Greece's economy has returned to the headlines recently after a successful return to the debt markets and a report that the National Bank of Greece (NBG) would raise $3.0 billion in capital via an equity raise. Greece's bond issuance, while only a small fraction of Greece's total debt burden, demonstrated investor's confidence returning to the country, while NBG's equity sale came as a surprise. The company previously stated they would not resort to an equity sale to raise additional capital and this announcement came as a shock sending shares of NBG down as much as 14%.
With the company getting another bailout from Europe and the company selling equity to fill the funding gaps left from the bailout, investors interested in distressed companies may turn their attention back to NBG. An obvious investment choice is buying NBG's common stock, but is that the best way?
NBG preferred stock
While common stock in NBG has declined nearly 90% in the past 5 years, its preferred stock (NBG-A) has declined from $25 to under $3 and has since rallied over 150% in the past year alone and is currently trading at approximately $17.50-$18.00 per share. NBG-A is a non-cumulative preferred stock with a $25 par/redemption value and a coupon of $2.25, or 9% when at par, but has not been paying dividends due to the company's poor performance. Click here for the prospectus and complete details of the preferred stock issuance.
Naturally, this begs the question, why purchase a preferred stock that hasn't paid dividends in years and will not compensate an investor for the lost dividends?
Take advantage of NBG's capital structure
There are a number of distinct advantages to owning the preferred stock over common stock. The first is to take advantage of the company's capital structure. In the event of a bankruptcy, preferred stock holders are in line to recoup losses after bondholders yet before common equity holders. The preferred stock offers you a margin of safety not available to common stock holders. In the event of a bankruptcy, it is more than likely that common stock holders will realize a loss of 100% of their investment while preferred holders may receive a payout. NBG is trying to recapitalize itself and restructure its capital structure. It is safe to assume, that a company trying to lower its debt burden does not want to pay 9% interest on a preferred stock. On top of the dividends needed to be paid to preferred holders, retiring NBG-A will add at least an additional 100 basis points to the company's capital ratios. This is a huge positive for a bank who is trying to regain investor confidence and prove it is a well-capitalized bank that can handle any additional slowdowns in the Greek or European economy.
Does NBG want to redeem its preferred stock?
In 2012, NBG offered a voluntary redemption of convertible bonds and preferred shares to investors outside of the US. The first redemption date possible for the US-issued preferred stock was 6/6/2013. On May 31, 2013, NBG offered a voluntary redemption of its US preferred shares at $12.50 and while this represents a 50% discount to par value, it was significantly above the market price at the time. With two attempts in the past two years to redeem their preferred securities, it is safe to assume they no longer wish to have these securities outstanding. While both redemption offers were for less than par value, they were also voluntary. If the company wants to mandate redemption, they can only do so at par or $25 per share.
Adding more fuel to the argument is that NBG was profitable in 2013 earning $0.81 per share for the full year. The significance of this is that Greek law mandates NBG distribute 35% of profits to its shareholders annually. Here is the verbiage from the preferred shares prospectus:
"According to our Articles of Association and Greek law, we are required to pay a minimum dividend equal to at least 35% of our annual distributable net profits. Dividends for the Series A preference shares would constitute a portion of such minimum dividend and would be required to be allocated prior to the allocation of any dividends to our ordinary shareholders."
The significance of this is that not only is the company legally mandated by law to pay dividends but like most capital structures preferred stock dividends must be paid before dividends can be paid to common shareholders.
The largest and most extreme example of the risk involved is that the company goes bankrupt and there is $0 left to compensate preferred shareholders for their losses. After two bailouts and €240 billion invested in Greece and NBG by the International Monetary Fund and euro-zone lenders it is difficult to imagine they would let the country, or bank, go bankrupt and risk losing a huge investment on their part.
There is also a risk that the company turns its profits into losses again and is no longer mandated to pay dividends. While this scenario is more likely than the first, it is possible that the company would use that additional time to redeem more of the outstanding preferred stock for a discount to par. While this outcome could make returns to investors minimal or negative, it provides a safe way to exit the investment, minimizes losses, or even provides a floor to the preferred stock price for those that continue to hold.
It is my opinion that NBG wants and will attempt to redeem all of its outstanding preferred stock before having to pay dividends. This would enable them to pay dividends only to common stock holders and reward them for their support during a tumultuous period of their history. The one-year anniversary date of the preferred stock first being redeemable is 06/06/2014 and I expect them to actively try to redeem them this year during their recapitalization efforts. One such scenario would be a voluntary redemption below par but above the current market value. An example would be for voluntary redemption at approximately $22.50 per share. In the event of this scenario, and based on the current price, this would represent upside of over 31%. The second option would be for a mandatory redemption at par or $25 per share. This would be an upside of over 40%. Given that the company is currently profitable and mandated to pay dividends, it may be in an investor's best interest to hold the preferred, wait for redemption at par and potentially collect dividends in the mean time. While the preferred does not offer the potential upside of the common stock, it does offer a margin of safety that the common stock cannot provide.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NBG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.