Bits and Pieces

Today, the details regarding the conversion of publicly-owned preferreds CprP, CprM, CprI (convertible, $50 par) and the $1,000 par C 8.40% perpetual preferred. According to the official terms CprP and CprM shareholders would receive 7.30769 shares of C common in exchange for each preferred share. CprI shareholders would receive 13.0769 shares of C common. Owners of the $1,000 C 8.40% will receive 292.30769 shares of C common. TRUPs and E-TRUPs owners would also receive the same 7.3069 shares of common should they decide to convert.

This begs the question: Should preferred owners convert? If one wants to be on the lowest possible place on the capital structure. If one wants the lowest possibility of receiving a dividend. If someone wants to risk further dilution should C need even more assistance then yes, convert to common equity. All other investors should move up the capital structure or move on to another name altogether.

The popular question has been: Why have prices of the preferred shares rallied into the $8.00 area. It is really quite simple. There is an arbitrage to be had should one want to speculate. We know that CprM and CprP holders will receive 7.30769 shares of common for each preferred share. C common closed at $1.20 per share. A simple calculation tells us that 7.30769 shares at $1.20 per share equals a preferred share value of $8.77. So, if one purchase CprP or CprM at a price which is advantageous versus the exchange (we don't know what C common will be worth at the time of the exchange - hence the speculation) there may be profit to be had. Of course, guess wrong and you just overpaid to own a pile of manure. Of course their are ways to hedge oneself by shorting the common or buying puts or selling calls, but this is not what most traditional preferred holders want. They want dividends. Unfortunately, they have come to the wrong place.

You see the ratings agencies have performed a dirty deed on good ol' C. The downgraded C preferreds to the bottom of the junk world. Your eyes do not deceive you, C preferreds are rated Ca by Moody's and C by S&P. TRUPs and E-TRUPs are now rated Baa3 / CC. The ratings agencies are telling us that they are concerned that cumulative Trust Preferred dividends may not be secure,

So now we know what the preferred shares are worth to speculators, what will the be worth after the exchange period is over. Without a dividend or any immediate prospects of paying one CprP and CprM are probably not worth the time it takes to punch in a quote. More disconcerting is that BAC and WFC could be right behind C.

The street consensus is that the government will want banks to have tangible common equity of 4.00% of total assets. C was 1.5%. BAC and WFC are between 2.6% and 2.8%. It is unlikely that either bank will be able to initiate equity IPOs any time soon. An exchange of preferred for common could be in the cards. Suspending of preferred dividends could once again be used to coerce sovereign wealth funds and other institutional investors to convert their holdings to common shares.


My former Schroder colleague, Larry Kudlow had as a guest this evening strategist Dick Bove'. Mr. Bove' once again downplayed the troubles at the banks. He did so last March, right before Bear Stearns imploded (causing me to call him out on the topic). Once again, he made comparisons between today's crisis and the early 1990s (as he did last year) ignoring the vast differences between the two events. His strategy is to buy equities, especially banks, because it is only a matter of time until the "93% of Americans who have jobs begin to spend." Is Mr. Bove' blind, deaf or clueless?

The 93% of Americans who are employed are busy paying their own debts and are getting ready to pay the debts of those who cannot by way of higher taxes and tighter lending standards instituted by banks to protect themselves from onerous government-instituted lending laws. Does he not understand that the economy of the past 20 years was fueled by cheap credit and a lack of inflation due to productivity gains and outsourcing? These employed Americans will not spend has they had in the recent past. Sure, there will be replacement spending and while that will help slow the slide, it will not turn around the economy. In fact, an economy based on income, rather than borrowing, will probably be the norm for a number of years, if not longer.