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Common Stock Merely a Paper Deal


They add no capital -- just capital reconciliation.

Minyan Peter,

How exactly does converting preferred stock to common increase capital? (If, for example, you're Bank of America (BAC), or Citigroup (C).)

Seems to me its strictly a paper deal, although it does reduce the higher dividend requirement.

Minyan Bill H.

Minyan Bill,

"Just a paper deal" is a great way to describe it. Converting the preferred to common doesn't add capital. What it does do, however, is to better reconcile regulatory capital with accounting capital.

Last year, when the government created the TARP, they passed a little-noticed provision which stated that all government-provided preferred stock would count as Tier 1 Capital for regulatory purposes. Not to bore you, but, up until that point, the kind of preferred stock which the government bought -- cumulative preferred -- wouldn't have been considered Tier 1.

So folks like myself thought: "You can call TARP preferred stock Tier 1 Capital all you want, and you can change the definition of Tier 1 capital all you want - but we'll look at Tangible Common Equity instead." This is because -- at least until the changes in mark-to-market accounting -- this couldn't be manipulated.

(And I would highlight here, that if you look at the relationship between Tier 1 capital and Tangible Capital Common over the past year, Tier 1 capital boomed (thanks the TARP preferreds), while Tangible Common shrank considerably.)

Admittedly, the conversion of preferred to common reduces the dividend cash flow drag which many banks have lamented under the TARP program, but I would offer that this is hardly a costless exchange for common shareholders. Further, I doubt we'll see any ratings upgrades coming from S&P or Moody's (MCO) on the conversion.

Be that as it may, the government believes/hopes that once "select" banks convert their TARP preferred to common, these banks will have a more stable base on which to go out and issue new preferred stock, subordinated debt, even non-FDIC insured senior debt.

Candidly, I don't buy this, particularly when you read comments from folks like Barney Frank (in last Friday's Financial Times) suggesting that subordinated debt holders either be converted to common as well, or take a haircut like the creditors at General Motors (GM).

-Minyan Peter
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