When the two government sponsored enterprises (GSEs) were originally placed in conservatorship on September 7, federal regulators estimated that only a few dozen banks were holding preferred paper in the institution. However, the ABA survey has found that about 27 percent of banks are preferred stockholders and another 3-1/2 percent owe auction-rate securities that are backed by preferred stock. For those banks which are preferred stockholders, the average exposure of their core capital is 11 percent.
In the event of a bankruptcy or conservatorship the pecking order for payment of claims puts several categories of creditors (depositors in the case of banks, for example) ahead of stockholders although owners of preferred stock are given priority over owners of common stock.
These investments do not present any threat to the survival of individual banks; however elimination of the stock and the dividends heretofore paid will reduce capital and thus lending.
"The negative impact on banks – particularly Main Street community banks – is far greater than the regulators first thought," said ABA President and CEO Edward L. Yingling in a letter to Treasury Secretary Henry Paulson and the heads of The Federal Deposit Insurance Corporation, Office of Thrift Supervision, Office of Comptroller of the Currency and the Chairman of the Federal Reserve.
"The impact on capital from the Fannie and Freddie preferred stock write-downs will restrain even the best banks in this country from making new loans," Yingling added.
In its letter on September 22 the ABA requested that the government take six actions to resolve the preferred stock situation:
- Dividends on preferred stock should not be reduced until after the end of the current quarter (September 30), allowing time for Congress and regulators to weigh the situation and address solutions.
- A reasonable dividend should be paid, which would restore a portion of the share value and reduce impairment charges.
- Losses should be treated as ordinary income for tax purposes and be allowed to be offset against a bank's ordinary income.
- The risk weightings on Fannie and Freddie debt and guaranteed mortgage backed securities should be reduced from the current 20 percent weight.
- The risk weighting of auction rate preferred securities backed by Fannie and Freddie should be 20 percent.
- Regulators should increase the flexibility of capital restoration plans for banks that fall below minimum standards.