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A Good Strategic Move
By: Dr. Charles Lieberman
Date: 3/2/2009
The government's decision to convert its preferred shares in Citigroup into common is a positive development for the bank industry. It reinforced Fed Chairman Bernanke's statement that there's no need to nationalize our largest banks, calming a major fear of investors. Instead, the government will stand behind the banks and will not go out of its way to punish shareholders.
Treasury's strategy to encourage/force conversion of preferred shares into common significantly boosts Tangible Common Equity for Citi, a sore spot to those investors who dismissed Citi's high Tier One ratio and worried about its low TCE. Preferred shares are included in Tier One, but excluded from TCE. This distinction seems overblown in importance, since the same cash is available to the bank whether it comes in as Tier One or TCE. And Treasury's actions do not add a dime to Citi's balance sheet, but simply reclassifies the capital already there. The most important difference, at least in our judgment, is that the common pays no dividend, so Citi will retain more than $4 billion in dividend payments, which will help it rebuild capital faster.
Most critically, Treasury's conversion of preferred into common lowers its priority among all investors. Bondholders come first, of course, but Treasury had given itself a primary position ahead of all other preferred shareholders and ahead of common. Swapping preferred into common places Treasury on an equal footing with all common shareholders and gives more backing to the preferred shareholders that remain outstanding. Readers here will recall that I ranted over the stupidity and damage Paulson inflicted when he suspended dividend payments on Fannie and Freddie's preferred shares, which imposed large capital losses on banks that owned these shares and undermined the entire preferred stock market and the ability of banks to raise more capital. Treasury Secretary Geithner was clearly careful to avoid the same mistake. But his action underscores his intention to keep the banks in the private sector by choosing not to nationalize them, if possible.
The large banks are still undergoing stress tests to determine if they require an injection of more capital. Public statements and the handling of Citi suggest that Treasury will add capital if needed and will nationalize a bank only if it is absolutely necessary. Such actions will help restore public confidence in the banking sector, a necessity to turn the economy around. The latest GDP figures show that the economy has considerable momentum to the downside that must be arrested. That's the objective of the fiscal stimulus and the Fed's actions to lower bond yields and financing costs.
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