Tag: banks

  • Preferred Stock=Subordinated Debt

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    Adam Levitin

    The important thing to notice about the Treasury’s “equity” injection into major financial institutions is that it is equity in name only. The preferred stock the Treasury is taking is at a prescribed dividend (5% for 5 years, 9% thereafter) and has no voting rights. Economically, it is a subordinated loan without a term.

    A few observations come out of this. First, is that it means that Treasury has very little economic upside. No matter how well the banks perform, the best that Treasury can do is get a 5% return. True, the Treasury will get warrants for common stock, which gives it some upside, but that is only for around 13% of the deal; the other 87% of the deal has no upside. Also, Warren Buffet was able to get 10% from Goldman Sachs. Why isn’t Treasury getting the same deal? (And how fast do you think Goldman will use 5% Treasury dollars to buy back Buffett’s 10% stock, if he doesn’t have redemption restrictions in the deal?)

    Second, by making an economic loan, but doing it in the form of preferred stock, Treasury has functionally subordinated itself to the bondholders and other debt obligations of the banks. That is a HUGE boon for the bondholders, because it functions a lot like a government guarantee of their positions. It also benefits the common shareholders by making sure that they won’t be taken to the cleaners like WaMu and Lehman shareholders.

    Third, as has been noted elsewhere, Treasury didn’t forbid the financial institutions from paying dividends on the common stock, only from raising the dividends. So formerly cash strapped institutions are going to be able to keep paying out dividends…from taxpayer funds.

    So why did Treasury do the deal as preferred stock?

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  • The Banks, Private Equity, and the Fate of Consumers

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    Adam Levitin

    The New York Times has an interesting op-ed about private equity investment in banks. Long story short: banks need money now, and private equity is one of the last remaining sources of capital available. PE investment strategy is to buy a control stake, maximize efficiencies, and resell the company in 5-7 years. Because current bank regulations require that an entity holding beyond a certain threshold of a bank’s stock either register as a bank holding company (which subjects it to various regulation, including disclosure requirements) or forgo involvement in the bank’s management, PE firms are reluctant to invest in banks. Private equity is about control and lack of transparency. PE smells a great buy in banks, however, so PE shops are pushing federal banking regulators to relax the regulations. Their argument: without us, the banks will fail and/or credit will contract, and this will be on your heads, banking regulators, so beggars can’t be choosers.

    The Times rightly notes that PE shops shouldn’t get special treatment and if banks fail, well let that be a lesson to their investors and creditors to monitor lending practices better in the future. Depositors are largely protected by FDIC insurance.

    But there’s another worrisome angle left unmentioned in the Times editorial. Because PE shops are simply trying to maximize efficiencies in the short-term in order maximize their return on exit, they aren’t concerned about the long-term safety-and-soundness of banks. If the company blows up after the sale, the PE shop doesn’t really care. This could spell bad news for consumers. If a PE shop buys a bank and sets out to maximize revenue/cut costs, it will likely start milking the consumer cow much more vigorously. And this means PE shops might be tempted to push all sorts of abusive, but very profitable lending practices. This is quite concerning, and if federal bank regulators do loosen the investment requirements for PE, it should be with very explicit commitments to maintaining best practices vis-a-vis consumers. Of course, once the camel’s nose is under the tent, these commitments could start to look a lot like the ones on human rights that China made the International Olympic Committee.

  • ATM Surcharges and Bank Consolidation

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    Adam Levitin

    Last month Bank of America raised its ATM surcharge from $2 to $3. The surcharge is the fee charged to customers of other banks for using Bank of America’s automated teller machines (ATMs). Bank of America is the first bank in the United States to raise its ATM surcharge to the $3 level.

    Why did Bank of America suddenly raise its ATM surcharge 50%? My theory is below the break.

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