FITB Case Study: Caution Now Required With Banking Trust Preferred Stocks

May.30.11 | About: Fifth Third (FITB)

Holders of Fifth Third Bancorp (NASDAQ:FITB) Trust Preferred Shares got an unwelcome surprise last week when the corporation used a little recognized provision in their trust agreement to call the shares at $25 plus accrued dividends.

These trust preferred shares had an 'earliest call date' of 5/15/2013 and a maturity date of 5/15/2058. The coupon on these shares was 8-7/8%, meaning that in the scramble by investors to maximize yield the price was driven as high as $27 recently and the shares had been trading at $26.60 the day before the call was announced. Immediately after the call the shares dropped to the $25 area leaving investors with an instant 5% loss.

While not generally recognized, almost all bank trust preferred shares contain a provision allowing the calling of the shares in case of a 'capital treatment event'.

The Dodd-Frank Act provision which calls for the phasing out of Trust Preferreds as Tier 1 capital can be interpreted as a 'capital treatment event' by banks and thus allows Fifth Third Bancorp to call these shares even when they would not be generally called for 2 more years.

It is normal for most preferred shares that carry a high coupon to trade above par when they are 2-5 years from a possible call---but now we must also be aware of this little used provision in most trust documents. Note that this is an issue with banking securities, and generally will not affect the Trust Preferreds of companies such as Red Lion Hotel (NYSE:RLH) which are non banking companies.

We would advise that investors be very careful with either TRuPs they currently own or with those they are considering purchasing. As of now, purchasing any banking TRuP above par has a new added risk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.