Citigroup

When financial stocks slumped in February to the lowest level in at least 17 years, U.S. Federal Reserve Chairman Ben S. Bernanke told Congress the government might end up owning “substantial” stakes in the country’s biggest banks.

Three months later, New York-based Citigroup Inc. may be the only large bank that has to accept his offer.

Bank of America Corp., Wells Fargo & Co. and seven other firms judged to need extra capital by the Fed’s “stress tests” plan to raise the required $69.1 billion through a combination of share offerings, asset sales, private securities exchanges and earnings. They will do anything to escape the government meddling that probably awaits Citigroup, said Philip Orlando, who helps manage $410 billion as the New York-based chief equity strategist of Federated Investors Inc.

“You never want to have the government involved in your business,” said Orlando, whose firm owns 7.3 million JPMorgan Chase & Co. shares and 1,483 shares of Citigroup. “They’re not businessmen; they’re bureaucrats. They don’t understand capitalism, they don’t understand the profit motive and they don’t understand the financial industry.”

Citigroup Chief Executive Officer Vikram Pandit’s plan to convert $25 billion of government-held preferred shares into a 34 percent voting stake contrasts with the negotiations that New York-based JPMorgan and Goldman Sachs Group Inc. are conducting to redeem preferred shares they sold in October to the U.S. through the Troubled Asset Relief Program.

Government Influence

“Companies that repay TARP will get out of the hottest part of the government’s heat lamp,” said Kevin Fitzsimmons, an analyst at Sandler O’Neill & Partners LP in New York. “But if you go to that next level of having to convert TARP to common, that could be a whole other level of government influence.”

Citigroup Shortfall

“The investing community doesn’t welcome long-term involvement by the U.S. government in the private economy,” said Kevin Starke, an analyst at CRT Capital Group LLC in Stamford, Connecticut. “Every time I try to pitch an idea to investors that has some government involvement, the automatic reaction is, ‘I don’t want to get involved.’”

Citigroup was found by the Fed to need $93 billion more in common equity as of the end of 2008, the biggest gap among the 19 U.S. banks that underwent the stress tests.

The bank already had a plan in place to convert $52 billion of preferred shares, including the government’s, into common. It also got $29 billion of credit for first-quarter earnings and gains on asset sales, so it only needed $5.5 billion more by the time the stress-test results were announced in May. Citigroup says it will close the gap by expanding the exchange offer to $58 billion.

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CitiGroup

Citigroup, the third-biggest U.S. bank by assets, could face stricter pay rules, limiting its ability to keep talented executives, said Jason Goldberg, a New York-based analyst at Barclays Capital, who has an, overweight, investment rating on Citigroups stock. The bank may have to exit risk-taking businesses that are profitable for competitors, he said. Politics also may color the Treasury Departments votes on board members or shareholder proposals at annual meetings, said Thomas Brown, CEO of New York-based hedge fund Second Curve Capital.

Any government investment in financial institutions raises the prospect of banks being ordered to focus on, state-approved social objectives, instead of increasing earnings, according to a report last week from the Committee on Capital Markets Regulation, a 25-member group of financial-industry executives, lawyers, consultants and academics.