Wednesday, January 21, 2009

Interesting Question: Priority of Government Bank Preferred Stock or Equal Ranking with Existing Preferred Previously Sold to Investors?

An interesting question was just raised and I do not have an answer.  The query was whether Citigroup  could eliminate the preferred dividend on stock sold to investors and continue to pay the government its preferred dividends?  Or would Citigroup have to eliminate both at the same time or proportionally reduce both?  I would have to see the supporting documents underlying the agreement with the government to venture an opinion.  According to the prospectuses for Citigroup's preferred stock sold to investors,  all preferred stocks of equal rank have to be paid if any in the same rank are paid.  It is possible that you could eliminate all regular preferred dividends (the ones classified as equity) and pay the dividends on the trust preferred stocks (classified at a higher priority, as junior debt).  This is a sample passage from a regular preferred stock prospectus:  "Except as provided below, for so long as any share of Preferred Stock remains outstanding, if dividends are not declared and paid in full upon the shares of Preferred Stock and any parity stock, all dividends declared upon shares of Preferred Stock and any parity stock will be declared on a proportional basis so that the amount of dividends declared per share will bear to each other the same ratio that accrued dividends for the then-current dividend period per share of Preferred Stock, and accrued dividends for the then-current dividend period per share of any parity stock (including, in the case of any such parity securities that bear cumulative dividends, all accrued and unpaid dividends) bear to each other."

(p. s-8 of 424B2) And, this is a quote from page 3 of the same prospectus: 
"Generally, each series of preferred stock will rank on an equal basis with each other series of preferred stock and will rank prior to Citigroup’s common stock. The prospectus supplement will also describe how and when dividends will be paid on the series of preferred stock."

So, this is an interesting question. Is the government's preferred "parity" preferred.  Does the involvement of the government actually provide some protection to a regular preferred shareholder, assuming the government's preferred stock is also classified as equity rather than debt because the bank will be reluctant to stiff the Feds unless it is absolutely necessary while the willingness to stiff private investors would barely cause a moment's hesitation? 


  1. My understanding is the govt. preferred shares are pari passu with existing preferreds, but rank junior to trust preferreds. This would suggest some protection for both trust preferred and regular preferred shareholders.

  2. I suspect that you are right but I want more certainty. So far, I have just read the term sheets summarizing the deal points between the banks and the governments. Those summaries suggest that the government preferred stock is equity preferred and would be in parity with all other equity preferred issues from the same issuer. The trust preferred, being debt, would have a higher priority than the government's preferred in that case. If the government is paid in full, then the trust preferred and the equity preferred shareholders would have to be paid. I want to confirm the precise status of the government's preferred stock by actually reading an SEC filing of the entire agreement between a bank and the government. If you are correct, the bank could still refuse to pay all preferred shareholders including the government, just stiff everybody. I would be interested in knowing whether there are more conservative deferral provisions regarding payment of the government's preferred dividend. Some of the Citigroup Trust Preferred issues allow for a 10 year deferral of the preferred dividends, five is common in many trust preferred prospectuses, before a default is triggered. If I can confirm some of these details, I will be more likely to speculate in some of them. Bill Gross seems to have a favorable opinion of the bank preferred issues based on his recent interviews.

    If the government's preferred is pari passu with equity preferred, the additional protection is not a legal protection, but the bank's fear of the big government stick.

    I did look around for a few minutes today to see if I could find a filing of an executed agreement with the government at the SEC but I have come up empty so far. If anybody finds one, please let me know by leaving a comment on my most recent post even if it is on another subject.