New Business December 9, 2009, 10:04PM EST

TARP: Last Bank Out Is a Rotten Egg

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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."

With Ian Katz in Washington, D.C., and Michael Moore in New York.