measure of a lender’s ability to absorb shocks.

Treasury Secretary Timothy Geithner is poised to announce details of a new "stress test" for the nation’s largest banks this week. The test will determine which firms should hold an extra buffer of capital to withstand a more severe economic climate, according to a person familiar with the Obama administration’s plans. Those that fail will be given additional support, said the person, who declined to be identified because the policy hasn’t been announced.

’We are open’

Financial firms can apply to convert U.S. preferred stakes into common equity "to strengthen their capital structure," said Treasury Department spokesman Isaac Baker, who declined to comment on specific banks. "We are open to considering a request to do so if the institution and it’s regulator believe it would promote the long-term stability of that institution, and if we believe it’s in the best interest of long-term stability of our economy and financial system," Baker said.

The idea of nationalizing banks has gained traction in recent weeks as Nouriel Roubini, the economist and professor at New York University’s Stern School of Business, Republican Senator Lindsey Graham of South Carolina and former Federal Reserve Chairman Alan Greenspan all suggested it as a solution to banks’ woes.

Senate Banking Committee Chairman Christopher Dodd said in a Jan. 20 interview with Bloomberg Television that "short- term" government takeovers may be unavoidable.

Bank shares plummeted last week, with Citigroup sinking in New York trading to an 18-year low of $1.95. Bank of America fell to $3.79, the lowest price since 1984.

"Nationalization has become part of the public debate, and that’s the first step," said Paul Miller, an analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia, who added that the U.S. is moving "faster than people think" toward government control.

"This is the only way out," Miller said. "Losses are just going to accelerate in the next couple of quarters. The holes in these banks are just too big."

By converting its preferred shares to common, the government could pad too-thin tangible common equity, or TCE, ratios. TCE strips out intangible assets, goodwill Ğ the premium above net assets paid for acquisitions -- and preferred stock, including shares issued to the U.S. Treasury. The ratio measures TCE against tangible assets.

The government holds $52 billion of preferred shares in Citigroup, five times the bank’s market value as of Feb. 20. If the U.S. were to convert all of its holdings into common shares, it would own more than 80 percent of the company.

Charlotte, North Carolina-based Bank of America, which has received $45 billion in TARP funds in exchange for preferred shares and warrants, would be 66 percent owned by the government if its entire stake were converted to common equity, according to data compiled by KBW Inc., a New York-based investment bank. The figure would be 69 percent at Regions Financial Corp. in Birmingham, Alabama, which has received $3.5 billion from the U.S. It would be 83 percent at Fifth Third Bancorp, the largest Ohio-based lender, which got $3.4 billion. KBW calculated the government stakes based on a conversion price of 80 percent of the stock’s value as of Feb. 5.

Bank of America, Citigroup and Wells Fargo & Co. in San Francisco are among more than 400 financial institutions that have received cash in exchange for preferred shares under the program. They now face increased scrutiny from regulators and investors, who are focused on their tangible common equity.