The U.S. Treasury, which gave Central Pacific Bank $135 million in exchange for preferred shares in January 2009, has agreed to convert those shares into common stock.

The exchange meets a condition set by parent company Central Pacific’s two lead investors in the bank’s $325 million capital-raising plan.

"We are pleased to have accomplished a key component of our company’s capital-raising initiative," said John Dean, executive chairman of Central Pacific. "We believe that moving forward with new capital is in the best interest of all of our shareholders, employees and customers."

Central Pacific is the state’s fourth-largest bank with $4.2 billion in assets and 35 branches statewide.

The lead investors—the Carlyle Group and Anchorage Capital Group—have agreed to invest $98.6 million each, for a total of $197.2 million, in parent company Central Pacific Financial Corp. in exchange for common stock.

The deal with the two investors is dependent on the bank raising the remaining $127.8 million of its $325 million target as well as regulatory approvals.

Central Pacific, which lost nearly $250 million in the first nine months of this year, has been struggling for years due to troubled loans it made to California homebuilders in the mid-2000s.

Carlyle and Anchorage said their investment was contingent on Central Pacific converting the U.S. Treasury’s preferred shares to common shares. The preferred shares were sold to the Treasury as part of the federal government’s Troubled Assets Relief Program, or TARP.

The change from preferred shares to common shares means Central Pacific will no longer guarantee the Treasury a payout of $135 million plus dividends for its cash infusion in 2009. Instead, the Treasury will own more than 100 million shares of common stock. At yesterday’s closing price of $1.40 per share, the Treasury holdings would be worth more than $140 million.

The deal allows the Treasury, Carlyle and Anchorage to buy Central Pacific common shares at 50 cents per share.

Central Pacific said in November that it plans to conduct a 1-for-20 reverse stock split at the time the capital raising plan closes. All shareholders will be offered a rights plan to allow them to purchase a pro-rata number of common shares at 50 cents a share.

"While current shareholders’ percentage ownership of Central Pacific gets diluted, these agreements allow CPF to complete its recapitalization plan and return to solid financial footing," Central Pacific spokesman Wayne Kirihara said.