TARP: Last Bank Out Is a Rotten Egg

By Bradley Keoun and David Mildenberg

When Bank of America (BAC) CEO Kenneth D. Lewis announced plans to pay back the government on Dec. 2, Citigroup (C) CEO Vikram Pandit took the surprising news as a wake-up call. Early the next morning, several Citi executives called officials at the Treasury Dept. to discuss their options, according to a person close to the agency. They wanted to know how BofA negotiated such a quick exit from the Troubled Asset Relief Program and how Citi might follow suit.

Now Pandit is busy pressing regulators for an agreement that would allow the New York-based bank to repay its remaining $20 billion in funds from TARP. (In September the government converted $25 billion of Citi's bailout money into an equity stake in the bank.) Pandit's hoping to hash out a plan in the next week or so, say people familiar with the situation. With BofA wiring the money to Treasury on Dec. 9, Citi is the only big bank with so-called exceptional assistance. The designation, which Citi received after getting a second helping of aid, means the bank must comply with federal limits on compensation. Stuck under the government's watch, Citi risks losing top traders and bankers to rival companies dangling fatter paychecks. Citi spokesman Jon Diat declined to comment for this story.

The talks between Citigroup and its regulators could be more complex than those for Bank of America, whose lending operations are in better shape. The BofA discussions stretched over two months as regulators and executives tried to come to terms. In the case of Citi, Treasury is insisting that any exit strategy also include a formal process for selling the government's 34% equity stake in the lender, currently worth $30 billion. The parties also must address what to do with the government guarantees on $301 billion of Citi's riskiest mortgages, auto loans, commercial real estate, and other assets. Citi and BofA are "very different beasts," says Dennis Santiago, chief executive of research firm Institutional Risk Analytics.

For months, Citi hadn't made much of an effort to return the federal aid. Instead Pandit concentrated on winding down and selling businesses, as well as stockpiling cash, which has doubled over the past year to $244 billion. The bank was also battling with Treasury pay czar Kenneth Feinberg, who told Citi to cut total 2009 compensation for its 25 highest-paid people by about 70% from the previous year. In October, Pandit said he was "focused on repaying TARP as soon as possible." But it wasn't until after the BofA announcement that Citi started to make progress on talks with regulators, people close to the bank say.

Bank of America's Exit If BofA's dealings are any indication, Pandit may not be able to move as fast as he hopes. The 62-year-old Lewis, who first indicated in the summer his desire to pay back the federal funds, ramped up his efforts in September around the same time he said that he would step down from the top spot at the end of the year. It helped his cause that BofA's profits had gotten a boost from the acquisition of brokerage Merrill Lynch, which accounted for a third of earnings in the first three quarters of the year. "Repaying TARP is a way for Lewis to say he did something good before he left," says Jonathan Finger, an activist investor whose family controls 1.1 million BofA shares.

After meeting with Treasury Secretary Timothy Geithner, Lewis tapped Chief Risk Officer Gregory L. Curl to head up the talks with four different government agencies. Curl "just put in a lot of personal face time working with the federal officials," says Bank of America spokesman James E. Mahoney. Regulators "turned over every possible rock to make themselves comfortable with the company." Curl, who's considered a top candidate to replace Lewis, even spent much of the Thanksgiving holiday at his Missouri farm on the phone with regulators and deferred dental surgery to get the deal done.

Similar discussions could prove tricky for Citi. For one, Pandit will have to satisfy Sheila Bair, chairman of the Federal Deposit Insurance Corp., that the bank can stand on its own. The two haven't had a cozy relationship. In April, Bair told associates that she thought Pandit should be replaced, people familiar with the matter said at the time. In July she forced Citi to reassign its chief financial officer, Edward J. Kelly III, now a vice-chairman overseeing strategy.

Bair also proved a sticking point in discussions with BofA. In October the bank proposed raising as little as $10 billion in fresh capital as part of its plan to repay $45 billion in bailout funds. Officials, including Bair, pressed for more from BofA. She pointed out that her agency guaranteed at least $21 billion of the bank's debt and much of its $899.5 billion of U.S. deposits, people familiar with the matter say. BofA eventually agreed to add more than $18.8 billion in capital and ultimately raised $19.3 billion in December.

Those terms may serve as a starting point for an eventual agreement with Citigroup, a person close to the Treasury says. Consider BofA's capital levels. In a press release on Dec. 9, BofA said that its capital by one measure stood at 11% of assets after raising new money and repaying TARP. That's down from 12.5% on Sept. 30. As of the most recent data, Citi's capital amounted to 12.8%. Says Chris Kotowski, an analyst at Oppenheimer & Co. (OPY) in New York: "It's a question of how much the regulators will force banks to raise to clear themselves of the stigma of being a TARP bank."

Stigmatized To plump up its cushion, Citi would have to rally investors. CreditSights analyst David Hendler estimates that the bank would need to sell about $10 billion in equity and $10 billion of other securities. The offering could be popular. At roughly $4 a share, Citi is trading at a significant discount to the assets on its books. "People will think it's a great deal," says Ralph W. Cole IV, senior vice-president at Ferguson Wellman, a Portland (Ore.) firm that manages more than $2 billion.

Unless Citi can strike a deal with regulators, the bank may struggle to compete. In investment banking, compensation is the biggest expense, and Pandit is concerned the pay caps might drive away some of his biggest producers. That's why Citi agreed to sell its Phibro oil trading subsidiary in October for $250 million, less than the unit's average annual earnings; the bank had been warned that Treasury would balk at the $100 million pay package to head trader Andrew Hall.

There's also the stigma. While investors and customers initially viewed the TARP money as a regulatory seal of approval, they now see it as a sign of weakness. With BofA exiting the bailout program, corporate clients have yet another option if they don't want to bank with a government-affiliated institution. Depositors may also factor in the distinction. "The costs of getting out of TARP are worth it," says Matt McCormick, a banking industry analyst at Bahl & Gaynor in Cincinnati. "Right now Pandit has a hand tied behind his back, and his competitors do not."

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