New U.S. stake in Citigroup may not calm doubts

By Dan Wilchins and Jonathan Stempel

NEW YORK (Reuters) - Even if the government took a large common equity stake in Citigroup Inc, worries would likely persist about the bank's ability to absorb soaring losses in a deepening recession.

The third-largest U.S. bank by assets is in talks with federal regulators on a plan for the government to increase its stake, a person familiar with the matter said. Converting $45 billion of preferred stock, which the government obtained last fall, to common stock is one of many options, the person said.

An agreement could be announced Monday or Tuesday, CNBC television said.

Citigroup shares rose on Monday after the White House repeated that President Barack Obama believes keeping banks in private hands is "the best way to go.

U.S. bank regulators, meanwhile, said they stood ready to provide more capital to the sector and keep "systemically important financial institutions" viable.

But investors remained worried that losses from credit cards, emerging markets, trading and toxic assets could overwhelm Citigroup Chief Executive Vikram Pandit's efforts to restore the bank's fiscal footing. Analysts do not expect the New York-based bank to be profitable in 2009 or 2010.

Converting preferred shares to common equity "helps their capital ratios but it doesn't help their problem assets," said Walter Todd, portfolio manager at Greenwood Capital Associates LLC in Greenwood, South Carolina. "If Citi were out of the woods, the stock would not be at $2."

The government plans on Wednesday to subject banks with more than $100 billion of assets to "stress tests" to decide which need more capital. Citigroup ended 2008 with $1.95 trillion of assets.

Citigroup shares closed up 9.7 percent at $2.14. They earlier traded as high as $2.48, but gave up some gains as broader indexes fell.

GOVERNMENT TALKS

Citing people familiar with the situation, The Wall Street Journal said Citigroup was in talks for the government to convert much of its preferred shares to as much as a 40 percent common equity stake, though bank executives hope to limit the stake to about 25 percent.

"It can be taken as a commitment that some banks are too big to fail and the economic consequences too bad to contemplate," said Tony Morriss, senior markets strategist at ANZ Investment Bank, in Sydney.

Washington got the Citigroup preferred shares, which equate to a 7.8 percent stake, when it bailed out the bank last fall and agreed to share in losses on $301 billion of toxic assets.

"The government doesn't want to do this," said Art Hogan, chief market analyst at Jefferies & Co in Boston. "This is government looking into Citigroup, saying what is the best way to keep the banks alive, not the stocks alive. That's the important part."

Treasury Secretary Timothy Geithner's bank stabilization plan allows lenders to apply to convert preferred shares into convertible preferred shares and later into common equity, a spokesman said.