If the government converts its stake in Citigroup Inc. from preferred to common stock, how much will it pay?
An above-market price exposes the Obama administration to further criticism that the government is more concerned about protecting Wall Street than Main Street. But pay too little, and it risks not resolving Citi's problems.
"The final price is a huge issue," said Terry Maltese, the president of Sandler O'Neill Asset Management LLC. The Treasury Department is likely to have "a bias toward the lower end, because its job is to protect the taxpayer and not the Citi shareholder."
Stuart Plesser, an equity analyst at Standard & Poor's Corp., agreed. "You shouldn't price a conversion higher than the price of the stock."
The most likely price range is narrow — $2 to $4 a share, or roughly where Citigroup's stock is currently trading and where it closed on Feb. 9. The Treasury said it would use a "modest discount" to that day's closing price when investing new capital into a bank after it has undergone a "stress test" to judge capital adequacy. The agency said Monday that these tests would start Wednesday.
"What the government is trying to do, in a creative way, is get Citibank in a position where it would actually pass the stress test," said Arthur Hogan, the chief market analyst at Jefferies & Co. However, determining the ultimate price for a conversion is difficult. "It is much like the price for what you take on toxic assets," he said. "It's hard to say."
Steve Blumenthal, a former regulator who is now a lawyer with Williams & Jensen law firm in Washington, said it is time for the Treasury to shift its thinking.
"The government needs to come to grips with the fact that moral hazard is dead," he said.
The way to get private capital back into the banking system, he said, is to protect shareholders.
Anthony Polini, an analyst at Raymond James Financial Inc., said that, by buying at an above-market price, the government would signal its belief that the market is undervaluing banks.
"Where banks are trading today is not necessarily fair prices. They have been pushed down to distressed levels," Mr. Polini said. "A fair price today does not mean a price at or below market" values.
Converting the stake would lower Citi's costs. Currently the company is paying the government dividends ranging from 5% to 8%; it pays a penny dividend on common stock.
But David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote in a note to clients Monday that a conversion could impair Citigroup's "marginal earnings power, growth, and profitability."
"We worry that the government could harmfully meddle in Citi's operations and strategy" and that "potential customers and employees will avoid" the company, he wrote.
Richard Bookbinder, the managing member of Bookbinder Capital Management LLC, a hedge fund of funds, agreed that a conversion will not solve Citi's problems.
"A hybrid nationalization alone for Citigroup can't be positive," he said. "There is a reason they are trading at $2, and it is psychology and fear. Has the balance sheet changed? Has the operation of the company or the management team changed?"
A Citi spokesman declined to discuss the issue Monday. He emphasized that Citi's Tier 1 ratio, which takes into account both common and preferred stock, "is very strong."
Vikram Pandit, the company's chief executive, issued a memo to employees Friday drawing attention to statements by the White House supporting "a privately held banking system."