First Midwest Bancorp (FMBI) issued its Series A 7% preferred shares on May 13th. The preferred shares were issued just a couple of days after the company filed a mixed shelf offering with the intent to raise an unspecified amount of capital.The mixed shelf offering stated that the company may use different combinations of securities including, but not limited to, common shares, preferred shares, warrants, and debt securities to raise capital. Before deciding on investing in a new preferred issuance, investors should understand the nature of the specific preferred security and the company offering it.
Symbol: FMEEL (trading OTC), FMBIP (listing on NASDAQ by June 12 th)
Company Name: First Midwest Bancorp, Inc.
Call Price: $25
Call Date: 8/20/2025
Annual Dividend ($): $1.75
Dividend Yield (% of Call): 7.00%
Current Yield to Call (As of May 22nd): 6.97%
Fixed or Floating: Fixed
Moody’s/S&P Credit Rating: Ba1/BB-
Tax Treatment: Dividends are eligible for preferential tax treatment depending on holder’s tax bracket
Information Courtesy of: Quantum Online
Like many new preferred shares, this one trades over the counter until it can trade on the Nasdaq. For more information on interim OTC trading, Quantum Online has put together a useful FAQ. Since the issuing company is a bank, they are required to make the dividends non-cumulative to keep the issuance from diluting Tier 1 capital. Non-cumulative dividends can allow the company to suspend preferred dividends without accumulating the missed dividends as a liability.
First Midwest has indicated that they will use the $95.7 million in proceeds from the capital issuance for “general corporate purposes.” As for the capital structure, the preferred share issuance will reduce the bank’s overall leverage from 7.11 times equity to 6.84 times equity. Aside from deposits, the bank has $2.88 billion in borrowed funds and senior debt that would rank senior to preferred shares in the event of a default or liquidation. The preferred shares rank senior to common shares in the now $2.53 billion equity stack.
Source: 424B Filing, May 14, 2020
As for the securities performance, it is currently trading at slightly above par with a 6.99% dividend yield and a 6.97% yield to call. The 6.99% preferred dividend yield ranks 24th out of 199 common, preferred, baby bonds, and bonds tracked in the banking sector of the High Yield Digest database. The company’s CET1 ratio was also ranked 24th out of the 50 banks tracked.
The likely reason for the need of capital stems from the bank’s loan to deposit ratio. At 99% as of Q1 2020, almost all the bank’s deposits had been lent out. In order to lend additional capital, the bank would need to either grow its deposits or raise some type of equity or debt. Since 2016, the bank’s loan to deposit ratio has steadily grown and with programs such as the PPP increasing loan demand, the need for capital is apparent.
Source: Quarterly Earnings Data kept in High Yield Digest database
As for risks, First Midwest is in the same boat with other banks in that interest rates continue to tumble. While that may be good in respect to lowering the costs of deposits, it makes it more difficult to recoup healthy interest margin from a capital raise that has a 7% dividend attached to it. If the bank were to suspend its preferred share dividends, it would need to suspend its common share dividends first. These drastic cuts to income investors would only likely happen if the bank saw a surge in bad loans and needed to preserve liquidity. In this event, investors would get a heads up with a decline in the CET1 ratio.
Overall, First Midwest Bancorp’s preferred share is “middle of the road” when it comes to risk. Retiree investors may want to take advantage of the 15% tax rate treatment. The higher than normal yield is certainly attractive, however, I am waiting for the next round of volatility to hit, which will give me additional time to assess the banking sector, before investing.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.