Raising Capital to Grow Your Mortgage Operation: Preferred vs. Common Stock

We receive many inquiries about raising capital.  With the increase in capital requirements from the FHA, GSEs, warehouse lenders, investors and broker dealers---owner /operators of mortgage banking companies are confronted with the dilemma of building their balance sheet through organic growth (earnings) or raising outside capital from investors.  Subordinate debt can help liquidity needs and help meet some warehouse lender requirements, but it is not really capital.

Capital can be exchanged by issuing two types of stock:  Common and Preferred Stock

Let’s look at two approaches of raising capital. 

Common Stock:  Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than preferred shares or bonds over time.

Common stock is usually voting shares, though not always. Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering. There is no fixed dividend paid out to common stock holders and so their returns are uncertain, contingent on earnings, company reinvestment, and efficiency of the market to value and sell stock.

Additional benefits from common stock include earning dividends and capital appreciation.

Preferred Stock:  Preferred stock, also called preferred shares, preference shares, or simply "preferreds", is a special equity security that resembles properties of both equity and a debt instrument and generally considered a hybrid instrument. Preferreds are senior (i.e. higher ranking) to common stock, but are subordinate to bonds.

Preferred stock usually carries no voting rights, but may carry priority over common stock in the payment of dividends and upon liquidation.  Preferred stock may carry a dividend that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock. Terms of the preferred stock are stated in a "Certificate of Designation".

The following is quick table to show the key differences of Common and Preferred Stock

If you are considering raising capital today, take some time to understand the difference between Common and Preferred Stock.  If you are looking to maintain control and ownership, Preferred is probably the best approach.  Many investors today also consider Preferred over Common because of the minimum return generated from the coupon rate and the position during liquidation.