Mortgage Documentation Mess Triggers Opportunity For Preferred Stock Buyers

The mortgage foreclosure documentation snafu has created a short-term opportunity for preferred stock buyers. Investors started to take notice on October 14 when the large volume of mortgage loans being reviewed at Bank of America started to become apparent.

Common stock prices of large mortgage lenders and servicers, beginning with BofA, started to slip as concerns about the impact on profits started to spread.

Common stock dividends are tied very closely to quarterly profits so the costly, labor-intensive nature of this task triggered a sell-off very quickly. BofA’s common stock dropped 10% in 48 hours, closing at $11.98 on October 15. And others (Wells Fargo, JPMorgan, SunTrust to name a few) followed.

It did not take long (milliseconds in many cases) before the selling spread to these company’s preferred stocks. Automated selling orders were clearly in charge as daily share volumes tripled instantly on October 15.

What the computer programs have failed to remember is that cumulative preferred stock dividends are more closely tied to cash on hand and are much less tied to this quarter’s profit than the dividends paid on common stock. The dividend payout on cumulative preferred stock is known and reserved in advance, unlike quarterly profit from which common stock dividend distributions are made.

Triggering sell orders for cumulative preferred stock under the same conditions that trigger a sell-off of common stock shares is short-sighted, but has created a great opportunity for preferred stock investors who are paying attention.

Over the same 48 hours that computer programs and other investors were dumping common stock shares of large mortgage lenders and servicers earlier this month, the market prices of these same company’s cumulative preferred stock shares fell by about $1 per share (these have a par value of $25.00). BofA’s investment grade, cumulative preferred stock BAC-C, for example, fell from about $25.15 per share to less than $24 per share and is now trading at $23.88. At $23.88 this preferred stock provides preferred stock investors with an annual dividend yield of about 7.2%.

As messy as it has been to watch, preferred stock investors are benefiting from this latest panic and the automated selling that it has triggered. Market prices on these issues have dropped to levels that they have not been at for many months. If you missed out on the opporunity then, you've just been given a rare, but short-lived, second chance.

Many Happy Returns.