Question

In 2009, New York First National Bank acquired New Jersey National Bank. In an exchange, New York First National Bank issued three series of preferred stock for New Jersey National Bank's net assets. Series Senior A (the most senior series), was given to four of New Jersey National Bank's creditors so that the debt could then be retired. The four preferred shareholders are listed as follows: two regional banks, one money center bank, and a non-financial corporation. Senior Series A has a total par value of $20 million, which carries a non-cumulative dividend per the following schedule:

Year	Annual Dividend
2010	7.5%
2011	10%
2012	12.5%
2013	15%
2014 and beyond	20%

New York First National Bank did not pay dividends in 2010, 2011, or 2013 however, they will start paying dividends annually at the start of 2014 thus, they will pay 20% on the Senior Series A preferred.

The Senior Series A stock may be called at any given time, at par plus dividends cumulated from January 1, 2010. New York First National Bank estimates that it can float a new issue of 10% non-cumulative preferred stock at par, with issuance costs amounting to $1,000,000. The new issue of preferred would be callable at par plus unpaid dividends.

Should New York First National Bank call in the Senior Series A and issue new preferred? (assume that the Senior Series A would be called effective December 31, 2013.)

Answer 1

New York First National Bank acquired New Jersey National Bank. For the acquisition, the New York First National Bank will have to pay the creditors of the New Jersey National Bank. So, New York First National Bank paid the 4 creditors of New Jersey National Bank by issuing them Series A preferred stocks.

The total par value of Senior Series A preferred stocks =  $20 million

Here, since the preferred stock has non-cumulative dividends, the stockholders do not have the right to receive past un-paid dividers. So, if New York First National Bank didn't pay any dividend(s) between 2010 and 2013, the 4 creditors of New Jersey National Bank don't have the right to ask New York First National Bank to pay the past dividends.

(In the case of cumulative preferred shares, if an issuing entity decides not to pay dividends then the stockholders are entitled to receive the past dividends. But in the case of non-cumulative preferred shares, the stockholders are not entitled to receive the past dividends)

If the New York First National Bank doesn't call back the Senior Series A stocks, then it will have to pay dividend of 20% on $20 million for 2014 and beyond until the stocks are called. The total outflow for the bank would be

= $20 M x 20% / r

= $ 4 M / r

Here, r is the required rate of return for the stockholders

If the bank calls the Senior Series A shares effective December 13, 2013, and issues new preferred shares, the total outflow (or cost) for the bank would be

= cost of callable preferred shares + cost of issuing new preferred shares + dividend payout of new preferred shares (assuming till perpetuity)

= par value of Senior Series A + dividend payouts from 2010 to 2013 + issuance cost + dividends (assuming perpetuity)

= $20 M + 20 M * (45%) + $1 M + $20 M x 10% / r

= $30 M + $ 2 M / r

if 4 / r = 30 + 2 / r

r = 2 / 30 = 1 / 15 = 6.67%

So, if the required rate of return for the stockholders is more than 6.67%, the bank should not go for new issue of stocks.