The company logo of Citigroup is displayed outside Citibank Tower in Hong Kong Monday. The lender could be among the banks that are nationalized under a US government plan.

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

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.

Citigroup rose 25 percent to US$2.44 in German trading Monday.

Citigroup is talking to regulators about expanding the US stake to as much as 40 percent, the Wall Street Journal newspaper reported, citing unidentified people familiar with the situation.

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 would be given additional support, said the person, who declined to be identified because the policy has not been announced.

‘We are open’

Financial firms can apply to convert US 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 its regulator believe it would promote the long-term stability of that institution, and if we believe it is 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 January 20 interview with Bloomberg Television that “short-term” government takeovers may be unavoidable.

Step one

“Nationalization has become part of the public debate, and that is the first step,” said Paul Miller, an analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia, who added that the US 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 – the premium above net assets paid for acquisitions – and preferred stock, including shares issued to the US Treasury. The ratio measures TCE against tangible assets.

Preferred stakes

Such conversions could be imposed unilaterally under terms of the Troubled Asset Relief Program (TARP) passed by Congress last fall, which has so far appropriated $300 billion to banks, insurers and credit card companies.

Changing the government’s preferred holdings to common shares would provide a cash infusion to a bank’s lowest tier of capital, boosting its first line of defense against losses.

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

Regions, Fifth Third

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.

KBW calculated the government stakes based on a conversion price of 80 percent of the stock’s value as of February 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.

Bank of America, the largest US bank by assets, said in January its tangible common equity was 2.83 percent of tangible assets.

At Citigroup, it’s only 1.5 percent, according to estimates from Goldman Sachs Group Inc. analysts led by Richard Ramsden. JPMorgan Chase & Co., based in New York, has tangible common equity equal to 3.8 percent of tangible assets.

Bank of America has enough “capital, liquidity and earnings power to make it through this downturn on our own,” Chief Executive Officer Kenneth Lewis, 61, said in a January 20 memo to employees. “Bank of America does not need any further assistance today, and I am confident we will not need any further assistance in the future.”

The company is not talking with the government about expanding its ownership stake, spokesman Robert Stickler said on Sunday.

“There is nothing going on with us,” he said. Public policy should be promoting new private capital into the banking system, not discouraging it, he said.

Source: Bloomberg