April 17 (Bloomberg) -- Citigroup Inc. delayed the conversion of as much as $52.5 billion in preferred stock until after a government evaluation of the bank’s financial health and said it doesn’t plan to change the number of shares it issues.

The New York-based bank said in a statement today that it was making progress on meeting regulatory requirements to proceed with the conversion. Chief Financial Officer Edward Kelly told investors on a conference call that he “cannot currently envision” altering how much common stock is issued to owners of preferred shares.

Citigroup stock has almost tripled since Feb. 27, when the exchange offer was announced, causing losses for investors who sold short the common shares and bought the preferred. Leaving the terms unchanged alleviated pressure on hedge funds and speculators who initiated the arbitrage trade to exploit the difference in prices between the two securities.

“The risk arbitrage community is probably a little disappointed that they are pushing it back,” said George Douglas, who oversees $1.2 billion in convertible bonds as chief investment officer at SSI Investment Management in Los Angeles. “At the same time, Citigroup reaffirmed that they are doing it on the terms originally specified, so that’s a positive.”

May 4 Completion

The Federal Reserve and other regulators are aiming to release the results of stress tests on the 19 biggest U.S. banks on May 4, a central bank official who declined to be identified said yesterday. Citigroup had previously expected regulatory approval for the deal by early April.

Citigroup fell 9 percent to $3.65 in New York Stock Exchange composite trading, while a gauge of banks in the Standard & Poor’s 500 Index added 1.3 percent. The stock had surged 167 percent since Feb. 27 as investors who sold shares short to finance their purchase of the preferred securities unwound the trade.

Under terms of the exchange, the company will swap as much as $27.5 billion of its preferred securities at a conversion price of $3.25 a share. The U.S. Treasury will convert as much as $25 billion of preferred shares, gaining a 36 percent stake in Citigroup.

“We cannot currently envision circumstances under which we would change either the implied $3.25 conversion price or the announced tender prices for the preferred stock being sought,” Kelly said during today’s conference call.

When asked whether there was a chance the exchange would be canceled, Kelly said, “The short answer is no.”

Government Aid

The swap is part of the U.S. government’s third attempt to shore up Citigroup, which has been battered by $88.3 billion in credit losses and provisions for bad loans since the start of 2007. The conversion would help Citigroup save money on dividends and increase its tangible common equity, a measure of the bank’s ability to absorb losses.

For investors holding the preferreds, the swap offered sizable profits. The 8.125 percent Series AA securities, among the more actively traded preferred shares, closed at $5.48 the day before the announcement. The 8.5 percent Series F fetched $6.09. Under terms of the deal, Citigroup would convert the shares into about 7.31 common shares, which on Feb. 26 was worth a total of $17.98. Both classes of preferred shares have more than tripled in price since then.

The preferreds may still offer investors gains of more than 40 percent as Citigroup begins the exchange offer, perhaps as soon as May or early June, said Barclays Plc analyst Venu Krishna. The shares had lagged behind Citigroup common stock over the past three weeks amid concern that terms of the deal could be changed.

More Comfortable

“We are meaningfully more comfortable that this transaction’s risk is lower than what it was yesterday, but what’s interesting is that the market is not pricing that,” Krishna said in an interview. “That could be because the timing is still uncertain. But that creates an interesting opportunity.”

The number of Citigroup shares sold short surged fivefold to 1.21 billion as of March 31 as arbitrage traders bet on the preferred stock conversion. Traders would have had to buy more Citigroup shares in order to cover short positions, if the company decided to amend the deal and give preferred holders fewer shares.

Short selling is the sale of borrowed stock in the hope of profiting by buying the securities later at a lower price and returning them to the lender.

“There has been somewhat of a relief,” said Sveinn Palsoon, a derivatives strategist at Credit Suisse Group AG in New York. Because of the delay in the exchange, investors are now extending their hedge through options to contracts that expire in September instead of June, he said. “The further out you go, it becomes a little bit more expensive.”

To contact the reporter on this story: Edgar Ortega in New York at ebarrales@bloomberg.net.

Last Updated: April 17, 2009 16:24 EDT