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U.S. regulators eye more bank capital, common equity

WASHINGTON (Reuters) - Large U.S. banks can seek to convert government preferred shares to common equity to shore up their capital, federal regulators said on Monday, adding that Washington stands ready to provide extra funds to institutions that need it.

The regulators said they will begin assessing major institutions’ capital needs on Wednesday under a new “stress test” program that will gauge their ability to weather a deeper recession.

“The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses,” the regulators said in a statement issued by the U.S. Treasury.

In addition to the Treasury, the federal regulators making the announcement included the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

“The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth,” they said. “Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.”

The announcement follows reports that Citigroup C.N is in talks with the U.S. government on converting its existing stake in the bank into a larger common stock holding, a move that would give Washington a far greater say in the bank's operations.

A report in The Wall Street Journal said taxpayers could end up owning as much as 40 percent of the ailing lender’s common stock, but the Treasury-issued announcement did not specifically name Citigroup or any other financial institution.

TANGIBLE CUSHION

Late on Sunday, the Treasury said it was open to an institution converting preferred stock into convertible preferred shares and later into common equity as needed to boost a bank’s capital structure.

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Under the program to be launched on Wednesday, known as the Capital Assistance Program, regulators said banks will be able access government capital in the form of mandatory convertible preferred shares if they are found to need an extra, temporary capital buffer.

Banks that previously received capital injections under the Troubled Asset Relief Program -- the Bush administration’s name for the $700 billion financial rescue fund -- will have the ability to convert those preferred stock investments to convertible preferred shares and later to common equity.

While some of these conversions may not involve new funds, they could help the banks by increasing the amount of tangible common equity they hold, providing a more effective cushion against write-downs.

If the government converted $45 billion of Citigroup preferred shares into common stock, analysts say the bank’s tangible common equity ratio would more than double to 3.9 percent of tangible assets from its current 1.5 percent.

Although the government may end up in control, having the Treasury as a common stockholder may provide some comfort to equity investors that they will not be wiped out completely.

Announced by U.S. Treasury Secretary Timothy Geithner on February 10, the program calls for regulators to conduct “stress tests” on major banks to evaluate their capital needs should the economy perform more poorly than expected.

“Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital,” the regulators said. “Otherwise, the temporary capital buffer will be made available from the government.”

The regulators stressed, however, that major institutions currently have more than enough capital to be considered well-capitalized.

The Capital Assistance Program will aim to ensure that the banks have sufficient capital to support economic recovery, even if conditions worsen.

“Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands,” the regulators said.

Reporting by David Lawder; editing by Gary Crosse

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