Another Principal Protection Strategy For Today's Preferred Stock Investors

 |  Includes: PLD, WFC
by: Doug K. Le Du

An interesting opportunity has presented itself with respect to six specific preferred stocks, an opportunity that allows preferred stock investors to purchase shares above these securities' $25 par values and still realize a positive return on their investment.

While an earlier article explained a principal protection strategy that uses the wholesale Over-The-Counter stock exchange to purchase preferred stock shares below their $25 par value (see "Principal Protection For Preferred Stock Investors During A Low Rate Environment"), this article presents a very different approach to principal protection.

Calculating the Final Payment Amount

When a formal redemption announcement is made for a preferred stock, the company will state that they will be buying back the shares from holders on a specific date for a price equal to the security's par value ($25.00 per share is used here) plus any accrued dividend amount since the most recently completed quarterly payment date. Annoyingly, the announcement will generally not state what that accrued distribution amount is, forcing everyone who cares to reach for their calculator.

Also remember that redemption announcements must be made at least 30 days in advance of the announced call date. This becomes important later.

Here is the formula used to calculate that final "accrued distribution" amount for a redeemed preferred stock (the final, and usually partial, quarterly dividend):

[accrued distribution] =
{ ( [par value] x [div rate%] ) / 360 } x ([number of days] - 1)

The [number of days] value is the number of days between the first day of the current dividend quarter (the day after the most recent dividend payment) and the announced call date (but not including the announced call date itself, so you need to subtract one day).

The [final payment] amount received by shareholders will therefore be equal to the [par value] plus the [accrued distribution]. The next time you receive a redemption notice for one of your preferreds you can use the above formula to figure out the exact amount of your final payment.

Price Behavior of a Redeemed Preferred Stock

As you might guess, after a redemption announcement is made, but before the announced call date arrives, the market price of the redeemed preferred stock will jump right to the [final payment] amount, plus or minus a few pennies, and stay there as the announced call date approaches.

A current example is the widely held BWF trust preferred stock which Wells Fargo (NYSE:WFC) just called on January 30, 2013 for March 15, 2013. Feeling generous, Wells Fargo gave 45 days' notice to shareholders rather than the 30 days required by BWF's prospectus.

In their January 30 redemption announcement for BWF the bank stated "This issue will be called for redemption on March 15, 2013 at $25.00 per share plus any accrued distributions." Using the above accrued distribution formula, the final payment for BWF should be:

$25 + { ( $25] times [7.875%] ) divided by 360 } times ([90] - 1)

or $25.48 per share.

BWF Redeemed on Jan 30 for Mar 15

Notice how the market price of BWF has settled at this exact price, $25.48 per share (Friday, February 15, 2013).

Using the above formula, the amount of the final payment can be calculated for any day that a redemption may occur throughout a dividend quarter.

If a redemption is not announced, those holding shares (regardless of the price they paid) will receive the upcoming quarterly dividend payment which counts toward the total return of their investment regardless of when a redemption may occur in the future.

The Positive Return Line

Since the final payment includes the accrued distribution amount for the final quarter (or portion thereof), the issuing company will owe shareholders a larger amount for every day that goes by throughout a dividend quarter without a call.

The black line on this chart shows the final payment amount over a 90 day quarter that holders of a 6.75% preferred stock will receive using the above formula.

Those who purchase shares for a price that is below this line will realize a positive return on their investment in the event of a redemption (that is, their purchase price will be less than the final payment received on the final day).

Final Payment Amount - 6.75%

It is for this reason that you will see preferred stock shares trading above their par value, even when they are obvious redemption candidates (e.g. today's bank-issued trust preferred stocks).

As noted earlier, companies usually give 30 days' notice of a redemption. If a redemption is announced 45 days into the quarter, for example, shareholders will actually receive the final payment 30 days later on day 75 (in an amount equal to 74 days of dividend income since the final day is not counted).

Obviously, those purchasing above par, but below the final payment amount, are hoping that the security is redeemed sooner rather than later. So this approach to principal protection is a shorter-term strategy and delivers returns more quickly if you can identify a preferred stock that is highly likely to be redeemed in the not too distant future.

Who Ya Gonna Call

One way to gauge the likelihood of a call is discussed in the SA article titled "Is Your Preferred Stock about to be Called?" from April 2012.

Another way is if a spokesperson from the issuing company discloses something that they probably should not have.

On February 6, 2013 the executive team from ProLogis (NYSE:PLD) held their quarterly conference call (see transcript) to discuss the company's performance for Q4/2012 with Wall Street analysts. During his prepared remarks, CFO Thomas Olinger described their strategy in the wake of the April 2011 merger with AMB for selling underperforming properties and using the proceeds to pay down the company's obligations, saying

...As we've been saying for some time, this is an asset-driven plan, and our achievements will significantly improve our cost structure, our balance sheet and our liquidity. To put this all in perspective, by the end of 2013, we will have reduced our leverage, including preferreds from 50% at the merger to 37%...

After their prepared remarks, the floor was opened to questions from the analysts. Michael Bilerman from Citigroup Inc.'s research division asked Mr. Olinger to "peel back the onion a little bit" and provide the next layer of detail on these plans for 2013, specifically mentioning PLD's outstanding preferred stocks. Mr. Olinger then stated more piece would be the preferreds, as you mentioned. We can redeem all but one series of our preferreds. That's just under about $0.5 billion.

PLD has seven preferred stock series currently trading, six of which are well beyond their respective call dates and can be redeemed at any time.

While short of a formal redemption announcement, these two statements, taken together, are about as close as executives ever come to divulging future plans for redeeming their outstanding preferred stock shares and the timeframe within which they may do so.


The blue line on the below chart shows the daily closing price for PLD-S, a 6.75% preferred stock from ProLogis, since its most recent dividend payment date on December 31, 2012.

PLD-S In Positive Return Territory

Notice that PLD-S has been trading well below what the final payment amount would be if this security were to be called this quarter.

For example, if ProLogis had announced a call of PLD-S last Friday with 30 days' notice, the actual call date would occur 74 days into the current quarter on March 16 (being a Saturday, shareholders would receive the payment the following Monday, March 18).

Using the formula that I provided earlier, 74 days worth of dividend for the 6.75% PLD-S amounts to $0.35 so shareholders would receive $25.35 per share if ProLogis had called PLD-S last Friday - the day that buyers were scooping up shares of PLD-S for $25.18.

Using Redeemable Preferred Stocks as a Principal Protection Strategy

Purchasing redeemable preferred stocks that are priced below their final redemption payment amount is more of a principal protection strategy than an approach taken for yield maximization. Those pursuing this strategy are trying to protect their principal with the possibility of additional dividend income for each quarter that the expected redemption does not materialize.

CFO Olinger's February 6 comments make ProLogis preferred stocks good candidates for this principal protection strategy since the company's six preferred stock issues should now be considered highly likely to be redeemed this year.

The table below the above chart provides the daily dividend amount needed to calculate the magic market price for each of these ProLogis securities, below which buyers will realize a positive return in the event that ProLogis announces a redemption.

As long as the current market price of a preferred stock is below the amount of the final payment as calculated 30 days into the future (using the formula provided earlier), today's buyers can use redeemable preferred stocks to realize positive returns while protecting their principal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Securities identified within this article are for illustration purposes only and are not to be taken as recommendations. I hold shares of PLD-O, PLD-P and PLD-S.