Wells Fargo (WFC) inherited some strange things when it acquired the failing Wachovia during the financial crisis. In addition to billions of dollars worth of sour mortgages and a mess of a balance sheet, WFC inherited some high coupon preferred securities. One such security is the 8.00% Depositary Shares Non-Cumulative Perpetual Class A Preferred Stock Series J (WFC-J, may differ depending on your broker) and it is the subject of this article.
Wachovia issued this security in 2007, not long before the real trouble began that would eventually hurdle the bank towards failure and into the waiting arms of Wells Fargo. The issue is pretty standard for the time and we'll take a look at its characteristics now. The Series J is a depositary share issue meaning that investors don't buy entire shares in the preferred; rather, investors buy "shares of shares," so to speak. The issue price for these shares was $1,000 but the depositary shares are traded on the NYSE for an issue price of $25 each, with each share representing 1/40th of a Series J preferred share.
In addition, these shares are non-cumulative, which means that if Wells misses a dividend payment, it is not required to make up those missed dividend payments to investors. This is a very large negative for a preferred issue because you could theoretically purchase this preferred and never receive a dividend payment. Of course, with Wells as the payer, there is virtually no chance of that actually happening but if Wells were to get into serious financial trouble at some point in the future, it is something investors must consider.
This issue is also perpetual, meaning that there is no stated maturity date. Unlike exchange traded debt, which can sometimes be confused for a preferred stock issue, true preferreds have no maturity date. Thus, if Wells doesn't call this issue it will persist "forever." There is, however, a call date on this preferred of December 2017. This means that Wells has the option to redeem this security at that time at a price of $25 per share.
This brings us to the main negative I see with this issue and that is the current premium to the liquidation preference. At present, the series J is trading for a very large 13% premium to its liquidation preference. In other words, if an investor went long today and Wells redeemed this issue in four years, the investor would be subject to a 13% capital loss on their position, eating away almost two years' worth of dividend payments. This issue pays a robust $2 dividend on each depositary share which, at the issue price of $25, is good for a very strong 8% coupon. However, with the premium shares are currently trading, the current yield has fallen to 7.1%. While that is still an outstanding yield, one must be cognizant of the premium shares currently held.
Finally, a big plus of this preferred is that it is eligible for the favorable 15% dividend tax rate that will help taxable account holders of this security lower their tax liability. That is a very large plus and should not be overlooked as interest payments, for instance, are not eligible for this favorable treatment and thus, would need a higher pre-tax yield in order to equal this issues after-tax yield.
The Series J is a mixed bag for me. On the one hand, it pays a terrific dividend of $2 per depositary share which, at the current price, means a very strong yield of 7.1%. However, the premium that is currently assigned shares will likely dissipate at some point, leaving investors with significant capital losses. Indeed, we've already seen the price of these shares fall from $31.67 to the current price of just over $28 in just the past year, illustrating the danger of buying a preferred at a significant premium to its issue price. This issue is also non-cumulative and while I don't think Wells is in any imminent danger of missing dividend payments on its preferreds, if you are holding the Series J for more than a few years, it is something you must consider. Finally, the favorable tax treatment is a bonus as it means the after-tax yield for taxable account holders of the Series J get a reduction in their tax liabilities from this issue. If you add it all up, while the Series J is a decent issue, there are better options out there. If you want to stay with Wells issues, the Series N and Series O are much better choices.