Citigroup (C) was on the brink of insolvency during the financial crisis after years of poor management. The company has turned the corner, however, and is back to producing billions upon billions in profits each year. The common stock still pays Citi's famous one cent per quarter dividend, a dubious distinction it shares with its too-big-too-fail brother Bank of America (BAC), so income investors likely aren't interested in Citi common shares. However, income investors can still take advantage of Citi's improving fundamentals through preferred shares. One that I like is the Citigroup Capital XVII 6.35% Enhanced Trust Preferred Security (C.PRE, may differ depending on your broker).
This preferred is essentially a way to get in on subordinated debt that Citi has offered. The subsidiary, Capital XVII, purchases debt from Citi and then pays the interest payments on the debt out to holders of the TRuPS shares. Each share, with a liquidation preference of $25, receives a quarterly dividend of 39.6875 cents for an annualized coupon of 6.35%. As shares are currently trading for just three cents over their liquidation value, the preferred's current yield is a robust 6.34%. In an environment where the S&P 500 (SPY) pays less than one-third of that amount, that is a very strong yield.
However, principal protection is everything in income investing and one of the main reasons I like this preferred is because it has several provisions in it that essentially, but not absolutely, make it almost impossible that Citi would defer dividends on it. To start, in the unlikely event that dividends were deferred, Citi could do so for a period of up to ten years. Before you stop reading right here, let's take a look at why I think that is extraordinarily unlikely.
First, the dividends on this preferred are cumulative. This means that even if Citi defers dividends it cannot throw them out; dividends must be made up after a period of no longer than ten years or on the redemption date. Second, there are numerous conditions placed on Citi if it misses dividend payments on the XVII. In the event a dividend payment is missed, Citi cannot: pay a dividend or make any distributions on its capital stock or redeem, purchase, acquire or make a liquidation payment on any of its capital stock, or make an interest, principal or premium payment on, or purchase or redeem, any of its debt securities or guarantees that rank equal with or junior to the junior subordinated debt securities. In other words, Citi wouldn't be allowed to do much at all if it were to miss a payment on this TRuPS. This includes being forbidden to repurchase any common shares for a period of one year if dividends on the XVII are deferred for four quarters or more. You can imagine the displeasure common shareholders would express if buybacks weren't permitted because of missed TRuPS dividend payments. I believe that one provision alone essentially puts a ceiling on the amount of time Citi would ever consider deferring payments on the XVII.
This security offers terrific income potential with the added principal protection that comes with such robust penalties for Citi if it were to miss dividend payments. This TRuPS became callable in March of 2012 and can be called at any time by Citi at the liquidation preference of $25 per share. However, as shares are trading for $25.03 currently, there is virtually no capital loss implied if you get long here. Another very nice characteristic of this preferred is that it offers terrific liquidity for a preferred security. Average volume on this preferred is 10,000+ shares daily so if you want to get in, it is easy to do so without huge slippage costs. Finally, this TRuPS has a stated end date, March of 2067, which is out of range for most of us but just know that this is a non-perpetual preferred.
The XVII TRuPS offers investors a chance to take advantage of Citi's vastly improved fundamentals without the inherent risks of owning the common stock. In addition, with the common stock paying essentially no dividend to speak of this is a great way for investors to generate a huge amount of quarterly income with implied principal protection that comes along with strong penalties for missing dividend payments on this preferred. These clauses offer investors strong protection of their dividend payments and peace of mind in knowing their money is safe. Citi has fully emerged from the crisis as a stronger bank and with continuously improving fundamentals, income investors can do worse than the XVII TRuPS.