Wouldn't you like to be a bank too?

GMAC and its bondholders received a gift from the Fed on Christmas Eve. In spite of being undercapitalized and being jointly owned between a private equity firm (Cerberus) and a failing automaker (GM), GMAC was granted bank holding company status with the Fed invoking emergency powers to complete the deal. GMAC will now have access to the full range of Fed liquidity programs and, in theory, the ability to issue FDIC-guaranteed TLGP corporate bonds. This takes GMAC creditors out of the fire, past the frying pan and back onto the cool kitchen counter of the fixed income world.

For GMAC to become a bank holding company, GM will transfer its ownership in GMAC to a trust which will sell its stake in GMAC over the next three years. Cerberus must reduce its stake in GMAC from 51% to no more than 14.9% in voting shares and 33% overall. According to the Wall Street Journal, although GMAC and Cerberus are divesting their investments in GMAC, they are required to add a combined $750 million to GMAC's balance sheet and that number could grow to $2 billion.

What does this mean for GM bondholders? It means that GM has a chance at survival as it will have a finance company to fund purchases of GM vehicles. However, I am still of the opinion that GM creditors will receive less than par for their bonds.

CIT was also granted bank holding company status. This means that it could issue FDIC-guaranteed bonds. Uninsured CIT bonds maturing within the TLGP period (out to 6/30/12) are probably worth holding and could represent buying opportunities for more sophisticated investors. Conservative and moderate risk investors holding longer-term CIT bonds may want to sell into any strength.


I have been of the opinion that non-cumulative preferred stock present significant dividend suspension risk due to their being on par with the government's level of preferred investment and the possibility that the government could order those dividends suspended if it deems it necessary. According to an article on CFO.com, the Fed has ordered three small banks Michigan Heritage Bank, Birthright Inc. and Cherokee Bancshares to suspend dividends so that the banks can maintain their "financial soundness".

This is something I and my more experienced colleagues have feared since the government's increased involvement with the running of U.S. banks. The article states that the banks in question cannot declare or pay any dividends with out first obtaining written permission from the Fed, the director of the Division of Banking Supervision and Regulation of the board of governors, and Office of Financial and Insurance Regulation. All requests for prior approval must be received by the Reserve Bank and OFIR at least 30 days prior to the proposed dividend declaration date and must contain, at a minimum, current and projected information on earnings, capital, asset quality, and loan loss reserve needs of the Bank.

If the Fed can do this to small banks it can to it to any bank. No mention was made of interest payments. This is because, short of seizure, the government cannot restrict banks from paying their debts. In fact, the suspending of dividends is ensure that banks can meet their financial obligations. I will say it again, investors considering investing in preferreds should consider trust preferreds as they actually pay interest and, if the dividend is voluntarily suspended, it is cumulative and must be paid to investors unless the bank fails or falls into some kind of receivership.

Here's to a better year in 2009