wring capital from private investors instead of U.S. bailout funds as a way of bolstering equity without ceding control to the government

TO BE NOTED: From Bloomberg:

"Citigroup Said to Weigh Capital Boost That Averts U.S. Control

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By Bradley Keoun

May 4 (Bloomberg) -- Citigroup Inc., girding for results of the Federal Reserve’s bank stress test, may try to wring capital from private investors instead of U.S. bailout funds as a way of bolstering equity without ceding control to the government, people briefed on the matter said.

Regulators have indicated to the New York-based bank, which got a $52 billion rescue last year, that another taxpayer-funded cash infusion won’t be required, according to one of the people, who asked not to be identified because the talks aren’t public. Discussions now center on how much of the government’s preferred shares in the firm must be converted into common stock, the person said. Under a plan set in February, the government would convert as much as $25 billion of its stake, for a 36 percent voting interest.

Getting money from private backers may help Citigroup dissuade the Treasury Department from converting all or part of its remaining $27 billion investment -- a step that may increase the government’s ownership to more than 50 percent and nationalize what was once the biggest U.S. bank. One likely solution for the company would be to convert $10 billion of privately held securities that could easily be added to the pending exchange, said Kevin Starke, who analyzes bank capital structures for hedge-fund clients of CRT Capital Group LLC.

“That would bring in another $10 billion of common equity, which could be enough to bring Citi over the threshold” required by regulators, said Starke, whose Stamford, Connecticut-based firm specializes in evaluating multiple classes of a company’s securities. He has no rating on Citigroup’s stock.

Government Control

Jon Diat, a Citigroup spokesman in New York, said he couldn’t comment on the stress tests. Michelle Smith, a spokeswoman for the Federal Reserve, which is overseeing the administration of the stress tests, declined to comment.

None of the largest U.S. banks has succumbed to government control, as insurer American International Group Inc. and mortgage-finance companies Fannie Mae and Freddie Mac did last year. The Treasury Department designed the Troubled Asset Relief Program, or TARP, so the government got non-voting preferred shares in exchange for bank-bailout funds.

The KBW Bank Index, which tracks the 24 biggest banking stocks, has plunged 63 percent in the past year, partly on concern that banks don’t have enough common equity, one of the most conservative measures of capital, to absorb mounting losses during a prolonged recession.

Treasury Secretary Timothy Geithner, who on Feb. 10 announced a plan to test how bank balance sheets would fare under a “stress” scenario where unemployment climbs above 10 percent, says the government will ensure the 19 biggest U.S. banks get enough capital to withstand the crisis.

Tangible Common Equity

The government says it will inject additional capital where needed and consider converting TARP preferreds into common stock.

Last year, the Treasury amassed $45 billion of preferred shares in Citigroup in exchange for bailout funds and another $7 billion of preferreds for a guarantee on $301 billion of the bank’s troubled loans and bonds.

Bank of America Corp., which like Citigroup got $45 billion of bailout funds, also may wind up partially owned by the government if its TARP preferreds are converted into common.

Citigroup, beset by mortgage-bond writedowns and surging losses on credit-card loans, has recorded a $36 billion net deficit over the past six quarters, reducing its tangible common equity to $29.7 billion as of March 31.

Some investors say tangible common equity is the most reliable portion of a bank’s capital because it excludes goodwill, the intangible asset booked when a company makes acquisitions. Goodwill may have to be written off in a market where the value of acquired businesses becomes suspect.

Asset Sales

Chief Executive Officer Vikram Pandit, 52, has announced a plan to sell “non-core” businesses to free up capital. Last week the bank said it would get a $2.5 billion boost to tangible common equity from the sale of its Japanese brokerage, Nikko Cordial Securities.

The bank also is selling majority control of its Smith Barney brokerage to Morgan Stanley, a transaction that will add another $6.5 billion to Citigroup’s tangible common equity. That deal is scheduled to close in the third quarter.

Regulators completing the stress tests are working with banks to forecast profits and losses over the next two years. The goal is to see how much their capital would dwindle in a severe recession, and force them to address any potential shortfall. The results are scheduled to be released May 7.

Dividends, E-Trups

Under Citigroup’s plan to convert $25 billion of the government’s investment into common stock, holders of about $27 billion of privately held preferred shares also will convert their stakes. Citigroup induced the private holders to participate by suspending dividends on the preferreds -- eliminating an advantage the securities had over common stock. The bank also agreed to convert the preferreds at a premium to their market value.

Citigroup may make a similar offer to holders of about $10 billion of enhanced trust preferred securities, known as E-Trups, which rank above regular preferreds in repayment order, according to CreditSights Inc. analyst David Hendler. The E-Trups are a bond-like security whose coupon can be deferred for 10 years without triggering a default.

Markets aren’t likely to warm to a secondary stock offering, and the bank may have trouble attracting investors who aren’t already entangled, he said.

“It’s hard to get third parties involved if the investors who are already there haven’t had their pound of flesh extracted,” Hendler said. “And the next class of investors to be in that donation mode are these E-Trups holders.”

Shareholders’ Cost

Since the E-Trups are trading at 40 to 60 cents on the dollar, holders probably would come out ahead if Citigroup expands its exchange offer to include them, according to CRT’s Starke.

“They just need to open the window wider,” Starke said.

Such a deal would come at the expense of common shareholders, who already have watched the stock price tumble 95 percent since the end of 2006. Citigroup last week fell 6.9 percent in New York trading to $2.97. Under the existing conversion plan, common shareholders would be diluted by 74 percent, and the dilution would increase if additional preferred holders were invited into the exchange.

Citigroup’s E-Trups issued in December 2007 with an 8.3 percent coupon surged 12 percent last week to 61.5 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net."

We could pump money into the banks and in a lousy credit environment they’re not supposed to lend

TO BE NOTED: From Bloomberg:

"Regulators Said to Plan Stress-Test Disclosures May 7 (Update2)

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By Craig Torres

May 1 (Bloomberg) -- The Federal Reserve and U.S. banking regulators delayed the release of the results from stress tests on the country’s 19 largest banks by three days, to May 7, according to a government official.

The government will unveil both aggregate information about the capital buffer required to absorb losses if the recession worsens and firm-specific details, the official said on condition of anonymity. Regulators will make the announcement after financial markets close, the person said.

The delay follows an internal debate among regulators about how best to reveal to markets the health of the biggest banks, information usually reserved for bank examiners. The details may help investors distinguish strong from weak banks, leaving the latter to turn to the government for capital.

Officials “are trying to whittle the herd,” Joe Davis, an economist for Vanguard Group Inc. in Malvern, Pennsylvania, said in a Bloomberg Television interview. “It is a very messy process.”

Regulators have said the tests aren’t pass or fail and are aimed at ensuring lenders can maintain a solid capital base and sustain lending during any worsening of the economy. Fed Chairman Ben S. Bernanke, a Great Depression scholar, has said a sustainable recovery isn’t possible without a stable financial system.

Capital Ratio

Banks were given preliminary results from the stress tests last week, and have been discussing the findings this week with regulators. Officials favor tangible common equity of about 4 percent of a bank’s assets weighted for risk and Tier 1 capital worth about 6 percent of assets weighted for risk, according to people familiar with the tests.

Tangible common equity is a measure of financial health that excludes intangibles such as goodwill or trademarks that can’t actually be used as payments.

The Fed and the Treasury are trying to get the banking system to build a capital buffer as the worst U.S. recession in half a century reduces spending and jobs. Unemployment rose to 8.5 percent in March, the highest level since 1983.

“It is just a cultural clash of epic proportions to have the government tell them they’ve got to lend when they are trained not to lend in a time like this,” said Allen Sinai, president of Decision Economics Inc. in New York. “We could pump money into the banks and in a lousy credit environment they’re not supposed to lend.”

More Loans

Commercial and industrial loans held by commercial banks in the U.S. were 4.3 percent higher at $1.54 trillion in March 2009 compared with March 2008, according to Fed data. Real estate loans held by banks over the same period rose 4.7 percent to $3.83 trillion. By comparison, business lending grew 13 percent to March 2007 from the same month a year earlier, and real estate lending grew 12 percent.

Dowd Ritter, chief executive officer of Regions Financial Corp., said in an April 21 interview that the Treasury’s Troubled Asset Relief Program, or TARP, the taxpayer-supported fund the government has used to put money into banks, has become “a way to look at social program implementation.”

“The rules change daily,” he said. Regions is the 12th largest U.S. bank by assets.

‘Burn-Down’

R. Scott Siefers, managing director at Sandler O’Neill Partners L.P. in New York, said regulators may be conducting an exercise similar to what investors have been doing for months. So-called “burn-down” analysis looks at how much common equity will be destroyed if assets are marked to worst performance.

“The regulatory community seems to be moving toward a heavier focus on tangible common equity,” said Siefers.

The Standard & Poor’s Financials Index, which comprises 80 companies, rose 22 percent in April as officials played down the prospect of nationalization and as the economy showed signs of stabilization. The gauge fell 1.7 percent today.

Treasury Secretary Timothy Geithner told U.S. lawmakers yesterday there is no need for new bank bailout money as of now, Senate Budget Committee Chairman Kent Conrad said. That indicates that the stress-test banks won’t need to tap more than the current remaining funds in TARP. Geithner said April 21 that $109.6 billion remains, or $134.6 billion including expected repayments in the coming year.

Still, some financial analysts have warned that a bigger government role may be unavoidable.

Capital Needs

“I don’t think people understand the amount of capital these companies are going to need,” said Paul Miller, analyst at FBR Capital Markets Corp. in Arlington, Virginia. If investors don’t step up, the government will have to increase its stake in several financial institutions, he said.

The 19 firms include Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc., GMAC LLC, MetLife Inc. and regional lenders including Fifth Third Bancorp and Regions.

The banks in the test hold two-thirds of the assets and more than one-half of the loans in the U.S. banking system, according to a Fed study released April 24.

Scenarios for the stress tests included a baseline outlook of a 2 percent decline in gross domestic product this year, with the national unemployment rate averaging 8.4 percent. The more adverse scenario was based on a 3.3 percent contraction this year with an average unemployment rate of 8.9 percent this year and 10.3 percent next year.

Fed officials said last week that supervisors will work with banks to maintain the buffer, indicating firms with high- risk portfolios will face a bigger challenge maintaining it.

Regulators used the market shocks of the second half of 2008, when Lehman Brothers Holdings Inc. declared bankruptcy, as the model for testing banks with trading portfolios of $100 billion or more.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net"

unemployment goes to 14%... well then nearly all all of the major banks will have negative Tangible Common Equity, or put in other way: insolvency

TO BE NOTED: From Clusterstock:

"Everything Hinges On Unemployment

Joe Weisenthal|Apr. 22, 2009, 3:18 PM|7

Print

Tags: Economy, Banks, Credit Cards, Housing Crisis, Recession

Defaults among prime borrowers are really starting to pick up. Why? Cause even solid borrowers can fall behind if they lose their jobs.

Credit card companies see much deeper charge offs than they'd foreseen just a few months ago. Again, unemployment.

While the talking heads insist that unemployment is a "lagging indicator", it's pretty clear that the financial system is highly levered to this numbers, so it's hard to imagine a real turnaround unless the economy stops bleeding jobs.

A new report from FBR analyst Paul Miller says the health of the banking system all depends on this number:

FBR has constructed it own stress test ahead of the planned release of the government's stress test parameters this Friday, April 24. We tested nine commercial banks under coverage, using 10%, 12%, and 14% unemployment rate scenarios. We conclude that, if unemployment peaks at 10%, roughly consistent with the government's stress test, most of the big banks will be able to earn through it.
On the other hand, if unemployment is closer to 12%, which FBR believes is more realistic, their viability without additional capital is more questionable. FBR surveyed 62 buy-side clients and found that 41% expect unemployment to peak between 10% and 11% and that 39% expect unemployment to peak between 11% and 12%.

And if unemployment goes to 14%... well then nearly all all of the major banks will have negative Tangible Common Equity, or put in other way: insolvency.

Obviously this is the number that elected officials look at, since for most people, a good economy means that they and the people they know have jobs. Employed people are less likely to vote out politicians.

But as we've been saying, we expect unemployment to remain exceptionally high even into the "recovery" period, whatever that means. That's because besides the cyclical changes, the economy is also experiencing deep secular shifts resulting in displacement and lag time between jobs, as workers and industries take longer to adopt."

juggle broad economic objectives with the narrower responsibility to maximize the value of their bank shares on behalf of taxpayer

TO BE NOTED: From the NY Times:

"U.S. May Convert Banks’ Bailouts to Equity Share

By EDMUND L. ANDREWS

WASHINGTON — President Obama’s top economic advisers have determined that they can shore up the nation’s banking system without having to ask Congress for more money any time soon, according to administration officials.

In a significant shift, White House and Treasury Department officials now say they can stretch what is left of the $700 billion financial bailout fund further than they had expected a few months ago, simply by converting the government’s existing loans to the nation’s 19 biggest banks into common stock.

Converting those loans to common shares would turn the federal aid into available capital for a bank — and give the government a large ownership stake in return.

While the option appears to be a quick and easy way to avoid a confrontation with Congressional leaders wary of putting more money into the banks, some critics would consider it a back door to nationalization, since the government could become the largest shareholder in several banks.

The Treasury has already negotiated this kind of conversion with Citigroup and has said it would consider doing the same with other banks, as needed. But now the administration seems convinced that this maneuver can be used to make up for any shortfall in capital that the big banks confront in the near term.

Each conversion of this type would force the administration to decide how to handle its considerable voting rights on a bank’s board. Taxpayers would also be taking on more risk, because there is no way to know what the common shares might be worth when it comes time for the government to sell them.

Treasury officials estimate that they will have about $135 billion left after they follow through on all the loans that have already been announced. But the nation’s banks are believed to need far more than that to maintain enough capital to absorb all their losses from soured mortgages and other loan defaults.

In his budget proposal for next year, Mr. Obama included $250 billion in additional spending to prop up the financial system. Because of the way the government accounts for such spending, the budget actually indicated that Mr. Obama might ask Congress for as much as $750 billion.

The most immediate expense will come in the next several weeks, when federal bank regulators complete “stress tests” on the nation’s 19 biggest banks. The tests are expected to show that at least several major institutions, probably including Bank of America, need to increase their capital cushions by billions of dollars each.

The change to common stock would not require the government to contribute any additional cash, but it could increase the capital of big banks by more than $100 billion.

The White House chief of staff, Rahm Emanuel, alluded to the strategy on Sunday in an interview on the ABC program “This Week.” Mr. Emanuel asserted that the government had enough money to shore up the 19 banks without asking for more.

“We believe we have those resources available in the government as the final backstop to make sure that the 19 are financially viable and effective,” Mr. Emanuel said. “If they need capital, we have that capacity.”

If that calculation is correct, Mr. Obama would gain important political maneuvering room because Democratic leaders in Congress have warned that they cannot possibly muster enough votes any time soon in support of spending more money to bail out some of the same financial institutions whose aggressive lending precipitated the financial crisis.

The administration said in January that it would alter its arrangement with Citigroup by converting up to $25 billion of preferred stock, which is like a loan, to common stock, which represents equity.

After the conversion, the Treasury would end up with about 36 percent of Citigroup’s common shares, which come with full voting rights. That would make the government Citigroup’s biggest shareholder, effectively nudging the government one step closer to nationalizing a major bank.

Nationalization, or even just the hint of nationalization, is a politically explosive step that White House and Treasury officials have fought hard to avoid.

Administration officials acknowledged that they might still have to ask Congress for extra money. Beyond the 19 big banks, which are defined as those with more than $100 billion in assets, the Treasury has also injected capital into hundreds of regional and community banks and may need to provide more money before the financial crisis is over.

Treasury officials say they have more money left in the rescue fund than might be apparent. Officials estimate that the fund will have about $134.5 billion left after the Treasury completes its $100 billion plan to buy toxic assets from banks and after it uses $50 billion to help homeowners avoid foreclosure.

In practice, the toxic-asset programs are not expected to start for another few months, and it could be more than a year before the Treasury uses up the entire $100 billion. Likewise, it will be at least a year before the Treasury uses up all the money budgeted for homeowners.

But the biggest way to stretch funds could be to convert preferred shares to common stock, a strategy that the government seems prepared to use on a case-by-case basis.

Ever since the Treasury agreed to restructure Citigroup’s loans, officials have made it clear that other banks could follow suit and convert their government loans to voting shares of common stock as well.

In the stress tests now under way, regulators are examining whether the big banks would have enough capital to withstand an economic downturn in which unemployment climbs to 10 percent and housing prices fall much further than they already have.

As their yardstick, regulators are expected to examine a measure of bank capital called “tangible common equity.” By that measure of capital, every dollar a bank converts from preferred to common shares becomes an additional dollar of capital.

The 19 big banks have received more than $140 billion from the Treasury’s financial rescue fund, and all of that has been in exchange for nonvoting preferred shares that pay an annual interest rate of about 5 percent.

If all the banks that are found to have a capital shortfall fill that gap by converting their shares, rather than by obtaining more cash, the Treasury could stretch its dwindling rescue fund by more than $100 billion.

The Treasury would also become a major shareholder, and perhaps even the controlling shareholder, in some financial institutions. That could lead to increasingly difficult conflicts of interest for the government, as policy makers juggle broad economic objectives with the narrower responsibility to maximize the value of their bank shares on behalf of taxpayers.

Those are exactly the kinds of conflicts that Treasury and Fed officials were trying to avoid when they first began injecting capital into banks last fall."