During the summer of 2012, a number of banks began to contemplate calling Trust Preferreds (TruPS) as the capital treatment of the asset class changed and a few issued new traditional preferreds to replace the TruPS that had been called. With four to six months of performance behind these traditional preferreds, a couple are still trading at attractive levels - especially the bank preferreds that have recently paid their first dividend.
Using two financial preferred stock ETFs - PGF and PFF - the general bank preferred market is up slightly (~2%) from mid-June. For any new issues in mid-July to the end of August, the overall bank preferred market performance is flat to negative.
This performance can be attributed to many things, including the uncertainty surrounding the future treatment of dividends and the sudden redemption of some TruPS securities. The performance of individual bank preferreds varies, but by analyzing the right metrics and investing in financial institutions with strong capital ratios, it's possible to pick up relatively safe dividend income in an environment where 0.75% interest rates in savings accounts is considered overwhelmingly high.
Prior to investing in any bank preferreds, I recommend that investors make sure they understand the risks and nuances associated with the asset class. An overview of these risks is available in Navigating The Risks Of Buying Bank Preferred Stocks.
TCF Financial Corp (TCB), 7.50% Series A Non-Cumulative Perpetual Preferred Stock
TCF Financial issued a new traditional preferred in mid-June to replace the 10.75% TruPS preferred that the company called when the change in capital treatment was announced. At 7.5%, the preferred offers a great current yield, especially if an investor had purchased the preferred within the first couple of days of trading. Since then, however, the price of TCB-B has traded up to a level that may not make sense for a conservative investor to get involved:
By all three ratios, TFC is considered to be a "well capitalized" financial institution:
Recommendation: While the current yield of TCB-B remains attractive at just over 7%, the high premium is a tough pill to swallow. At $1.73, it will take four quarters to recapture all of the premium paid - a long time to have this outstanding in the current environment. With such a high premium and only 4.5 years until the call date, the yield-to-call is 5.745% - not a bad number but definitely not 7%. On top of that, the 10 day average volume is only 13k shares, so this is not a very liquid preferred stock. With the high premium, low liquidity, and yield-to-call in line with less risky investments, I would think long and hard about investing in TCB-B, especially with TCF issuing a new traditional preferred soon.
BB&T Corporation (BBT), 5.625% Series E Non-Cumulative Perpetual Preferred Stock
BB&T has been very active in the bank preferred market, issuing three traditional preferreds in the past nine months. Over the summer, BB&T issued Series E, which offers a current yield of 5.517%.
BB&T's three preferreds all trade to comparable current yields, with BBT-D the highest at 5.614% and BBT-F the lowest at 5.324%.
By all three ratios, BB&T is a well capitalized financial institution:
Recommendation: BBT-E offers a lot of liquidity, a current yield of 5.5% and has a premium that will take two quarters to recover. Without the other BB&T preferreds, I think it would look very attractive. That being said, BBT-F offers a comparable current yield (5.3%), better liquidity (197k shares vs. 159k), and trades at a discount so you are not putting any premium at risk. Because BBT-F trades at a discount and has a full five years until the call date, it also has a more attractive yield-to-call than BBT-E: 5.7% vs. 5.2%. At this time I would purchase BBT-F instead of the summer issue BBT-E. Given the price action around the last Ex-Div date (mid-November), I would wait to purchase BBT-E to see if it trades down again after the next one.
*Full disclosure: I am long BBT-F.
Wells Fargo & Co (WFC), 5.20% Series N Non-Cumulative Perpetual Preferred Stock
Wells Fargo issued a new 5.20% traditional preferred - WFC-N - in the middle of August and another 5.125% (WFC-O) three months later. WFC-N closed Friday (12/14) at $25.00, so there is no premium to pay for this security and the current yield is 5.2%.
Both new issues have been trading around comparable current yields while the older (originally Wachovia) issue has been trading at a much higher yield (with a much higher premium). There are also a number of other Wells Fargo preferreds outstanding - a number of them are either TruPS or convertibles.
By all capital ratio measures, Wells Fargo is a well capitalized financial institution.
Recommendation: WFC-N offers investors a current yield and yield-to-call of 5.20% with a solid amount of liquidity (168k shares on average for the past 10 days) while its younger sibling - WFC-O - is trading slightly below par and offers a current yield of 5.17%, a yield-to-call of 5.34%, and has sufficient liquidity of 130k shares for the 10-day average. Both of these look more attractive to me than the older Wachovia preferred - WFC-J. While WFC-J may offer a higher current yield (6.87%) and slightly more liquidity (203k avg. volume), the current price is at a premium that would take nine quarters to recapture, and the yield-to-call is only 4.31%. Bottom line - invest in bank preferreds assuming that the security is going to be called and do not risk paying a premium that will be outstanding for more than two years. For WFC, play it safe with either WFC-N or WFC-O.
*Full Disclosure: I am long WFC-N and WFC-O.
Capital One Financial Corp (COF), 6.00% Series B Non-Cumulative Perpetual Preferred Stock
Capital One issued COF-P in the middle of August to replace the TruPS that they were calling - COF-B. COF-P paid its first dividend at the beginning of December (Ex-Div mid-November) and currently offers an attractive yield, sufficient liquidity, and does not require any premium risk.
Prior to the Ex-Div date, COF-P closed at 25.36 - a premium that would just barely be recovered after the first dividend payment. Since then, the price has traded below par as the preferred market has struggled with uncertainty. COF-P has seemingly found some stability around a yield of 6.0%.
By all three ratios, Capital One Financial is a well capitalized financial institution.
Recommendation: With a yield above 6%, a 10-day average volume of 232k, no premium to worry about, and backed by an institution with great capital ratios, there doesn't seem to be a lot of reason not to invest in COF-P. The only thing that stands out are the ratings: both Moody's and S&P rate COF's preferreds just below investment grade. Given the strength of Capital One's core businesses, I am comfortable with COF-P and its below investment grade rating. This is something, however, that you should make sure you are comfortable with prior to investing.
*Full Disclosure: I am long COF-P.
State Street Corp (STT), 5.25% Series C Non-Cumulative Perpetual Preferred Stock
In mid-August, State Street issued an investment-grade preferred at 5.25%. At the current price, the slight premium will be recovered with the next dividend payment and the yield-to-call of 5.22% is slightly lower than the current yield of 5.24%. Having recently traded Ex-Div (and making its first dividend payment on 12/17), STT-C has traded down from $26 to around par, a price drop that now offers an attractive dividend with virtually no premium risk.
State Street Corp is well capitalized by all ratios.
Recommendation: From mid-September until mid-November, STT-C traded up to a premium that would have made me think twice about investing (and I figured I would be selling if the trend continued). Since then, STT-C has traded back down nearly to par, offers a current yield around 5.25% and a yield-to-call that is very close to that. State Street is well capitalized and STT-C is rated investment grade and offers sufficient liquidity.
*Full Disclosure: I am long STT-C.
JPMorgan Chase & Co (JPM), 5.50% Series O Non-Cumulative Perpetual Preferred Stock
JPMorgan issued a new preferred at the end of August at 5.5% - compare that to the 8.625% preferred they issued at the end of August in 2008 and you get an idea of how much the bank preferred market has changed (and how much rates have come down). JPM-D paid its first dividend at the beginning of December and has since stayed at an attractive level near par.
Comparing the current yield of JPM-D to JPM-I makes for a fairly non-descriptive graph because of the vastly different levels. Given the premium and short time until the call date, it makes sense to focus closer on JPM-D.
The yield of JPM-D has remained in a relatively tight band, trading between 5.4% and 5.55% since being issued.
JPMorgan is a well capitalized financial institution by all three ratios.
Recommendation: JPM-D is trading around par with solid liquidity (241k average shares over the past 10 days), and a current yield and yield-to-call around 5.50%. The one downside that comes to mind about the position is the split rating - Moody's rates JPMorgan's traditional preferreds as just below investment grade while S&P rates them above. This is something that an investor needs to be comfortable with.
*Full Disclosure: I am long JPM-D.
New Bank Preferreds from Summer 2012
A number of the bank preferreds that were issued during summer 2012 are trading near par and offer attractive returns. Many of them have recently paid their first dividend and have not traded back up to pre-Ex-Div levels.
As I said at the beginning of this article, it is pertinent that prior to investing in any bank preferreds an investor makes sure that they understand what they are purchasing. I would highly recommend analyzing the docs from the IPO, looking at the recent financials of the underlying company, and reading Navigating The Risks Of Buying Bank Preferred Stocks.