New Preferred Stocks: How To Buy Shares For A Discount Below Par

Due to some interesting timing, 2012 is likely to be a banner year for new preferred stock issues. Because many new preferreds are expected to be introduced throughout the year, it is important for preferred stock investors to understand a little known technique that allows you to purchase newly issued preferred stock shares for a discount.

As I am about to explain, savvy preferred stock investors are able to buy shares of newly issued preferred stocks for a market price below par. It's easy to do but surprisingly few preferred stock investors take advantage of this technique and end up paying more than they need to for their shares.

Most preferred stocks become callable five years after they are first introduced to the marketplace. When retiring (calling) older preferred stock shares companies will frequently issue a new preferred stock at today's lower rates and use the proceeds to call their older, more expensive issues (they refinance)...

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Fed Policy Delivers Stable Prices And 7.3% Preferred Stock Dividend Yield

The Federal Reserve's low-to-no interest rate policy has pushed preferred stock investors to the top of the pile for yet another year. For high quality preferred stock shares purchased throughout 2011, preferred stock investors earned about 7.3% at what many would consider to be very low risk. Very few others are making that claim.

Here are the results for high quality preferred stocks, savers (those investing in bank Certificates of Deposit) and common stock investors (as reflected by the S&P 500 common stock index) for 2011.

High Quality Preferred Stock Performance, 2011

Thanks to the Fed's low-to-no interest rate policy, which the Fed has committed to for at least another couple of years, market prices for high quality preferred stocks remained stable throughout the year as did their dividend yields.

As illustrated by Figure 1...

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REIT Preferreds: An Attractive Alternative To Big Bank TRUPS In 2012

As odd as it seems, the Wall Street Reform Act, signed into law in July 2010, is likely to make high quality preferred stocks issued by Real Estate Investment Trusts (REITs) very popular throughout 2012. Odd since the Act has nothing to do with REITs.

Trust Preferred Stocks (TRUPS), issued by our Big Banks for the purpose of boosting a key metric of their regulatory reserves ("Tier 1 Capital"), are no longer going to be able to be counted as such beginning on January 1, 2013. Consequently, such TRUPS, which are very popular with preferred stock investors, are highly likely to be retired ("called") as their call dates arrive.

As the relevant provisions of the Wall Street Reform Act reduce the supply of bank-issued TRUPS throughout the year, high quality preferred stocks from REITs will offer an attractive alternative to many risk-averse investors seeking to preserve their dividend income...

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Preferred Stock ETFs: The Downside That Preferred Stock Investors Can Avoid

Exchange Traded Funds (ETFs) offer convenience to investors since buying a share of an ETF provides you with a position in each of the securities that the ETF is composed of in one shot.

But for many preferred stock investors that convenience may not be worth the downside, a downside that is specific to ETFs as Wall Street has applied that model to preferred stocks...

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How To Upgrade A Low Dividend Preferred Stock To A Higher Payer And Have Cash Left Over

Savvy preferred stock investors use a technique called "upgrading" to trade in their low dividend payers for higher payers, and have cash left over.

Upgrading is one technique that preferred stock investors can use to help get more out of your invested funds plus add a layer of principal protection by keeping up with interest rate changes over time...

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September Inflation Highlights Wisdom Of Preferred Stock Investors

2011 has been one of those relatively rare years where the rate of inflation has exceeded the returns provided by bank CDs. Corporate bond yields are also now being entirely eliminated by the current CPI reported this week for September.

The index now sits at an annualized value of 3.87%, up from 3.77% in August.

For 12 of the last 15 months, the CPI has headed up. Increasing commodity costs, largely due to speculators, are more to blame than surging consumer demand (understatement of the year, that). What is surprising about the new CPI value is that, in many financial press venues, the results are being reported as a win for the Fed's monetary policy.

The Fed has a stated goal of keeping the CPI at about 2%. September's number is almost twice that and rising. Also, the Fed's current monetary policy is not, according to their own statements, intended to produce short-term consumer price increases; it is intended to lower borrowing costs in order to stimulate business and, ultimately, economic growth. Not clear how we get to the Fed's Win column with a 3.87% CPI number.

In January 2011 the CPI increased above the average interest yield being paid by 24-month bank CDs in the US. While 24-month bank CD APYs have steadily fallen all the way down to an average 1.3%, the CPI has steadily risen having started 2011 at 2.67%.

Rising inflation impacts income the same way regardless of where that income comes from (bank CDs, bonds, preferred stocks, wages, whatever). In terms of your spending power, there is no escaping it.

At 3.87%, inflation is eating bank CD earnings three times over and has caught up to the 4% being offered by corporate bond yields as well.

The average 7% yield that preferred stock investors are earning on the current crop of high quality* preferred stocks is looking pretty good. Those who have chosen to add high quality preferred stocks to their portfolios are making the right choice.

The CPI will head back down again at some point, but in the meantime it is nice to know that preferred stock investors are getting it right once again. Our feet remain dry at a time when CDs are well under the inflation water level and bond holders should be reaching for the snorkel.

Not clear how this can be tallied in the Win column for the Fed but that's the word from the financial press this week. Odd.

Many Happy Returns.

* High quality preferred stocks have 'cumulative' dividends, carry investment grade ratings and are offered by companies that have a perfect track record of never having suspended a preferred stock dividend.

Citi Trust Preferred Stocks: Can Your Shares Be Prematurely Called?

Citigroup’s trust preferred stocks (TRUPS) are probably the most widely held preferred stocks on the planet. The Big Bank has thirteen TRUPS issues current trading so if you have been investing in preferred stocks for any length of time it is very likely that your portfolio includes some from Citi.

Given that many Citi TRUPS shareholders count on the dividend income provided by these, and other similar, securities there is some concern that Citi could issue a “premature call” of one or more of its TRUPS issues unexpectedly leaving those shareholders without that income.

This is exactly what happened to those holding FTB-C (Fifth Third) last May; that premature call caught many off guard (see the May 20, 2011 post below titled “Fifth Third’s Premature Call of FTB-C: Are Others Next?”).

With the two important exceptions explained here, holders of Citi TRUPS do not need to worry about this. Here’s why.

The Wall Street Reform Act, signed into law on July 21, 2010, removed the primary reason that our Big Banks (assets greater than $15 billion) issued TRUPS to begin with. Beginning on January 1, 2013 these securities will no longer be able to be counted toward the bank’s reserves (“Tier 1 Capital,” closely watched by regulators).

The prospectus of most TRUPS, and certainly those of Citi’s, commonly include language that allows the bank to prematurely retire (“call”) their TRUPS if the government changes the rules of the game after the TRUPS is issued (which is exactly what happened when the Act was signed into law). A “premature call” is what happens if the bank exercises their option to call the TRUPS prior to the security’s published call date. In that event, the bank buys your shares back from you at $25.00 per share and the shares stop trading.

In most cases, that prospectus language says that while the bank is allowed to prematurely call their TRUPS, they must do so within 90 days of the “event.” All of Citi’s TRUPS have this 90 day limitation language, but it is not quite that simple.

The prospectus language defines such an “event” as either (a) the announcement of a change in the Tier 1 Capital formula or (b) the actual implementation of such a change.

That means that Citi has two windows during which they can prematurely call their TRUPS. The first window, now closed, was open for the 90 days following July 21, 2010 when the Act was signed into law (an announcement of a change). The second window, yet to be upon us, will open for 90 days beginning on January 1, 2013 when the change becomes effective.

So what is your exposure to a premature call of Citi’s thirteen TRUPS issues?

First, we can eliminate the seven Citi TRUPS that have already reached and exceeded their respective call dates: C-V (July 13, 2006), C-Z (September 17, 2006), C-S (February 13, 2008), C-R (September 30, 2008), C-Q (September 27, 2009), C-O (June 30, 2011) and C-U (September 15, 2011). These seven issues are not at risk of being prematurely called by Citi since these issues are already callable.

That leaves six Citi TRUPS that need to be looked at.

The next premature call window opens on January 1, 2013, so we can eliminate the four Citi TRUPS issues that will reach their published call dates between now and then: C-W (December 31, 2011), C-E (March 15, 2012), C-F (August 15, 2012) and C-G (December 15, 2012). You do not need to be worried about a surprise premature call for these four Citi TRUPS since they will have reached their respective call dates before the next premature call window opens on January 1, 2013. If you own shares of these four you are safe.

So we are down to the two remaining Citi TRUPS, C-J (March 30, 2015) and C-N (October 30, 2015). If you own shares of C-J or C-N the Act made your shares callable during the 90 days beginning January 1, 2013 regardless of their published call dates.

Remember, per the prospectus if Citi is going to prematurely call these TRUPS they must so within 90 days of the “event.” If Citi chooses not to call C-J and/or C-N during the first 90 days of 2013, the window closes again. In that event, your shares of C-J and C-N cannot be called by Citi until their published call dates (March 30, 2015 and October 30, 2015, respectively).

If you paid less than $25 per share for any of these Citi TRUPS congratulations are in order. You will earn a nice capital gain in the event of a call (premature or otherwise). If you paid more than $25 (which you should never do) pay close attention to the price and call status of your shares as explained here. You may still be able to avoid a capital loss by doing so.

Many Happy Returns.