Are the Lights Going Out at Citi?

February 23, 2009 - 10:00AM

Over the weekend, Citigroup (C) approached the U.S. Government to up its equity stake in the bank following Friday’s session that saw its shares fall to an 18-year low. The increased equity stake would take place as a conversion of preferred shares into common shares, effectively diluting current shareholders.

The plan could see regulators take a 40% stake while Citi executives are hoping the position will be closer to 25%, according to a Wall Street Journal report. Currently, the U.S. government owns 8% of Citigroup obtained in the December 2008 capital infusion.

Nationalization fears continue to plague banks with shares of Citigroup, Bank of America (BAC), JPMorgan Chase (JPM), and U.S. Bancorp (USB) taking huge hits last week.

The Treasury issued a statement ensuring its commitment to the nation’s largest banks saying, “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 government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.”

Stress testing begins this week for the country’s largest banks to determine solvency going forward. Wall Street has been speculating that Citigroup’s assets, along with the largest U.S. banks, are underwater due to MBS and CDO exposure.

The Treasury added, “Currently, major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized… 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.”

Yet further Federal involvement at Citigroup hints at another step taken to effectively nationalize the bank. The U.S. will soon become the largest equity holder in Citigroup, and the arms-length nature of the transaction suggests Feds are keeping open the possibility of folding the once-largest worldwide bank into a healthier institution.

Wall Street did react favorably to the news, propping up stocks at the opening bell on Monday. Citi shares were up about 8% midday, leading the distressed financial sector higher.

But we’ve seen this act before. Late last year, when Citi fell below $4/share, regulators stepped in to backstop assets along with what would end up being a $45 billion cash infusion. Citi stock rallied above $8/share within weeks, but perpetual concerns over bank balance sheets have sunk financial stocks back into the danger zone. What’s different this time around?