8.2% Yield And 20% Potential Upside With This Financial Issue

| About: AmTrust Financial (AFSI)

AmTrust Financial Services (NASDAQ:AFSI) underwrites and provides property and casualty insurance in the US and abroad. Investors in the common stock have seen a pretty volatile 52 weeks with prices ranging from $26 to $42 and the dividend of 1.6% doesn't really attract income investors. However, AFSI has a 6.75% Non Cumulative Preferred Stock Series A (AFSI-A, may differ depending on your broker) that could provide income investors with a much higher yield and less volatility.

AFSI-A is a traditional preferred stock, meaning it pays regular quarterly dividends, has no debt issue backing and no stated maturity date. With the issue price at $25 per share, the $1.6875 annualized dividend is good for a coupon yield of 6.75%. However, shares are trading at an enormous discount to their issue price as of this writing at $20.62, implying a current yield of 8.2%. This is more than five times the yield of AFSI common shares and with less volatility as well.

As I said, AFSI-A is perpetual so it has no stated maturity date. However, it does have a call provision whereby AFSI can redeem this issue for the full $25 per share beginning in June of 2018. If this were to happen you'd be entitled to receive any declared but unpaid dividends as well as the call price of $25 per share. With shares trading at a massive $4.38 discount to that price, holders who buy today would potentially receive not only the 8.2% yield but a $4.38 (20%+) capital gain upon AFSI calling this issue. Whether it will be called or not is anyone's guess but in case it is, you'd be entitled to a huge capital gain.

Unfortunately, AFSI-A is non-cumulative, meaning that if AFSI were to miss dividend payments it is under no obligation to make them up. I suspect this plays into the discount to the issue price somewhat because non-cumulative issues are less attractive for obvious reasons. However, with AFSI being the serial security issuer it is, missing dividend payments would have disastrous effects on the company's ability to tap the capital markets in the future. I think the only way dividends would be missed is if AFSI was experiencing a liquidity crunch and it had no choice. That is a long way from happening as AFSI is well capitalized and profitable but it is something to keep in mind and monitor if you are going to own AFSI-A.

AFSI-A is also subject to interest rate risk just like any other preferred stock. Since it has no stated maturity date and no debt issue backing it, AFSI-A is based only on a promise that AFSI will continue to make the dividend payments. In addition, the yield of AFSI-A is going to be judged against other similar issues and as the yields on those issues move up with the broader interest rate market, holders of AFSI-A could see capital losses. The price has already moved down into the $20 range and if interest rates spike, you could see AFSI-A in the teens. This is something preferred stock investors must understand and be okay with before jumping in.

On the plus side, dividends received from AFSI-A are eligible for the preferential dividend tax treatment. This means that holders of AFSI-A in a taxable account will experience much lower taxation on their distributions than they otherwise would with an issue that is ineligible for the favorable treatment. This is a huge positive as it means the high taxation rates of interest payments is not a deterrent with AFSI-A. For those investors looking to hold AFSI-A for current income this is a very nice characteristic.

AFSI-A offers investors a very high current yield and the potential for a very nice capital gain should the issue be called in 2018. Hoping for a call is not a valid investing strategy but it is a very nice kicker on shares of AFSI-A if you are going to be long anyway. AFSI is a very profitable and well capitalized insurer and as long as that doesn't change, I think the dividends of AFSI-A are pretty safe. Understanding the risks I outlined above is important and if you can make peace with those, AFSI-A could provide you with a very nice current yield for many years.

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.