Citigroup (NYSE:C) is a very seasoned issuer of odd and complex securities. Before and during the financial crisis, the money center bank was quite creative in coming up with ways to generate capital. The good news is that if you are selective, you can benefit from these issues and generate some income of your own. One such way an income investor can take advantage of these securities is the Citigroup Capital XI 6.00% TruPS (C-Q, may differ depending on your broker). In this article, we'll take a look at how this security could provide your income portfolio with a boost and some principal protection as well.
The Q is a trust preferred security. This means it isn't a traditional preferred stock but is similar in nature. Basically, Citi issues debt which is then purchased by the trust using investor money. Then, when Citi makes debt payments they flow through the trust to the investors holding shares. In essence, you are buying Citi debt by owning the Q. And since this is debt and not a preferred, the payments received are interest and not dividends, thus disqualifying them for the preferential dividend tax treatment. If you are holding the Q in a retirement account, it doesn't matter but for those investors in taxable accounts, the additional taxes could potentially be substantial, materially reducing the after-tax yield. As with any interest-bearing security, it is something to consider if you are thinking of holding the Q in a taxable account.
Citi issued this security at a price of $25 per share and annual interest payments of $1.50, good for a coupon of 6%. As shares are currently trading for only a two cent premium to that price, the current yield, paid in quarterly installments, is also 6%. Thus, in purchasing the Q, you get not only a strong yield but no risk of capital loss upon Citi potentially calling the issue. Many preferreds that are past their respective call dates trade at large premiums to their call prices but no such discrepancy exists with the Q.
Speaking of calling the issue, Citi has had the option to redeem the Q at $25 per share since September of 2009. This means that it could potentially be redeemed at any time. However, this is true of many securities that subsequently remain outstanding for years; I simply mention it because Citi could decide today if it wants to redeem this security and if it does so, holders will receive $25 per share plus any interest payments they are owed. If Citi decides not to redeem this security, it will mature on its own in 2034. With the relatively low interest rate it is paying on this preferred, as 6% is cheap by bank preferred security standards, the odds of Citi redeeming this issue based solely upon the interest rate paid are relatively low in my view. However, Citi could decide for some other reason it doesn't want to pay on this security anymore and redeem it for that reason. No one can know that ahead of time but if Citi decides to keep it, you can receive a very strong yield and the principal protection inherent in the fact that it could be called at any time. If it is called, you receive a nice 6% yield until such time and are then made whole upon redemption.
With the Q, investors can receive a strong yield of 6% from a payer that I would consider very safe. I am fully aware of Citi's problems during the financial crisis but since that time, tremendous strides have been made to clean the bank up and the company's recent profits prove the turnaround is working. Thus, I have no apprehension regarding Citi's ability to pay on the Q; the only real risk I see is that it could be called at any time. With the market price of shares hugging the issue price due to the fact it could be called, I don't see interest rate risk as a problem. If shares drop materially below $25, I believe they'll be bid back up with the idea Citi could call them. If anything, interest rate risk may drive the price of shares up. Overall, the Q could offer investors a strong interest yield from a fundamentally sound payer, although Q shares may be better suited for a retirement account due to their tax status.
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.