Changes to Payment of Preferred Dividends of European Financials

Includes: BCS, RBS
by: Global Investing Editor

Something odd happened last week which led me to a stroll down nostalgia lane, and a stock sale. I was a reporter in Paris in the 1980s when Barclays Bank (NYSE:BCS) worked out the first foreign bank noncumulative preferred stock sale to USA retail investors. Although my beat was continental Europe, I turned out to be the only reporter on The Banker's staff with a US brokerage account. So I got to tell the world about this new instrument, which became a cornerstone of my own portfolio and, when I started Global Investing in 1991, of that of many readers.

Barclays used its establishment links to craft the instrument. The Bank of England, their central bank, agreed to treat this preferred stock as part of the bank's capital, allowing the bank to use it to offset 14 times as much borrowing and lending business, under the capital adequacy rules of the day. These leverage rules are set by the central bank of central banks, the Bank for International Settlements (BIS) of Basel, Switzerland.

Then the British Treasury chipped in with another bonus, agreeing to allow American investors to collect a refund of the “advance corporate tax” Barclays had paid Her Majesty's Government, substantially boosting the interest rate received.

Britain wanted to make Barclays into a national champion and the regulators of the City of London all chipped in to help. Thus was born a “hybrid instrument” which combined the benefit of common stock to bank capital with a payout like that of bonds but paid quarterly like US stocks.

Soon thereafter the initiative Barclays had taken was copied by other British banks, and Irish banks which had a similar tax regime. Then banks from other countries worked out similar deals, among them Banco Santander (STD) of Spain. The typical foreign bank preferred share was priced at $25, redeemable in 10 years, and paid high quarterly dividends.

Those days have passed. Barclays is the survivor among Britain's once numerous High Street banks, but it is about to be headed by an American, Bob Diamond, with less clout in the City. In any event, the Bank of England no longer responds to pressures from the government, having been granted its independence by the Blair government. The British Treasury is now seriously taxing banks for having grown to big to fail, rather than encouraging them to boost their balance sheets. The BIS is drafting new rules on leverage and capital adequacy to make it harder to fiddle with hybrids.

Moreover the payment of some tranches of preferred dividends by banks which had been rescued by the UK government was blocked by European Union competition authorities to level the playing field for other banks which had not received aid. This applied to Royal Bank of Scotland (NYSE:RBS) preferred shares which had not yet reached maturity, but not to older issues. Moreover, in some cases, inside owners got their dividends but not outside ones, a reversal of normal shareholder rules.