Leveraged ETF's Weigh Bank Preferred Redemptions (FAS, FAZ, UYG, SKF, PGF, BAC, JPM, WFC, GS, C)

The triple-leverage financial ETFs of Direxion Daily Financial Bull 3X Shares (NYSE: FAS) and Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) are getting to deal with yet another potential wrench in the machine: preferred share redemptions from major banks.  This will also pose a potential issue for the Ultra Financials ProShares (NYSE: UYG) and the UltraShort Financials ProShares (NYSE: SKF) ETFs that trade at double-leverage of the Dow Jones U.S. Financials index.

The PowerShares Financial Preferred (NYSE: PGF) is the ETF that specifically tracks the preferred shares of financial stocks.  This can also be impacted, although we would note that this ETF here has five of its top ten holdings which are European bank preferred shares and the top ten holdings are over half of the ETF.

This comes on the hells of this morning’s Bank of America Corporation (NYSE: BAC) announcement that it was offering a tender exchange offer on nine of its preferred series for up to 200 million shares of common stock.  At today’s prices, that would represent more than $2.2 billion in new common stock.  The largest US bank holding company issuers we have seen with Bank of America are JPMorgan Chase & Co. (NYSE: JPM), Wells Fargo & Co. (NYSE: WFC), and Goldman Sachs Group Inc. (NYSE: GS).

We have already seen some selective retirement of preferred stock from the likes of Citigroup, Inc. (NYSE: C), and that accomplished some of the same issues that Bank of America was trying to address.

All of these index levels actually track just the common stock, so the dilution, the new issuances, and the potentially larger market caps of the common shares would be what matters to these ETF’s.  These ETF’s are only full of the common stocks.

The biggest issue out there for how this will affect the ETF’s which track banks, financials, and preferred shares is the overall weighting.  If B of A is successful at this, we could easily see other banks following suit.  JPMorgan CEO Jamie Dimon already bought preferred shares.

The incentive here is actually rather simple to retire these at lower prices than the traditional $25.00 PAR if possible.  The yields on many of these preferred securities is close to 10%.  Some yields are even higher.  Bankers cannot make that much spread even if the credit card rules were not changing.

There is also the notion that these preferred share redemptions act as effective Tier-1 capital raising activities.  Some consider this a balance sheet trick, but if it lowers current obligations and long-term debt then that is ultimately good for shareholders of common stock in today’s environment even if you consider the dilution that the common holders have to accept.

JON C. OGG
May 28, 2009