Spanish banks, mostly the firms that were created from old savings banks, are looking for a solution for clients who ended up stuck in investments in preferred stock and subordinated debt without knowing entirely what products they had purchased. Why are clients unhappy? Because preferred stock and subordinated debt have a lower priority than other bonds that a bank has issued in the event that the bank undergoes liquidation during a bankruptcy. The solution the banks would like to see is to exchange the preferred stock for fixed income savings deposits.
But converting the debt is not easy and takes time. Banks are afraid of many appeals going to court, because many clients agreed to buy preferential stock because they didn?t read the fund descriptions and believed preferred stock was similar to fixed income deposits.
Preferred stock is a hybrid instrument that utilizes a bank?s proprietary funds, which implies that in the event that a bank suffers losses or a selloff, some of the preferred stock funds go toward dampening the loss. If a bank proves it has sufficient reserves, does not ask for public aid gets approval from the Bank of Spain, it can convert the preferred stock. Banks benefiting from the imminent EU bailout will not be able to convert so easily.
In their case, shareholders who own preferred stock will have to take on some of the cost of their bank?s losses, because banks will have to get permission before converting the instruments into capital and individuals who bought them will take a heavy discount on their total investment. Increasing the capital pool of the preferred stock will dilute its share value.
A similar dilution effect occurs when a person invests in the stock market and the stock price drops below the initial purchase price because of the issue of additional common shares. The problem is that many clients requested an investment vehicle similar to a fixed income deposit but got something very different instead. For now, the clients are stuck and struggling to find a solution.
