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Preferred Stocks


dcollon
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I wanted to start a brief discussion of preferred's that board members either own or are following closely.  Here are a few that I either own or am keeping a close eye on:

 

Markel (MKV)

Everest Re (RE b)

M&T Bank (MTB a)

US Bancorp (USB j)

Hilltop Holdings (HTH a)

Schering Plough (Convert) (SGP b)

JP Morgan Chase (JPM y)

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I also hold Harris Preferred Capital Corp HBC-, and WFC-L (thanks OEC!!!!!).

 

SJ, you're welcome! At the rate it's falling, I thought I'd better accept the thanks before you change your mind. ;)

 

I'm buying today, fwiw.

 

On the Canadian side, the preferreds of split share corps are beginning to look very interesting again. Many of them are trading at significant discounts to underlying NAV and redemption values in 3-5 years in addition to paying healthy yields. Added plus is that many of them have retraction features that should provide some short term arbitrage opps.

 

I'm normally not a "fixed income" investor but the potential returns now available in preferreds are, imo, equity-like with better protection. I can't remember another time when one could potentially lock in such high returns for very long periods. Someone with experience in the early 1980s might have a better perspective.

 

 

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oec2000,

 

I agree with your comments on the equity like returns.  I have built a small basket that should yield close to 9-10% pre-tax.  In addition, I also believe their is the potential for capital appreciation over time.

 

Time will tell if this is as good an opportunity as it appears to be.

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The price of WFC-L has been ridiculous!  I bought yet more this morning at $325.  This is unbelievable.

 

There are only about 4 basic outcomes that can be reasonably anticipated from Wells Fargo over the next 5 years:

 

1) WFC is as strong as they suggested in their Q4 report

2) WFC runs into some trouble, and maybe cuts the common dividend, but maintains the preferred dividend

3) WFC's loan losses get silly and they chop the preferred dividend for a couple of years out of the next 5.

4) The bottom drops out of our financial system and Wells goes under.

 

For somebody with a long-term (ie 10 years) holding horizon, the cards are stacked drastically in favour of ridiculous returns from the L-series:

 

In case #1, if they earn big bucks as they have suggested, we could see WFC-L approaching par in 5 years.  Based on today's prices, this would be a dividend of 20% plus a capital gain of 200% over five years!!!!  That's like an annual return of about 40%!!!!!

 

In case #2, if they maintain the dividend, I can't imagine the price of WFC-L going any lower than it is today....but it might not go higher.  So you get a dividend of 20% per year and 0% capital gain.  An annual return of 20%?????  Heavens!

 

In case #3 if the dividend gets chopped for 2 years out of 5, assuming that they fix their operations and WFC-L won't drop much more, but it probably wouldn't go up either.  In that case, you're looking at an average dividend of about 10% over the five years!

 

Case #4 is the unlikely armageddon  scenario, where you get whacked with a permanent loss of capital.  But even then, you'll probably get at least a year of dividends before disaster strikes.  So, that might be -80% over 5 years, or about -18% per year.

 

 

So, weight out the scenarios:

 

            Probability        Return

Case 1:  50%                40%

Case 2:  30%                20%

Case 3:  15%                10%

Case 4:    5%                -18%

 

Composite average:    26.6% per year for the next five years!

 

 

I'm pretty comfortable withe the four states of nature.  IF you don't like my subjective probabilities put in your own....but unless you figure there's a high probability of WFC going under, it's a drastic no-brainer at $325 per share!!!!

 

SJ

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Please point me to the ins and outs about WFC's preferred.

What are the terms and conditions and under what conditions their dividends can be suspended.

if they are suspended, when they resume again, should they catch up before giving common stock dividends ?

 

how does this work.

 

can they get converted to common, in the future ?

 

what can go wrong as per the terms and conditions of issue ?

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The "J" & "L" preferred series are non-cumulative -- meaning in the event a corporation does not declare a dividend, the corporation is not obligated to ever pay the missed dividend.

 

Traditional preferred stocks generally have a fixed dividend and are entitled to dividend payment before any distributions are made to common shareholders.

 

WELLS FARGO & CO. 7.50 NON-CUM. PERPETUAL CONV. CL A PFD. SERIES L WFCL

 

WELLS FARGO & CO.. DEP SHS (REP. 1/40TH INTEREST IN A SHARE OF 8.00% NON-CUM PERPETUAL CL A PFD J) WFCJ  (qualifies for the 15% US tax rate*)

 

There may be other provisions specific to these issues...I didn't check the Edgar filings

 

*according to www.perferredstockguide.com

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On the Canadian side, the preferreds of split share corps are beginning to look very interesting again. Many of them are trading at significant discounts to underlying NAV and redemption values in 3-5 years in addition to paying healthy yields. Added plus is that many of them have retraction features that should provide some short term arbitrage opps.

 

 

How do you use the retraction features? You just tell your broker?

 

 

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What about the scenario where the gov't and private investors come in ahead of the pfd and the pfd becomes a fixed income bond with no equity participation based upon selling the toxic asset acquired from WAC at market value to combined public/private fund?

 

Packer

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How do you use the retraction features? You just tell your broker?

 

Yep. Just call and tell them you want to surrender your preferreds for retraction. I use TD Waterhouse and I have had no problems with their reps with these instructions. You should read the prospectus and the presecribed retraction form - sometimes, you have choices/options that you will have to give the broker.

 

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Please point me to the ins and outs about WFC's preferred.

What are the terms and conditions and under what conditions their dividends can be suspended.

if they are suspended, when they resume again, should they catch up before giving common stock dividends ?

 

how does this work.

 

can they get converted to common, in the future ?

 

what can go wrong as per the terms and conditions of issue ?

 

WFC-L from www.quantumonline.com

 

SECURITY DESCRIPTION:  Wells Fargo & Co., formerly Wachovia Corp. 7.50% Non-Cumulative Perpetual Convertible Class A Preferred Stock, Series L, liquidation preference $1000 per share, not redeemable at any time, and with no stated maturity. Non-cumulative distributions of 7.50% ($75.00) per annum are paid quarterly on 3/15, 6/15, 9/15 & 12/15 to holders of record on the record date which will be the last day of the month prior to the payment date (NOTE: the ex-dividend date is at least 2 business days prior to the record date). The dividends are non-cumulative and if the board of directors does not declare a dividend or the company fails to pay a dividend declared by the board for any quarterly dividend period, the holder will not be entitled to receive any dividend for that quarterly period and the undeclared or unpaid dividend will not accumulate. Dividends paid by the preferred are eligible for the 15% tax rate on dividends under normal holding restrictions and are also eligible for the dividends received deduction for corporate holders (see page S-40 of the prospectus for further information). The preferred shares are convertible any time at the holder's option into 32.0513 common shares of Wachovia Corp. (NYSE: WB), an initial conversion price of $31.20 per common share. On or after 3/15/2013, if the price of the common stock exceeds 130% of the conversion price for 20 of any 30 consecutive trading days, the company may, at their option, cause the preferred shares to be converted into common shares at the then prevailing conversion price. In regard to the payment of dividends and upon liquidation, the preferred shares rank equally with other preferreds and senior to the common shares of the company.

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I'd appreciate comments about the PowerShares Preferred Financial Portfolio ETF (PGF)

 

It's currently yielding ~20%  Risk spread across ~40 pfds from ~20 companies

 

http://www.invescopowershares.com/products/holdings.aspx?ticker=PGF  holdings as of 2/20/09

 

http://www.invescopowershares.com/pdf/P-PGF-PC-1.pdf 

 

The underlying index (market-cap weighted) is rebalanced monthly and the ETF uses a 'sampling' methodology to select the issues.

 

I don't believe the govt will let another major fail, or nationalize the banks...what's the downside to using this basket of financial pfds?

 

 

 

 

 

 

 

 

 

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Guest kawikaho

Any recommendations on preferreds with high yields that are NOT in the financials?  I'm not comfortable with PFF's and PGF's top 10 holdings. 

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kawikaho,

 

Not many that I'm aware of, but Everest Re and Markel are in the insurance space and have less balance sheet risk as it relates to the banks.  However, they obviously face risks from the insurance business.

 

I would suggest taking companies you like and seeing if they have any preferred/debt outstanding that might be interesting.

 

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Bernanke again today said the government wasn't planning on nationalization of our banks.

 

http://finance.yahoo.com/news/Bernanke-again-spurns-talk-of-apf-14468925.html

 

From the above article - When asked about Citigroup during a House Financial Services Committee hearing, Bernanke said nationalization "is when the government seizes the bank and zeros out the shareholders and begins to manage and run the bank. And, we don't plan anything like that."

 

I believe Bernanke's statements and the detailed terms of the Capital Assistance Program announced today by the Treasury Department bodes well for improving the stability of major US banks. The terms include the ability for banks to convert existing government preferreds into common shares. That would lower the outflow of capital (preferred dividends) during a time when banks should be building capital.

 

Treasury announcement and link to white paper with details --  http://www.treas.gov/press/releases/tg40.htm

 

The CAP program also should bode well for existing bank preferreds like the Powershares Financial Preferred ETF (PGF) as banks become less risky.

 

PGF is currently yielding ~19% and has significant capital appreciation potential, my estimate is ~120% over three years, or an ~ 48% annual return.

 

Am I missing something here? 

 

Disclosure - I'm long PGF

 

 

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Eric,

Based on today's closing price for PGF the yield is about 13.59% (as per yahoo).

 

Would you buy at this prices ?

 

Between PFF and PGF, would you prefer to buy both, allocate some mix to both, only one, ??

 

Greatly value your opinions and appreciate if you post your thoughts.

 

Thankyou

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Cheapguy...

 

This position is risky... but I continue to believe the outlook for banks is improving. Today's budget announcement has more money for bank rescue funds $750B in 2009 and $250B in 2010. That sends a very positive message to investors -> The govt plans to do what it takes to keep the banks going. 

 

http://biz.yahoo.com/ap/090226/obama_budget_bailout.html

 

Yahoo's PGF yield is based on 12/31/08 prices. I figured the monthly dividend at $0.115 (last couple have been slightly above $0.115) x 12 = $1.38/year

 

Current yield is 1.38/8.11 ~ 17.0%    If interest rates returned to par (the average coupon for PGF is 7.51%, but I used 8.0%) PGF would trade at $17.25, or ~ 113% gain. Over three years that's 28.6% annualized. Add in the 17% annual dividend and avg total return is ~45%.  The dividend is taxed at 15% or less in the US.

 

That' a simplified calculation and it has holes in it - For example the ETF is not static -- holdings are re-balanced monthly based on the underlying mkt cap index, which weeds out the junk, but adds in appreciating pdfs that may reduce future yields and appreciation. As netnet mentioned a fixed portfolio of several preferreds might be better. Some banks in the EFT could eliminate their pfd dividend, or even be liquidated. But after Lehman the Fed/Treas have chosen to support and/or find a takeover bank that assumes the pfd. I don't think they'll let another major go down.

 

PGF is a bet on our banks and the govt supporting them. I wouldn't bet the ranch.

 

I believe PGF is a better opportunity than PFF because PFF holds 82% financial pfds, yet its current yield is < 11%.

 

Seems like PGF is a better risk/reward than PFF.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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