- The Washington Times - Tuesday, February 24, 2009

A technical change announced by financial regulators Monday could mean the government will end up owning a much bigger chunk of the nation’s largest banks - without necessarily using more taxpayer money.

The Treasury Department, Federal Reserve and other financial regulators, in an unusual joint statement, said they will now consider converting previous government investments in the banks from preferred shares to common shares.

What’s the difference? For one thing, such a move would give the government potentially larger ownership stakes, depending on how the conversions are calculated. In the case of Citigroup Inc. and Bank of America Corp., the government has already invested $45 billion in each, far above the current market value of each company - so the government could end up owning a substantial share of those banks.

At the same time, the regulatory agencies made clear they want to keep the banks in private hands and avoid government control, or “nationalization.”

Here are some questions and answers about the potential ramifications of the change for banks, their shareholders and taxpayers.

One difference is that owners of preferred shares are one step ahead of common shareholders in their claims on a company’s assets. That means they get paid first if a company goes belly up. On the other hand, holding common stock gives an investor more of an actual ownership stake in a company, and more influence over how the company operates.

Yes. Banks currently pay a dividend of 5 percent on the preferred shares they issued to the government in return for the bailout funds they began receiving last October. The common shares wouldn’t include a dividend, allowing the banks to hold on to that capital.

More important, analysts said, boosting a bank’s common stock increases its “tangible common equity,” a measure of its capital that is considered the most conservative estimate of a bank’s financial health. Tangible common equity is what a bank would have left after paying off all its creditors and depositors.

Preferred shares have some characteristics of debt, so their holders need to be paid off if a company fails. Common stock does not need to be paid off in this scenario. So having more common stock rather than preferred stock results in a higher tangible common equity.

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