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Preferred Versus Common Stock


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I know a few of you have purchased preferred stock versus common stock of some firms.  What drove you to that decision?  I have a situation where an undervalued modestly leveraged firm has both preferred and common.  The preferred is selling at 7% of face, is perpetual, pays a 6.5% dividend, the dividend has been suspended and is convertible into common at a 2757% of the current common price.  The preferred has a coverage ratio of about 3:1.  Given a typical EBITDA multiple, the total equity would be worth $187 million but the perferred trades for about $11 million and the common $26 million.  What securtiy would you invest in?  TIA

 

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Packer,

 

This seems a bit riskier than the preferred stocks I have been investing in. I usually focus on firms that are paying the preferred and yields were out of line with the value and the ability of the company to service preferred payments.

 

For instance, and you can reference the preferred stocks posting from earlier this year when there was a clear imbalance in the portfolios of these firms. This waas a great discussion that lead me to make a lot of money. http://cornerofberkshireandfairfax.ca/forum/index.php?topic=159.0

 

I think in your instance you have to look at what the overall face value + accruing interest due is on the preferred as a percentage of your estimated equity value stabilized. Then adjust accordingly for the returns.

 

 

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Packer,

 

I agree with Junto...there was a lot of mispricing in the credit markets (preferrds, bonds, etc.) earlier this year. Many of the preferrds have increased in value as the yields came back more reasonable levels. There are still a number of preferrd issues priced for default. The companies that manage to stay in business will eventually see their preferrds return to fair value with market yields.

 

The company's preferrds you mentioned seem to be very mis-priced if the coverage ratio is 3:1...Suspending the dividend would definately cause a drop the pfds value, but the price suggests bankruptcy, or never re-instating the dividend. I presume the pfd is not cumulative.

 

If a reasonable market price for the pfd is 85%+ of face (considering the 6.5% coupon), the pfd could move up 10x, or more. You'd have to make a "normalized" earnings estimate and apply a reasonable p/e ratio to value the common and determine its potential gain. My guess is the common has similar short-term potential and greater longer-term potential. I would ignore the common conversion aspect of the pfd because it is so far out of range.

 

Unless you plan on holding the pfd long-term for income in your portfolio, I'd opt for the common...

 

However, if the pfd is cuml, then I might consider buying both to gain the added boost from the ~100% yield on the pfd.

 

Eric

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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I jumped on the preferreds in a big way last winter and made some good bucks out of it.  There were a great many really high quality issues that were ridiculously priced, and it was obvious.  My favourite was HBC- which is a wholly owned subsidiary of the Bank of Montreal which traded as low as 40¢ on the dollar (over 20% yield!) while more senior BMO debt and preferreds were somewhat more rationally priced.  Then there`s WFC-L that OEC identified for us, that was just stupidly priced.  That silliness in the market seems to have come and gone.

 

I would simply suggest that it would be highly important that you know what you are buying and only make an appropriate sized investment in that context.  Without having any knowledge of the potential opprtunity that you are looking at, it would appear that it is a very, very ugly cigar butt.  There`s nothing wrong with that, as those types of opportunities can work out.  But if that`s what it is, then you need to make an appropriately small investment.  We are no longer in a world of buying wonderfully high-quality issues for super-cheap prices which enables us to allocate very large chunks of capital....

 

SJ

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Much like StubbleJumper, I saw 20%+ current yields in preferred stocks earlier this year. Cash paid out yields from solid businesses that would be amongst the last to suspend in a worst case scenario.  I compared those yields to the current and prospective earnings yields or comprehensive income yields for the same or similar companies' common stock (retained or paid out) and couldn't find better. So, thinking a bird in the hand and all that, I bought preferreds.

 

I decided it might be a good idea to buy the preferreds on margin since yields were paid out quarterly and I was onl paying 3.25% in CAD and 4.25% in USD. The spread was almost 18% for WFC-L alone.

 

By using margin I also effectively hedged any foreign currency exposure.

 

This allowed me to use equity cash to buy common stock in the same businesses for the long term.

 

The combination was pretty powerful.

 

The analysis was the same for both, only the implementation was different.

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You buy perpetuals when you`re sure of the cash flow, & yields are high (12%+) - in the expectation that the yield will drop over your holding period. They are volatile, & illiquid, so expect life to be awkward at times.

 

We used them extensively when Canadas were trading in the 16% range & did very well - but dont expect to resell them untill yields return to normal levels. The penalty for illiquidity is severe.

 

SD

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  • 2 weeks later...

Just read gaf63's mention of ORH.pr.A's recent price rise.  It could just be short-term dividend hunters; the dividend is paid to shareholders of record Sept. 30.

 

But at 8% annualized yield, that is attractive for a pretty safe investment.  Also, WFC.pr.L trades at a 9% yield.

 

With USD financing as low as overnight rates plus 0.375% (or much less than 1% in absolute), why aren't more people bidding these issues up?

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ROMC,

 

Actually the pfds have been moving up, although slowly...but I've asking myself the same question...I asked my Fidelity Rep why their house margin equity requirement was 50%, rather than 30% on a most financial pfds (including the PGF ETF). RBS Pfds are non-marginable at Fidelity, yet RBS is 70% owned by the British Government. OK, the government can change it's mind, but I would like to believe they are going to stand behind RBS, like the US and AIG, rather than risk a Lehman Bros collapse. His response was centered around 'risk with the financial sector'.

 

FWIW, Schwab's house requirement is 30% on some of the same issues.

 

Here's my thoughts why they are still mis-priced...

 

Low demand because

 

1) Most retail investors don't know about the pfd situation (hard to find info on them unless you know where to look) and there has not been much in the financial press regarding pdfs.

 

2) There are fewer hedge funds around that normally would be involved in keeping the mis-pricing to a minimum and most hedge funds are looking at bigger opportunities.

 

3) Potential risk...There's potential for eliminating pfd dividends, bankruptcy, etc. But that depends on each individual company.

 

I'm holding a diversified basket of pfds yielding 11.7%. I expect the yield will eventually reach ~7-8%, or lower if interest rates remain low. That suggests 40%-50% more upside potential and I'm earning 12% while I wait...I've only rolled two positions into higher yielding positions, JPM-Y and USB-J when their yields dropped below 7%.

 

I guess WF, BAC, RBS and a number of REITs and Ins Cos could go under, but I'm betting they don't. Hope I'm right!

 

 

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I will jump in on the preferred conversation. This will be a quick brief.

 

As per my posting back on March 25, 2009 I held the following preferreds in my portfolio:

CTZPRA Citizens Funding (Preferred)

WFCPRL Wells Fargo & Co. (Preferred)

HRPPRB HRPT Properties Trust (Preferred)

LNCPRG Lincoln National Corporation (Preferred)

AIVPRY Apartment Investment Mgt Company (Preferred)

HRPPRD HRPT Properties Trust PRFD 'D' (Preferred)

JPMPRY JP Morgan Chase Cap XI (Preferred)

ORHPRA Odyssey Holdings PFD A (Preferred)

 

I have since exited a number of them and entered a new position, so this is my current portfolio. Gross dollars invested between the two is about a third of where I was at before:

WFCPRL Wells Fargo & Co. (Preferred)

HRPPRB HRPT Properties Trust (Preferred)

HRPPRD HRPT Properties Trust PRFD 'D' (Preferred)

LXPPRD Lexington Realty Trust PRFD 'D'

 

I think WFC continues to perform well and the return moving forward at 8.52% on the preferred I believe is still a very good risk/return reward situation. WFC's CEO, John Stumpf was quoted in the Wall Street Journal this week indicating that they still have $30 billion in unused writedowns from the Wachovia merger and that the Wachovia merger is on track. Earnings continue to be realized given the low cost of deposits in the current interest rate environment. General economic conditions are also stabilizing with Bernanke indicating that we may have exited the recession although the job market will remain week. I also own WFC common shares.

 

HRP is a REIT that I believe is on solid footing. The balance sheet represents no maturities on debt until 2011, not detrimental leverage, and with the HRP-B preferred yielding 9.68% and the HRP-D yielding 9.16% I believe they are also good holdings in my stock portfolio. The spin-off of GOV allowed the firm to better enhance their balance sheet and position them well to take advantage of the CRE opportunities coming up because of the CMBS market. Given estimates, the firm has roughly a 6X coverage on the preferred payouts. This givens be comfort that these dividends will be coming for the foreseeable future.

 

LXP is a REIT where I appreciate the management and what they have done throughout the downturn. Although the common stock pays a split stock and cash dividend, the management has used these extra funds to reposition the balance sheet by buying its own debt at a discount. It has also used funds from selling properties at good cap rates to buy debt at even larger discounts; thereby, having a positive spread for the common shareholders as well as better comfort for the preferred shareholders. The company has ample cash flow to service the preferred dividends, around 7X.

 

Overall, I am very comfortable with my current positions. I definitely sold out of some of my earlier positions too soon, but I also hit some homeruns (WFC-L and CTZ-A for example).

 

 

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  • 3 months later...

A number of board members did well with financial preferreds and bank stocks this year, but it looks like David Tepper and his clients hit the jackpot!

 

Fund Boss Made $7 Billion in the Panic

 

http://finance.yahoo.com/career-work/article/108451/fund-boss-made-7-billion-in-the-panic?mod=career-leadership

 

Tepper has parted with some of his holdings, but I haven't. My PFD portfolio still has a 10.0%+ yield and I estimate there's 20%+ appreciation ahead.

 

 

 

 

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The Sears bonds and preferred indentures (SSRAP) are still trading in the low teen yields if anyone wants them.  I think the bonds that I own are trading for about $.60 and I bought some more (they're very illiquid) SSRAP the other day for $13 or so. 

 

Feel free to tell me what a crappy credit Sears is. 

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