The Hidden Risk Of Buying Today's Trust Preferred Stocks

 |  Includes: BBT, WFC
by: Doug K. Le Du

There is a special risk with several bank-issued trust preferred stocks (TRUPS) that many preferred stocks investors appear to have forgotten about (or never knew about before investing).

Several TRUPS, issued by our Big Banks over the years, are prematurely callable right now even though they have yet to reach their published call dates. Unknowingly, many preferred stock investors are buying shares of these prematurely callable preferred stocks every day for prices well above par, exposing themselves to a sudden and unexpected capital loss.

Case Study: BBT.PB From BB&T Corporation

BBT.PB from BB&T Corporation (NYSE:BBT) provides a good example[1].

BBT-B Trust Preferred Stock

Looking at the call date you might be saying "Hey wait Doug, this preferred stock is not callable until August 1, 2014. After all, August 1, 2014 is the call date that is published in this preferred stock's prospectus right on page 1. Sure it closed last Friday at $26.99, well above its $25 par value, but so what? It pays a whopping 9.6% dividend (8.89% annual yield) and is not callable for another two-and-a-half years! Sure I'd be paying above par but I'll just sell my shares in, say, one year and be well clear of that August 2014 call."

The average daily volume of BBT.PB is over 100,000 shares (50,423 last Friday) so there are obviously a lot of preferred stock investors, eyes glazed over by BBT.PB's 9.6% dividend rate, who are thinking this way.

As I am about to explain, these preferred stock investors are exposing themselves to a hidden risk in today's market for Big Bank TRUPS and are most likely doing so without being aware of it.

Standard Big Bank TRUPS Language: The 90 Day Limitation

Historically, banks issued TRUPS primarily because these securities count toward a key measure of a bank's reserves ("Tier 1 Capital"). But standard TRUPS prospectus language says that if the government changes the formula for Tier 1 Capital (a "capital treatment event") that they, the bank, will have 90 days to prematurely call the TRUPS since a change in the formula would be like changing the rules after the game has started.

Here is how standard Big Bank TRUPS prospectus language looks (shortened for readability here):

The shares are redeemable at our option at any time within 90 days following the occurrence of a 'capital treatment event' as set forth below.

The standard language goes on to define a capital treatment event as "...the occurrence of any amendment to, or change (including any announced prospective change) in the laws...which amend or change [our ability] to treat...the Trust Preferred Securities as Tier 1 capital..."

Notice that this standard TRUPS prospectus language defines a capital treatment event as having occurred if a change in the Tier 1 Capital formula is either "announced" or when such a change is actually implemented.

The Wall Street Reform Act, signed into law on July 21, 2010, announced that the government was going to be changing the formula for Tier 1 Capital to exclude Big Bank TRUPS and that this change would be implemented on January 1, 2013. That creates two capital treatment events, the first occurring on the day the Act was signed announcing the pending change and the second, which has yet to occur, when the change is actually implemented on January 1, 2013.

Regardless of their published call dates, all Big Bank TRUPS that include the above standard language became prematurely callable for the 90 days following July 21, 2010 and will become prematurely callable again for the first 90 days of 2013.

Non-Standard Language To Watch For

Now look at the same paragraph from the prospectus of BBT.PB (page S-40).

We will have the right to redeem the [shares] after the occurrence of a...'capital treatment event' defined below.

BBT.PB's prospectus then provides the standard definition of a capital treatment event as seen above in the first example. Notice the difference? The 90 day limitation language is missing from BBT.PB's prospectus.

When BB&T Corporation issued BBT.PB in July 2009 they removed the language that says that if the company is going to prematurely call BBT.PB they must do so within 90 days of the capital treatment event. Because the 90 day limitation language was deleted from BBT.PB's prospectus, the bank is allowed to prematurely call this security at any time if a "capital treatment event" occurs, which it did on July 21, 2010 when the Wall Street Reform Act was signed into law.

BBT.PB is callable right now and has been since July 2010. To their credit, BB&T announced at their February 2011 shareholder's conference that they would be calling BBT.PB, but they did not say when they would do so.

Several Big Bank TRUPS Are Prematurely Callable Right Now

And BB&T is not alone. Of the approximately 150 TRUPS trading on U.S. stock exchanges, there are several other Big Banks that removed the 90 day limitation language from the prospectus of their TRUPS just as BB&T did with BBT.PB.

Investors learned this the hard way when Fifth Third prematurely called FTB.PC on May 18, 2011, two years prior to its published call date. Wells Fargo (NYSE:WFC) had also removed the 90 day limitation from its WCO TRUPS as had Wachovia from its WB.PD TRUPS (subsequently acquired by Wells Fargo). WCO and WB.PD were both prematurely called by Wells Fargo in September 2011 well before to their published call dates.

Here is the daily closing price chart for BBT.PB since it was introduced in 2009. I have marked July 21, 2010 on the chart. This is the day that BBT.PB became prematurely callable. Buyers purchasing shares of BBT.PB after that date for more than $25 per share (which is all buyers) are exposed to a $1 to $4 per share capital loss at any time.

BBT-B Price Performance

BBT.PB closed last Friday at $26.99 after reaching a high of $27.05. While it is not possible to know for sure, it is very likely that most of these buyers are completely unaware that they are purchasing shares of a callable preferred stock issued by a company that has publicly announced that the shares will be called.

As investors, we are continually warned to read the mind-bending prospectus prior to investing. Those considering purchasing Big Bank TRUPS shares should do so knowing that the 90 day limitation language was removed from the prospectuses of several such securities when the securities were issued several years ago. The removal of the 90 day limitation language from these securities allows the issuing bank to call them at any time, regardless of what their published call dates indicate.

How To Find The 90 Day Limitation Language

To help find this key language, use your web browser's search function on the prospectus to look for these phrases (this is not an exhaustive list): 90 days, capital treatment event, redemption[2].

If your TRUPS has the standard 90 day limitation language shown in the first example above, then your shares become callable again either (A) on their published call date or (B) during the first 90 days of 2013, whichever comes first.

If, on the other hand, the TRUPS that you are considering purchasing does not include the 90 day limitation language per the second example above (BBT.PB), the shares you are considering buying are prematurely callable right now and have been since the Act was signed into law on July 21, 2010.

As tedious as it can be to read a security's prospectus, this is a clear case where preferred stock investors are at extreme risk of unknowingly paying more than par for a callable preferred stock.


[1] See Seeking Alpha's "Preferred Stock Trading Symbol Cross-Reference Table" to see how your online service denotes preferred stock trading symbols. The data presented in this table for BBT.PB is provided by the CDx3 Notification Service database from the close of trading on Friday, March 2, 2012. Disclaimer: The CDx3 Notification Service is my preferred stock email alert and research newsletter service.

[2] Do-it-yourselfers can find the prospectus of your Big Bank TRUPS from several online sources. The U.S. Securities and Exchange Commission at offers the massive but searchable EDGAR database. From their homepage click on Search for Company Filings then Company or Fund name. also provides prospectus links. Quantum requests a fee and uses the honor system to collect your contribution. Please contribute if you use their system. Subscribers to the CDx3 Notification Service can find the list of prematurely callable Big Bank TRUPS on the CDx3 Notification Service homepage and prospectus links for every preferred stock trading on U.S. stock exchanges.

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