Friday, March 25, 2011

Citi's $0.01 Announcement More Than Symbolic To Preferred Stock Investors

If I offered you these two dividend paying investments to pick from, both from the same company, which would you choose?

A: $0.45 per share each quarter with a written guarantee that if I missed a payment I would be required to make it up to you downstream (i.e. the dividend I owe you is ‘cumulative’); OR

B: $0.01 per share each quarter, you only get paid after I have paid everyone who chooses investment A and if I miss a payment to you, too bad for you.

Citigroup’s announcement on Wednesday that they were going to (a) perform a 10 for 1 reverse split of their common stock and (b) start paying common stock holders a $0.01 per share dividend was probably more meaningful to preferred stock investors than to those holding Citi common shares. The $0.01 dividend is the maximum allowable by the government until 2012.

A lot of cheering was heard from the corner of Citi’s common shareholders with the stock’s price jumping 4% on this largely symbolic announcement. But little reported was that the message was much more substantial, way beyond symbolic, to Citi’s preferred stock investors.

Since preferred stock investors are always paid their dividends before common stock dividends are paid, preferred stock investors know that they are safe as long as the company continues to pay a common stock dividend. Citi got the attention of their preferred stock shareholders when it eliminated its common dividend in February 2009 (message to preferred holders: you’re next). The safety net had been removed.

Then, after being net-free for a year, the ratings on the company’s preferreds were downgraded below investment grade on February 24, 2010 and have remained in speculative grade territory ever since.

Wednesday’s news that Citi is going to pay a common stock dividend (even a symbolic $0.01) lowers the risk profile of Citi’s preferred shareholders substantially. The safety net that was removed over two years ago has been put back in place; an infinitely thin net, but a net nonetheless.

The announcement not only made a statement to Citi’s current preferred stockholders, but it also said something to preferred stock investors considering a new purchase.

Take a look at this table from the perspective of an investor trying to decide between (A) Citi’s preferred stock or (B) Citi’s common stock. Citi has a total of 16 preferred stock issues currently trading. The five shown here not only have the ‘cumulative’ dividend provision (meaning that if Citi misses a dividend payment they still owe you the money per the prospectus), but they are currently (March 25) trading for less than their $25 par value (the value that shareholders will receive in the event that Citi retires these shares).

The annual yield on these five Citi preferreds is about 7% while the annual post-split yield on Citi’s common has so many zeros in front of it that it’s not worth printing. And with a $0.01 dividend an individual investor would have to buy 1,000 common shares just to pay for the $10.00 online broker transaction fee for that buy order.

Yeah, but what about the big downstream potential when Citi’s common stock recovers to its pre-crisis greatness you say. Take a look at the S&P500 chart for the last eleven years and ask yourself that question again.

While symbolic to its common shareholders, Citi’s Wednesday announcement spoke loud and clear to not only the company’s current preferred shareholders (safety net’s back, you’re no longer next) but also to those trying to decide between the company’s common and preferred stocks for a new purchase.

NOTE: the five Citi preferreds shown here are not investment grade securities and do not meet the CDx3 quality requirements described in my book Preferred Stock Investing.

While this symbolic announcement whispered to common shareholders “psst…things are improving,” it screamed to holders of Citi’s preferred shares “your dividends are not only 40x what we are going to pay our common stockholders for at least another year, but we have lowered your risk as well.”

A or B?

Many Happy Returns.