The Amazing, Shape-Shifting Convertible Preferred

Minyan Peter
  FEB 25, 2009 11:45 AM

If implemented, downside risk will increase exponentially.


I have been asked whether there was anything in Chairman Bernanke’s speech yesterday that changed my outlook on the prospects of nationalization for some of our largest financial institutions. In a word: “No.”

From my perspective, all Chairman Bernanke did was to confirm Monday’s Joint Statement from the bank regulators, which said the government was hoping to implement “temporary capital buffers” “to provide a cushion against larger-than-expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers.”

And that the government’s security of choice would be “mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory” (my emphasis). 

Knowing that there are teams of professionals on Wall Street dedicated to giving new hybrid securities cute names, let me suggest that the government henceforth refer to these incremental investments as “Maybetorily” Convertible Preferreds - as in, maybe they're straight preferred stock, maybe they're common stock, maybe they're gone altogether - it all depends on how bad the economy gets from here.

How these Maybetorily Convertible securities can in any way provide the impetus for further private-sector investment into the common stock of our banking system confounds me. As I see it, if implemented, existing common shareholders have at best the same upside they previously had, with exponentially larger downside.

At the same time, though, I do appreciate that these incremental investments provide some greater systemic stability - although with everything the Federal Reserve has done to date, it's hard to see that was ever in doubt.

So yet again, rather than throwing the frogs (banks) into nationalizing boiling water immediately, the government is going to place them in a tepid bath and watch, suggesting, at least this week, that while they may have to turn up the temperature a little bit (“temporarily”), no one will ultimately get burned.

Maybe, maybe not.
Position in SPY