A Smarter Citigroup Play: Preferred Shares ETF

Joe Bel Bruno has a good piece of reporting in today’s WSJ, saying that Citigroup shares have been bought in large numbers by retail investors looking for outsize returns.

Some discount-brokerage firms report a surge of individual, or retail, investors buying shares of Citigroup during the past five months, amid the New York bank’s stock-price slide…

“We’re speculators, and that can be really risky, but it’s worth it to take a shot,” said Jin Chen, a 22-year-old Rowland Heights, Calif., resident who recently bought 10,000 shares of Citigroup at $3.10 a share. “This is my opportunity to make some money.”

“Most brokerage customers are looking at a portfolio down 50% from a year ago, and thinking that they have to get even,” said Don Montanaro, TradeKing’s chairman and chief executive.

Citigroup stock is highly volatile — as is any stock trading on option value — and it’s tempting to look at the history of Citi’s share price and decide that if you’d bought at the bottom in March, you would have more than doubled your money right now.

But no retail investors should be going anywhere near Citigroup stock right now. Yes, you might have lost a lot of money in the market, but it’s not smart to try to get it back by taking wild gambles. And a glance at Citi’s preferred shares is all you need to see that the market is still pricing in some massive dilution of Citi common.

If you really feel the need to express the view that the government will always bail out the banks, then Bruce Kelly has a much better idea: buy PFF, the ETF of preferred shares. It’s chock-full of financials, which means that you’re not exposed to idiosyncratic Citigroup risk, it’s yielding a juicy 14% right now, and its expense ratio is very low. If the preferred does end up getting swapped into common equity, you’re better off buying common stock this way than buying it directly today. If it doesn’t, then you get a very nice yield on your money.

Then again, if you’re a 22-year-old making $30,000 bets on Citigroup, perhaps all you’re interested in is excitement. But there are surely cheaper ways of finding that.

Comments

[WebWatcher:]

fisherman, stop this little ad thing.

Apr 02 01:22 PM

[Bruce Kelly:]

Thanks for linking to my article Felix; you've definitely raised my stature in the eyes of my family and friends. My little blog is just the way I keep those same friends and family, whose portfolios I manage, updated without having to send out emails or letters.

I'm not much of a hand holder.

Thanks Again,
Bruce

Apr 02 02:00 PM

[klarsolo:]

An even better bet than PGF would be PFF or PGX, because they are more diversified and actually own trust preferreds, making them even safer. PGF doesn't own any TRUPS.

Apr 02 02:04 PM

[Bruce Kelly:]

The article IS about PFF.

On Apr 02 02:04 PM klarsolo wrote:

> An even better bet than PGF would be PFF or PGX, because they are
> more diversified and actually own trust preferreds, making them even
> safer. PGF doesn't own any TRUPS.

Apr 02 02:20 PM

[klarsolo:]

Whoops. Sorry, I'm being blind today. Thanks for heads up, Bruce. I've seen a lot of similar articles all recommending PGF, so I guess I was on autopilot when I wrote my response.

Apr 02 02:43 PM

[Amateur Hour:]

Felix -

The smarter play on the Citi preferred was to use a convertible arb strategy -- go long citi preferred and short citi common.
Because the conversion value of the preferred was set by the Treasury term sheet at 85% of par, this strategy allowed the investor to, in essence, lock in a risk free return.

IMHO, the safest way to play financials is to wait and see whether treasury will have to make additional capital injections into the other banks (e.g. BAC).

Assuming they use Citi as a template, it would be wiser to implement the convertible arb strategy I've touched on above rather than just go long preferred.

Good luck to all.

Apr 02 03:50 PM

[tedstr:]

I am into CPRF, the cumulative preferreds, at three points averaging about $13 for about $60k. A pretty big bet for me though overall a small piece of my portfolio. Yes I am a retail investor.

But my logic was that A) the conversion of the non-cumulative preferreds was designed to lower some borrowing costs for C, but mostly fix the reserve ratios. B) not likley they will seek to convert these since why would anyone want to give these up since the dividends are guaranteed though they could be suspended. C) If C is looking to lower interest costs they could suspend the dividend on these, but the liability doesn't go away, so it might imporve a cash position but would not help accrual earnings.
D) C earnings are not bad if you take out all the losses for mark to market which is about to happen.
E) I'm making 11% for a really long time and that might be a really excellent return for many years to come. If these things go back to $20-$25...happy days.

Anyone see a flaw in my logic?

Apr 03 08:30 AM

[r cohn:]

YOu can not borrow C stock to short in the preferred swap

Apr 03 12:03 PM

[aarc:]

Taking too much risk with Citigroup?

Giant companies that went through such a horror as C can end up consolidating within less than 32.8% of recovery from losses to the last low or lower lows. Since C ended at $0.97, there is not much lower to go for. However, it has a more probability of consolidating within the range $0.97 to $22.37 for years to come that may last from 5 to 15 years or more. That is a good enough 2,200% potential price appreciation from trough to peak. But most likely, most investors will be selling at a lower lower prices due to extremely stressed patience as time goes by. Examples are Microsoft and Intel that went nowhere for more than 6 years already since their initial bottom of Oct 2002. They are profitable and with significant cash positions but their price performance had been pathetic at best.

A better solution is investing in UYG. It is a 2x ETF of BKX. Less chance of going bankcrupt than Citigroup and more chance of successfully recovering from $1.37 low to $72.79 in 5 to 10 years time. A 32.8% price recovery to $28.72, assuming it performs just as bad as Citigroup, will give it a price appreciation of 2,000%. Less than 200% than the potential for Citigroup but you sleep much better at night.

UYG also gives a dividend of 15% - not bad at all against PFF of 14.27% as of today using Google Finance.

UYG can also jump much faster than PFF. During this last run up, PFF made 77% appreciation while UYG made 128%. Not bad at all. IF PFF recovers 100% of price loss since 2007 from $14.10 to $50.57 in 5 to 10 years, then the total potential price appreciation would be 261% - pathetic as compared to UYG's potential 2,000% even if UYG only recover 32.8% of price lost from 2007.

A full price recovery for UYG will give it a potential 3,591% price appreciation from trough to peak.

Apr 03 03:53 PM

[Vladimir Se...:]

Full price recovery for UYG?

UYG is a leveraged ETF attempts to replicate DAILY results. The important part is DAILY results. If you need more info on that please review a prospectus of any leveraged fund that attempts to replicate DAILY results, they all have examples that illustrate how they work.

I'm sure you didn't account for that in your calculation.

What I'm trying to say is that even IF the underlying return to the "levels of 2007", whatever that means, that does not mean that UYG would also return to those "levels of 2007".

Apr 06 12:32 AM

[bapolen:]

It was tanking on Friday over this Tuesday meeting and news of a reverse split causing a delusion of shares after the reverse split think it may be 7/1?

Apr 19 05:49 PM