NEW YORK Citigroup's (C.N) decision to halt dividend payments on some of its preferred shares may be the final blow for certain bank preferred stocks and may further dry up the willingness of private investors to buy other bank securities.
The government on Friday boosted its equity stake in Citigroup to as much as 36 percent and the bank said it will suspend dividends on some preferred and common stock and convert up to $25 billion in preferred shares to common stock as part of the agreement.
"While the dividend suspension was largely priced into current spreads, the announcement is a watershed event," and will likely dry up the ability to sell similar securities in the primary market, said Ricardo Kleinbaum, trading sector specialist at BNP Paribas in New York.
Investors will be concerned that the government may intervene in other banks, such as Bank of America (BAC.N) and Wells Fargo & Co (WFC.N), which have borrowed from the Troubled Asset Relief Program, and this will have a similarly negative impact on these types of preferred shares, he said.
Citigroup's dividend suspension affected its traditional preferred shares, but the bank will continue to pay dividends on its trust preferred shares, which rose on the announcement.
Credit ratings on the negatively affected Citigroup preferred securities were slashed to levels only slightly above default by all three major rating agencies on Friday.
"We believe there is a risk that Citi's future access to the capital markets could be impaired by this action," Standard & Poor's said in a statement.
"More broadly, we are also concerned that Citi's action could mark a tipping point for the financial institutions sector, and serve as a visible precedent for other companies considering a similar course of action," the rating agency added.
The intervention may also set a precedent for international banks to follow, said BNP's Kleinbaum.
"The Citi action opens the door for governments to look to preferred investors to sacrifice dividends in order to share losses," he said. "Thus, it would seem that institutions with higher government ownership are more vulnerable."
When Fannie Mae FNM.N and Freddie Mac FRE.N were nationalized last year their preferred shares lost almost all of their value.
Moody's Investors Service and Fitch Ratings also both cut American International Group's (AIG.N) trust preferred shares and subordinated debt into junk territory on Monday.
AIG was given access to up to $30 billion of capital in a new government bailout on Monday, at the same time as the insurer posted a record $61.7 billion quarterly loss.
Bank subordinated debt has also come under pressure as investors worry that payments on the bonds, which sit above a company's preferred shares but below its senior debt, may also be halted if bank liquidity woes persist.
The potential for the government to make loans to a company that is more senior to its other existing debt is also weighing on investors minds.
"The concern right now on banks is capital structure related," said John Atkins, credit analyst at IDEAglobal in New York. "I think everybody is worried about getting bumped down the food chain in a recovery event."
As investors take fresh losses to bank securities, financial companies are increasingly at the mercy of government programs for their funding.
Banks are able to sell bonds guaranteed by the Federal Deposit Insurance Corp (FDIC) as part of the Temporary Liquidity Guarantee Program (TLGP).
"The only way banks can continue to roll debt maturities is through the FDIC program," Atkins said.
(Editing by Kenneth Barry)