There were few places to turn to for capital for US financial institutions as write-downs emerged and subsequently ballooned from the last quarter of 2007 on. Raising extra capital to bolster depleted balance sheets via traditional equity capital was problematic, not least because of the dilutive impact on shareholders.
Nevertheless, the circumstances were such that various banks were willing to turn to private investors such as sovereign wealth funds and private equity funds. Not all, however. Bank of America created a new, innovative preferred instrument that enabled a large capital input for itself, and changed the capital-raising landscape for other financial institutions.
Issuance of dividends received deduction (DRD) preferred stock increased dramatically as financials used this tax-efficient product to strengthen their capital base. Dividend payments on DRD securities are 70% tax deductible.
Total preferred stock including DRD preferred stock issued by US financials last year was more than $105 billion, up from just under $79 billion in 2006, according to Dealogic.
Bank of America’s total outstanding DRD preferred stock, for example, increased over 55% in 2007.