Common and preferred stocks: a primer

[TechBear_Seattle]

I'm seeing a lot of confusion regarding the CitiBank conversion, and thought this might be helpful.

All stocks represent ownership in a company. Stockholders give the company money and get in exchange an ownership interest back.

All companies that issue stock must issue common stock. For each share of common stock, a stockholder gets one share of controlling interest in the company and thus has a voice in how the company is run. It used to be typical for holders of common stock to get a share of the company's profits as well, distributed periodically as a dividend. Nowadays, it is rare for common stock to carry dividends; instead, stockholders make their money by buying and selling shares on the open market, with share values determined by the perceived strength of the company.

Some companies also issue preferred stock. Preferred stock does not give a controlling interest, so holders of preferred stock do not get a voice in running the company. In exchange, preferred stockholders are guaranteed a distribution of dividends. Where a company's common stock also pays dividends, preferred stock will usually pay a higher amount, and dividends on preferred stock must be paid out before dividends on common stock. Many preferred stocks will carry a fixed dividend rate based on the stock's par value; other preferred stocks will have a dividend rate linked to a benchmark such as the Federal Funds rate or the London Interbank Offered Rate. Dividends on preferred stock are often cumulative: if the company does not pay dividends for three years, it must pay three years of dividends to preferred stockholders before it can pay any dividends to common stockholders. In the event the company goes into financial default, assets that remain after debt has been cleared will be distributed first to preferred stockholders, then to common stockholders.

The two different types of stock attract different types of investors. Investors in common stock are typically speculators: they are buying the stock with the expectation that the company will continue to do well, driving up the value of the stock so it can be sold later at a profit. Also, investors in common stock may seek to influence the direction and policies of the company. Investors in preferred stock typically are looking for a regular return on their investment and buy with the intent to hold the stock for a long time.

Often times, preferred stocks will carry a "convert to common" feature. This allows either the company or the stockholder, in specific circumstances, to give up a share of preferred and get back a share of common stock. Convertion will usually be done by a company only when it is doing poorly and needs to stem an outflow of money in the form of dividends. Shareholders might convert for a number of reasons, such as when the company is doing so well that the sell value of common stock has outpaced the sell value and dividend returns of the preferred stock.

[Joanne98]

1. So the Treasury only got one stock of common for one stock of preferred?

Isn't that a bad deal?

[TechBear_Seattle]

3. In this case, probably not

Again, the distinction is that preferred is meant to be held as a long term, reasonably safe investment. The Treasury does not need such investments. It is better off converting the preferred stock to common, which gives the Treasury a say in how the company is run. Also, common stock is more volatile than preferred; when the bank starts to do better, the value of the common stock will start to go up sooner and faster than the cost of the preferred stock. This allows the Treasury to start selling off its shares sooner, and for more profit.

So basically, what the Treasury is doing is giving up a smaller guaranteed income in exchange for a say in the company and the hope of a bigger profit later on.

[Joanne98]

5. Thanks. You're a really good explainer!

[A HERETIC I AM]

8. It also bears mentioning that the majority of Preferred shares have a "Par" of $25.00

and rarely trade much above that level. Common stock is issued with a Par value but it is often as low as $.01. Since there is no reason the common could not at some point trade much, much higher (2 years ago C traded in the $60 range) the Treasury stands to do rather well if, as you mention, the banks starts to do better.

Both Citi and BofA have issued several different preferreds as well, all with different coupons. Many of the large international banks have perhaps 10 or more different preferreds.

Included in this news today is that Citi has suspended divided payments on both its common and ALL its preferred shares. Those preferreds that are "cumulative" stand to receive a hefty dividend payment when Citi resumes such payments, as all missed or suspended payments must be made to the preferreds first, again, as you mentioned, TBear.

[A HERETIC I AM]

10. Correction;

My statement above that they will suspend dividend payments on their common and all their preferreds is incorrect.



"According to the Citigroup press release dated, Feb. 27, 2009, the following Citigroup trust preferreds listed below will continue to pay:

Citigroup: List of Trust Preferred Securities that will continue to pay:

Issuer                    Coupon         Symbol         Cusip  
Citigroup Capital IX      6.00%           C.S         173066200
Citigroup Capital VII     7.125%          C.V         17306N203
Citigroup Capital VIII    6.950%          C.Z         17306R204
Citigroup Capital X       6.100%          C.R         173064205
Citigroup Capital XI      6.000%          C.Q         17307Q205
Citigroup Capital XiV     6.875%          C.O         17309E200
Citigroup Capital XIX     7.250%          C.F         17311U200
Citigroup Capital XV      6.500%          C.U         17310G202
Citigroup Capital XVI     6.45%           C.W         17310L201
Citigroup Capital XVII    6.350%          C.E         17311H209
Citigroup Capital XX      7.875%          C.G         173085200

In addition, Citigroup stated the dividends payments of the Citigroup preferreds listed below will be suspended:

Citigroup: List of Suspended Dividend Payments of Preferred Securities:

Issuer              Coupon        Symbol       Cusip  
Citigroup Inc       6.500%         C.I       172967598
Citigroup Inc       8.500%         C.M       172967556
Citigroup Inc       8.125%         C.P       172967572

My apologies for the error.

[Joanne98]

2. Okay Techbear I have one more question.

The treasury is thinking about doing the same thing with BOA..

http://dealbook.blogs.nytimes.com/2009/02/27/bofa-may-be-next-credit-analysts-say/

If I bought BAC preferred right before they did this would I get a big bounce? You don't have to worry about me losing money. I just play investopedia.

[TechBear_Seattle]

4. That is very difficult to say

It is rare for large quantities of preferred stock to convert at once, and passing rare for such occasions to be as public. I am not aware of any precedent on which to base an opinion.

[Joanne98]

6. But the short term holders of preferred Citi did make a lot of money today

I'm just trying to figure out if anybody's doing that. I know it's all new. Maybe they will with BOA. Just a thought.

[Joanne98]

7. I just went ahead and did it. I just want to see if it works.

It's just investopedia. Not real money anyway.

[ipfilter]

9. If you want another preferred to play with.

Try F-A on ivestopedia. It's Ford preferred. It pays a $0.46 divvy where Ford common pays nothing right now.