Published February 24, 2009

US stake in Citi may reach 40%

Conversion of preferred shares into ordinary equity would severely dilute other shareholders

By CONRAD TAN

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(SINGAPORE) The US government is in talks with Citigroup to convert its preferred shares in the bank into ordinary shares, a move that would severely dilute the stakes of other investors including the Government of Singapore Investment Corp (GIC).

The plan could see the US government owning as much as 40 per cent of Citi's common stock, The Wall Street Journal reported yesterday, citing unnamed sources.

'GIC has no comment,' a spokeswoman said, when asked what impact such a development would have on GIC's US$6.88 billion investment in Citi's preferred stock.

Citi executives met US regulators at the weekend to discuss a plan in which the government and other preferred shareholders could convert up to US$75 billion of preferred shares into common stock, according to the Financial Times. Besides GIC and the US Treasury, the Abu Dhabi Investment Authority and the Kuwait Investment Authority also own preferred shares in Citi.

A deal has not been confirmed, nor have the terms of any potential conversion been disclosed, but these investors are likely to suffer huge paper losses if their preferred shares are converted to ordinary stock.

At last Friday's closing price of US$1.95, Citi's entire ordinary share capital was worth just US$10.6 billion - less than a quarter of the US$45 billion in preferred shares held by the US Treasury alone.

This means that any ordinary shares that preferred shareholders receive if they do convert their holdings are likely to be worth far less at current market prices than their original investment. Existing ordinary shareholders would suffer massive dilution.

But the government is unlikely to seize control of Citi through an outright nationalisation, the Financial Times reported, quoting people close to the situation.

A joint statement yesterday by the US Treasury and other government agencies said that 'banks should remain in private hands' but did little to quash reports that the government could raise its stake in Citi.

Instead, the statement focused on plans announced earlier to subject major US banks to stress tests starting on Feb 25 to determine if they have enough capital to withstand losses as the economy worsens. The government would then inject more capital as required, if the banks are unable to raise it privately.

'Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time,' the statement said. The preferred shares bought in earlier government injections can also be exchanged for the mandatory convertible preferred shares, which could then be converted to common stock.

Fears that ordinary shareholders in Citi and other major US banks, including Bank of America (BOA), could be wiped out by a government takeover have sent their share prices plummeting in recent days. Citi's shares plunged 44 per cent last week, while BOA's shares fell 32 per cent. But their shares rose at the start of trading yesterday in the United States as nationalisation fears receded.

Temasek Holdings now owns some 188.8 million shares or a 3 per cent stake in BOA, after the bank bought Merrill Lynch.

Investors worry that banks such as Citi and BOA are likely to face further massive losses on bad loans as the recession wears on. That has made it difficult for the banks to raise new capital by issuing ordinary shares to private investors, since they would bear any losses ahead of preferred shareholders.

Converting the government's preferred shares into ordinary equity would boost the banks' core capital - which includes retained profits and ordinary equity but not preferred stock - without the need to inject more money from the public purse. That would make it unnecessary for the government to seek approval from lawmakers for new bailout funds amid growing public fury over the use of taxpayers' money to save large banks.

Yesterday, Citi chief executive Vikram Pandit wrote to staff seeking to reassure them of the bank's fate. He did not deny reports that the US government could raise its stake in the bank, but cited statements by Treasury and White House officials last Friday suggesting that the government does not intend to nationalise the bank. 'I remain very confident in Citi's prospects and business position around the world,' said Mr Pandit.

But US Treasury spokesman Isaac Baker said on Sunday that the Treasury was open to converting its preferred shares into common stock 'if the institution and its 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', Reuters reported.