Information > Financial Terms > This page

Bank Securities
Source:  Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

The types of commercial bank securities now available include the following:  (1) convertible or nonconvertible capital debentures; (2) convertible or nonconvertible preferred stock; and (3) common stock.

Capital Debentures.  

The Comptroller of the Currency issued in December, 1962, a regulation (Sec. 14.5 Capital Debentures, in Part 14, Changes in Capital Structure, found in 12 CFR) indicating that it is the policy of the Comptroller of the Currency to permit the issuance of convertible or nonconvertible capital debentures by national banks, "in accordance with normal business considerations." 

National banks may, with the approval of the stockholders owning two-thirds of the stock of the bank entitled to vote, or without such approval if authorized by their articles of association, issue convertible or nonconvertible capital debentures in such amounts and under such terms and conditions as shall be approved by the Comptroller.  There is no covering statute.

However, the principal amount of capital debentures outstanding at any time, when added to all other outstanding indebtedness of the bank, except those forms of indebtedness exempt from the provisions of 12 U.S.C. 82 (which specifies the debt limitation which follows), shall not exceed an amount equal to 100% of the bank's unimpaired paid-in capital stock plus 50% of the amount of its unimpaired surplus fund. Most states also authorize their chartered banks to issue capital notes or debentures.  In fact, such senior debt securities were authorized by Act of March 9, 1933 , authorized the RECONSTRUCTION FINANCE CORPORATION to invest in national bank preferred stock and in such debt securities of state-chartered banks.

The sharp expansion in commercial bank issues of capital notes and debentures is indicated by the table appended.

Substantial increase in credit demand in recent years has required faster growth in capital funds than that arising from retained earnings alone.  But instead of raising the additional capital funds entirely in common stock, banks (especially the larger institutions) have turned to senior securities (largely convertible or nonconvertible capital notes and debentures). 

As between preferred stock and capital notes or debentures, there has been a marked preference for the latter as the media for senior security financing because, among other factors, of the cheaper cost of funds resulting from the full tax deductibility of interest on the capital notes or debentures.  Characteristics of issues of bank capital notes and debentures include the following:

1.    Capital notes or debentures as to liability of the parent bank may be direct liability subordinated issues (subordinated to deposits and other specified liabilities).  Because of the large relative volume of deposit liabilities alone, the strength of the claim of such subordinated bank capital notes or debentures is, compared to that of subordinated debentures of industrial companies, quite junior.  However, protective provisions in such bank subordinated capital notes or debentures may restrict or prohibit additional issues senior to or equal in strength of claim to existing issues, entirely aside from statutory limitation on total bank indebtedness, supra.  Parent banks may also guarantee principal and interest of debt issues by affiliates, which may also have outstanding unguaranteed issues, in connection with sale and leaseback of the parent bank's building.

2.    Typical maturity of capital notes of debentures has been 25 years, with or without sinking fund provision.  A large number of the issues have been placed with investors in private placements rather than public offerings.  Call provision is typical, many of the issues having deferred call provision.  A number of the issues are convertible into common stock, a source of  potential dilution for the common stock.  The extent of the total capital notes or debentures in proportion to total capital accounts does not appear large in the overall (see table appended), but among the banks issuing capital notes or debentures, capital structure proportions of 25% to 30% represented by such debt securities are not unusual.  This may be considered about the limit of prudent capital structure leverage, in view of the earning assets are normally loans, which unavoidably will reflect the ups and downs of business activity).


3.    The larger and thoroughly entrenched banks show ample earning power relative to interest requirements on capital notes or debentures.  But an analytical question arises as to total interest requirements in view of subordination of many such issues to deposits and other specified debt.  Another analytical question is whether interest coverage should be figured on the basis of above the line earnings (net current operating earnings) or below the line earnings (net income or transferred to undivided profits), referring to the bank accounting issues discussed in BANK ACCOUNTING.

Preferred Stock.  

Bank financing in preferred stock has been relatively light.  From an investing point of view, bank preferred stocks command high coverage of dividends, senior equity position, and, moreover, taxability of only 15% of dividend income to corporate investors.  But callability, nonparticipating fixed dividends, and, as high-grade preferreds, susceptibility adversely to rise in interest makes bank preferred stocks less satisfactory for long-term investment as bank equities than bank common stocks, unless such preferred stock carries convertibility into common stock of the bank concerned.

Common Stock.  

Common shares of well-entrenched, well-managed banks, as reflected in high current earning power and long-term growth rate, are entitled to high investment regard for long-term investing purposes.  Within given banking markets, management of particular banks may be more aggressive than the group as to mergers, branch banking, and diversification of banking services, resulting in superior earnings and growth rates. 

Bank common stocks are highly leveraged equities even without the capital structure leverage provided by capital notes, debentures, and/or preferred stock, because of the volume leverage derived from deposits and reflected in earning assets per dollar of capital funds.  In given banks, the issuance of capital notes or debentures to as much as 25% to 30% of total capital structure, along with deposits of 10 to 15 times capital funds, magnifies leverage more than ever and will result in greater variation in common stock earnings over cycles of business activity.

Even more leveraged, however, are common shares of bank holding companies, whose own capital structure leverage rests upon that of subsidiary banks and other subsidiaries, and whose own expansion in bank-related or other permitted fields would be greater than that of any one subsidiary bank. 

Constraints imposed by regulation would serve to temper expansion that otherwise might spill over into speculative non-banking or bank-related lines under the spur of competition.

Analytically, common shares of a bank holding company, even if such a holding company holds only interests in banks, call for analysis of consolidated and non-consolidated data to determine the respective sources of earning power and equity of such holding company common stock.  Diversification of holdings in banks and bank-related lines available in the bank holding company's common stock should normally be a favorable consideration and justify higher price-earnings multiples.

The massive changes created by the partial deregulation of the financial marketplace have often resulted in intense competition in products banks formerly thought to be secure profit generators.  In addition, problems in the energy (both petroleum and nuclear power), international, and real estate sectors have eroded the profitability of many banks.  High interest rates during the early eighties severely damaged the fixed-rate lending institutions in the thrift industry.  Thus, while the common stock of some banks has maintained a high investment status, the stock of many institutions has assumed a much more speculative character.


Back to Information