WASHINGTON, September 13, 2012 – The Prudent Man is contemplating adding some new and nearly new preferred stocks to his various personal portfolios to increase yield. These stocks are excruciatingly boring for those who like a lot of trading action. (We showed them to the kitty pictured above and look what happened.)
But, with the Fed’s actions driving bond prices down and eroding premiums for other high-yielding investments like REITs, we need to broaden our hunt for yield, and the new preferred might just be the place to look. They’re mostly being issued by traditional financial companies like banks and insurance giants. But some REITs have gotten into the act as well.
Given the arcana of the still-being-parsed legislative monstrosity known as Dodd-Frank, banks in particular are being forced to shuffle their balance sheets around to conform with new upcoming rules. One of these shuffles involves getting rid of their “Trust-preferred securities.” We won’t even bother to explain why, because it’s hard to understand if you’re not a banker.
Bottom line: issuing trust-preferred and preferred stocks is a traditional way for banks to raise capital at a relatively low “interest rate” (even though preferreds pay a dividend since they’re stocks). With trust-preferreds going away, a great way to refinance the debt they represent is by rolling them over and replacing them with regular old preferred like we used to have—and at lower interest rates to boot.
These new preferreds are being issued in a weird way by first being shuffled out on the NASDAQ or elsewhere over-the-counter and then swiveled over to where they’re usually listed, the NYSE. For purposes of the retail investor, unless you own expensive software and know when these new preferreds are going to go through their pupa stage over-the-counter, however, you’ll generally find them on the normal exchanges.
Most of these new preferreds, like the old ones, are issued at a nominal price of $25 per share. The dividend percentage, which almost never changes in a preferred, is based upon this $25 price. Once the stock trades, of course, the price can fluctuate up and down.
If you can get these stocks below $25 at any time, you’re buying the yield at a discount and your yield percentage will be higher. If you’re buying the stock above $25 (known as “par value”), however, you’re buying it at a premium, and your effective yield will be lower than the nominal yield at $25. But the actual amount of the dividend won’t change, making this investment seem a lot like a bond.
Preferred stocks are generally split into two broad types with the division focusing on the predictability of the dividend payout: cumulative or non-cumulative. Here’s what that means: In the class warfare order of investing, bondholders in general are known as senior investors. Stock investors are junior to them, with preferred holders being first in the stock pecking order and common stockholders being last in line in the event things in the company start heading south.
If the underlying company gets in trouble, it can stop paying dividends and even interest to its investors. First hit are the common stockholders. Next are the preferred stock holders. And finally, if the company is really in trouble, the bonds suspend paying.
Once a company gets out of trouble (assuming it’s not bankruptcy of course), it must first restore back and current interest (usually) to bondholders. It must then resume payment of dividends to the preferred holders. And only then can it consider resuming the payment of dividends to holders of the common. Which is where our terms “cumulative” and “non-cumulative” come in with reference to those preferred issues.
If you hold a “cumulative preferred” when the company’s accountants are happy again, you not only start receiving your agreed-upon dividend once again. The company also has to pay you all the back dividends you missed. So cumulative is good.
If your preferred is “non-cumulative,” however, tough luck. You’ll start getting your regular dividend again when the company has the moolah, but you’ll never be reimbursed for the dividends you didn’t get. On the other hand, you’ll start getting money again well before those hapless holders of the common shares do, if those shares even paid a dividend to begin with. Savvy?
For this reason, non-cumulative preferreds (the majority of preferreds to the best of the Prudent Man’s knowledge) often pay a slightly higher interest rate than the cumulatives. But cumulative preferred stocks tend to be somewhat safer, yield-wise at least.
There are other flavors of preferreds, like the interesting “convertible preferreds” which don’t have a set price after issue, as their price fluctuates roughly along the lines of the common. But we won’t go there right now. Our main interest today is in those new preferreds, whether they’re cumulative or non-cumulative. We stumbled upon these new kids on the block via an article on one of our favorite sites, Seeking Alpha.
Since many of the old, higher-yielding preferreds are going away, these new instruments are going to yield less, given our low interest rate environment currently. But they’re still pretty attractive, yield-wise. So we think they’re worth a look-see.
Issues we currently have our eyes on are, in no particular order: Offshore-based reinsurance company Maiden Holdings Preferred Series H (symbol: MD/PRH)* yielding 8.25% annually at par (i.e., the original $25 price); real estate company Kilroy Preferred H (KRC/PRH) yielding 6.375%; North-Carolina-based REIT Hatteras Financial Preferred A (HTS/PRA) @7.625%; local McLean, Virginia-based mega-bank and credit card giant Capital One (“What’s in YOUR wallet?”) Preferred P (COF/PRP) @6%; shopping mall mogul Taubman (original and perhaps still current owners of Fair Oaks Mall in northern Virginia) Preferred J (TCO/PRJ) @6.5%; and multi-property investment REIT Glimcher Preferred H (GRT/PRH) @7.5%.
Because these preferreds are new or nearly new, most have not yet paid their first dividend but have already set the date of the first dividend in their prospectus. At least one of them will pay a partial dividend in October since the preferred has yet to log in a full calendar quarter. Nonetheless, all will pay the promised dividend (based on $25 per share) until and unless they hit heavy financial waters at which point they have to warn you they might suspend the dividend.
These are not stocks in which you can usually make a capital gain, since they tend to trade on yield, like bonds. But if you can get them at a discount during market plunges, you can often get a sweet deal. The Prudent Man scooped earlier preferred issues up, along with select junk bonds, in a near-suicidal move right at the March 2009 market bottom. His remaining holding from that period—a Zions Bank preferred (ZB/PRC)—trades somewhat above par today, but was purchased at about $15 per share, a huge discount. It never stopped paying its dividend even though it’s been among the last of the larger banks to hold on to its TARP money, given how shaky its position was back when that program was started.
The reason it’s desirable to get preferreds like these at a discount is simple. Unlike most common stocks, preferreds at some point can and will be called. With a little exploration (a bit more on this in a minute), you can find out what the magic date is, usually 5-10 years after the preferred is issued. The reason why is that interest rates can change over time as we’ve seen; and when they go down, issuers of preferreds like to “refinance” by issuing new preferreds at lower rates as they retire the older, higher-yielding ones. Issuers of bonds with “call” provisions do the same thing.
It’s sort of like refinancing your house. You still can’t really pay off all the principal. But, by getting a lower rate on a re-fi, you can lower your monthly payment and increase, after a period, the speed at which you repay principal reducing the over-all cost of borrowing. We have some Citi preferreds (C/PRZ) we bought later at a less steep discount that we suspect will be called sometime next year. We’ll be sorry to part with them, but the interest/dividends have been fun.
But back to that discount. When preferreds are called, they’re called and redeemed at par, i.e., $25 for most of them. If you bought them at a discount, you’ll also get a reasonably nice capital gain when they’re called, adding a nifty kicker to that swell money you’ve been getting quarterly for years. If you bought them at a premium, however, i.e., over $25, you’ll only get $25 when you’re called.
Frankly, paying a small premium is no big deal, since you’ll make up that potential capital loss most likely with your first or second dividend. The rest is gravy, all things considered. But, if you don’t pay attention, and pick up a nice preferred, say, at $29 and they call it at $25 in the next calendar quarter, you’ll lose on the proposition. So beware. Most of the preferreds we listed above a very slightly at a premium, so it’s close enough that we consider them reasonable candidates. But travel at your own risk on this.
Also, careful please, on investment quality. We’re actually familiar with most of the companies mentioned above and regard them as of reasonably good quality, particularly Capital One. But Taubman has had some issues in the past, and Glimcher is probably riskier than the others, quality of assets and financial statement-wise. Just know this before you decide to get in, which is usually a good idea for any stock investment anyway.
A final hint: these stocks are generally not for trading. Many of them have fairly small “floats” or shares available for trading publicly. As a result, the bid-ask spread can sometimes be maddeningly wide, and you run some risk of buying or selling at a slightly less-than-optimum price. Issue’s we’ve listed here have floats that are considerably lower than the common. But they should be large enough to allow you to get in and out with minimal pain most of the time.
Nevertheless, these stocks are, contrary to current wisdom, perhaps the last of the true “buy and hold” situations worth owning if you need regular income.
For more in-depth information on various companies’ preferred, including links to the prospectuses (prospecti?) of the newer issues, visit QuantumOnline, a site where you can research various preferred stocks via the “mother stock’s” ticker symbol which you will need to know. (Note that some preferreds actually use a somewhat different symbol than the mother stock uses.) At this site, you can also find out when dividends are paid for a given issue and other interesting stuff.
As we wrap up this column, we’d like to mention in passing that the Prudent Man has spent a lot of time in the market since 1979 and is pretty good at this yield-sleuthing stuff, even in our current very-weird market. That said, things change, so if you’re considering doing something like what we’re outlining here in a fairly big way, or anything else for that matter, do check with your accountant and/or tax attorney on this particular investment idea.
Preferred dividends, for example, have been subject to certain favorable tax treatment, which may change after January 1, 2013 due either to Dodd-Frank, Obamacare, or both. But Congress—and the IRS—have a way of changing their minds on a dime, so beware if you’re not a professional in the field.
One of the serious problems American businesses and yours truly have had during the current Administration and Congresses is that fact that so much tax law is either indefinite at this point or in flux. As investors, even retail guys like you and the Prudent Man either are or may be subject to some unpleasant tax changes as well. The Administration is dying to get its clutches into your dividends and “passive” income, namely capital gains in stocks and real estate.
So beware. No matter what you get into, you might have some heartburn when you figure out what’s going to happen to your income flows in 2013. (You might also try to remember this when you vote in November.)
That said, the kinds of yields we’re talking about here are still going to be better than T-Bills or moneymarket funds, even though the risk is obviously somewhat higher. Just remember, though, that you might be netting a lower percentage than you first thought when you take potential 2013 taxation in mind.
It’s worth mentioning at this point that if we really do hit the threatened “tax cliff” everyone is talking about (and doing nothing about) on January 1, 2013, some of these high-yielding stocks might irrationally sell off, big time.
Frankly, we don’t worry about this a lot. We plan to pick in to some of the stocks on our list above over the next several trading sessions. But not a whole lot just yet. That way, if people start dumping these stocks near the end of the year, we can double down at lower prices, effectively increasing the yield. It’s always good, particularly today, to have some cash sitting in your drawer for just this kind of opportunity.
But always remember: nothing is guaranteed. When the Prudent Man scooped up those junk bonds and cheap preferreds in March 2009, he did so with white knuckles on his mouse (now a trackpad) and with a handy, open bottle of Maalox at his side. Although we don’t much admire Warren Buffett, we do subscribe to his main rule for establishing stock positions: namely, your best buying opportunities happen when there’s blood in the streets. But it’s emotionally hard to do this.
If the tax cliff really comes to fruition and if panic selling occurs late this year, probably after the elections, wait for it to climax in volume and violence. Then grit your teeth and go look for some bargains, particularly in yield.
It’s scary as hell, for sure.
But like the impossibly tanned, well-coiffed, and well-manicured women prowling Rodeo Drive like to say, “When the going gets tough, the tough go shopping.” Which is a great corollary to Buffett’s bloody rule.
Have a good weekend.
*(Note: The symbols used to call up various preferred stocks when you’re trading at home on your PC or Mac can vary wildly among brokers, websites, and exchanges. The symbols we list here generally work if you’re using one of the Schwab trading platforms as we do. You may have to fiddle around with variations to get the quotes on your machines. Irritating, but the info is there. If you use a full service broker, just tell him something like “Hatteras Financial Preferred A” and he or she should be able to take it from there.)
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He intends to nibble on the preferred stocks mentioned above as the occasion warrants.
He sold his positions in leveraged gold and silver ETFs DGP and ACQ near yesterday’s market close, as well a small, day-traded position in regular silver ETF SLV. He currently a position in IAU, a gold ETF. He intends to climb into some of the new preferred stocks mentioned above as the situation warrants.
Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.
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