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The No Longer Preferred Preferred Stock

Lately, there's been whining and sniveling from some corners of the commercial banking sector about the write down of Freddie Mac and Fannie Mae preferred stock as a result of the federal takeover of those political contribution ATMs stalwarts of home mortgage finance. Many of the holders of those shares are banks, and the conservatorship not only has hurt the value of those preferred shares (and, consequently, the earnings and, possibly, capital of the banks that own), but at the same time has provided some support for subordinated debt. As investment banker Jim Gardner notes:

Banks have long been big buyers of preferred securities issued by the troubled sibling mortgage lenders. That?s because the shares paid strong dividends, could be treated as assets on a bank?s books and produced income taxed at a less-than-corporate rate...For years, those shares performed well for bank owners, providing income and asset growth. But following the federal bailout of those institutions, the preferred shares have dwindled in value, while the government?s conservatorship plan actually provides backing for subordinated debt holders and other investors.

[...]

Following the Sept. 7 bailout, large public banks immediately began announcing million-dollar write-offs for the third quarter. The nation?s largest banks have the greatest exposure to the preferred shares of Fannie and Freddie, but as a percentage of capital, regional banks stand to be impacted more greatly.

Three regional bank holding companies in Virginia, Illinois and Washington state are facing write-downs so large that they could fall below bank regulators? top-graded well-capitalized standard, according to Keefe Bruyette.

Publicly traded institutions have been the first to report their exposure, because of stock disclosure rules, but it?s likely that larger private regional banks also will have to report losses on the values of those shares.

[...]

Private institutions likely will reveal their charges, if they have to take any, this fall when they file their third-quarter data with regulators.

Thus far, it doesn't appear that many Texas institutions will be adversely affected to any serious degree. That may explain why Texas banker Andy Beal, a man who owns a Texas-based bank that doesn't own any Freddie or Fannie preferred stock, is not exactly overflowing with tears over the plight of those banks that are being stiffed by Uncle Freddie and Aunt Fannie.

Financial institutions are encouraged to do many things, said Andy Beal, president of Plano-based Beal Bank.

?They?re also encouraged to go out and make a bunch of low-interest loans to low-income homeowners,? Beal said. ?While you?re encouraged to do things that are poor investments, you do some of it, but not a lot of it.?

Investments require risk, so institutions should be held responsible for bad investment decisions. In this instance, that should have extended beyond holders of Fannie Mae and Freddie Mac stock further into the entities? capital structures.

?The government has to provide that support to the housing market, but they don?t have to provide it to such great expense to the taxpayers,? Beal said. ?The fact is, there?s going to be a bunch of pain here, and it should be felt by the people who made the investments, not by the taxpayers.?

A banker who scorns being bailed out by the government? Maybe he ought to team up with that Texas bazillionaire with the East Texas twang that could strip paint from the side of a house, Ross Perot, and take a crack at straightening out this mess. I mean, when people think of safety and soundness, they think "Texas," right? Right?

OK, maybe not.

Full post as published by Bank Lawyers Blog on September 24, 2008 (boomark / email).