Fifth Third’s Premature Call Of FTB-C: Are Others Next?

Two days ago Fifth Third (FITB) announced that it is prematurely calling one of its trust preferred stocks (TRUPS) FTB-C. The announcement is going to create winners and losers come June 15, 2011 when the call is executed.

On that day shareholders of FTB-C will receive $25 per share in cash (plus any accrued dividends) and FTB-C will be retired.

What made the redemption of FTB-C unusual is that this security, introduced on April 30, 2008 and paying a generous 8.875% annual dividend, has a call date of May 15, 2013 (two years from now).

How Can They Do That?

So how is it that FITB was able to call FTB-C this week when the prospectus says that it may not do so for another two years? Who wins, who loses and what does this mean for other Big Bank TRUPS?

Banks commonly issue traditional preferreds and trust preferreds in order to boost their “Tier 1 Capital” reserve metric (a measure closely watched by regulators). Under the current Tier 1 Capital formula (set by the US government), trust preferred stocks count toward this metric.

However, the Wall Street Reform Act enacted last July changed the formula for Tier 1 Capital, excluding TRUPS beginning January 1, 2013. Such a change in the treatment of a bank’s capital reserve formula is referred to as a “capital treatment event” in prospectus language.

Under conditions that I will explain in a moment, banks are allowed to prematurely call their TRUPS if the government changes the formula after the bank has issued the security.

Prospectus Language: Why Just FTB-C?

FITB has several TRUPS trading right now, so why was FTB-C the only one called? The answer is that the language in FTB-C’s prospectus regarding a premature call is a bit non-standard and varies from the standard language in an important way.

The standard language that allows banks to execute a premature call has been included in the prospectus of almost every bank-issued traditional preferred stock and TRUPS for many, many years (no one should be thinking that the risk of investing in Big Bank TRUPS has changed because of FTB-C’s premature call this week).

The standard language allows the bank to prematurely call the security if there is a capital treatment event as long as the bank does so within 90 days of that event.

Now take a look at the applicable language from FTB-C’s prospectus (page S-40, shorted for presentation here, bold emphasis is mine):

"A ‘capital treatment event’ means Fifth Third’s reasonable determination that, as a result of the occurrence of any amendment to, or change (including any announced prospective change) in the laws… of the United States,… any official… pronouncement… which … there is more than an insubstantial risk that Fifth Third will not be entitled to treat… the Trust Preferred Securities as ‘Tier 1 capital’…"

Note that there is no mention of the 90 day restriction here. While the standard 90 day window language appears in the prospectuses of FITB’s other TRUPS, it was removed from that of FTB-C back in 2008 thereby allowing FITB to prematurely call FTB-C in the event that the government so much as announces that they are considering changing the Tier 1 Capital formula (which they did with the Wall Street Reform Act).

What About Other Big Bank TRUPS?

The reason that there was such a dust-up this week about FITB's premature call of FTB-C was because such a call almost never happens so investors were caught off guard.

Comerica executed a premature call with one of their TRUPS last September (within the 90 day window of the Act becoming law last July) and Fifth Third invoked their right to do so earlier this week with FTB-C (having no such 90 day restriction). To date, these are the only two TRUPS that this has happened to.

Also keep in mind that while many TRUPS that are trading today are beyond their call dates and can be called at any time, very few have been called (prematurely or otherwise) since they still qualify for Tier 1 Capital and will continue to do so until January 1, 2013.

Having said that, there are other Big Bank TRUPS that omitted the 90 day restriction from their prospectuses and can therefore be called at any time, just like FTB-C. Subscribers to the CDx3 Notification Service (my preferred stock newsletter and email alert service) have used the CDx3 Discussion Group on the subscriber's website to conducted a robust discussion on this topic.

The post from last month titled “BB&T Trust Preferred Stock Shareholders – Start Paying Attention” (seen below this post) warned readers. While BBT has announced that they will be calling their TRUPS, they have not specified when they might do so (prematurely or wait until the call dates). But know that BB&T removed the usual 90 day restriction on premature calls from their crisis-era TRUPS just like FITB did with FTB-C.

While it is not possible to know in advance what BB&T and other Big Banks might do, it would not be surprising if BBT (and potentially others) prematurely call some or all of their TRUPS. But they can only do so with TRUPS that do not have the standard 90 day restriction prospectus language.

Winners And Losers

The winners of FITB’s premature call of FTB-C are those who have followed the preferred stock investing method described throughout my book, Preferred Stock Investing, and readers of my monthly preferred stock newsletters and this blog.

Since the Wall Street Reform Act became law last summer every issue of the free CDx3 Newsletter has provided a table of Big Bank TRUPS but only those that are available for a market price less than $25.00 per share.

And the preferred stock investing method described in my book, Preferred Stock Investing, explains that investors should never pay more than $25 per share. This is one of many reasons why the model is set up that way. Those who paid more than $25 for FTB-C will realize a capital loss on June 15, 2011.

I sincerely hope that if you have purchased shares of Big Bank TRUPS that you did so following the CDx3 Income Engine method described throughout Preferred Stock Investing. Those who did so with FTB-C are about to receive a very nice and earlier-than-expected capital gain to pile on top of their 8.875% dividend income.

Many Happy Returns.