Citigroup (C), like many of its too-big-too-fail brethren, is still a huge fan of issuing preferred securities as a source of funding despite coming changes to regulatory capital that are on the horizon. The good news for income investors is that these issues represent decent choices for buy and hold investors that are interested in collecting large dividends for a long time. In this article, we'll take a look at Citi's newest preferred issue, the Series L (C-L, may differ depending on your broker), and see if it is right for your portfolio.
So what is the Series L? It is a traditional preferred stock, meaning it has no maturity date and no debt issue backing it. In essence, it is perpetual debt that never has to be repaid. This has some implications for investors, not the least of which is that at some point, barring a call, you will have to sell. Many debt investors prefer to hold to maturity to ensure all principal is returned but preferreds offer no such luxury.
And speaking of being called, Citi has the option to call this issue five years from the issue date, which was last week, meaning that mid-February 2019 is the earliest this issue can be redeemed. If this happens, it will be redeemed at the full issue price of $25 regardless of where shares are trading at the time of redemption. This can be positive or negative for holders of the Series L as it could mean you're made whole on your investment or, if rates drop, the price of the Series L may be more than $25 and Citi could redeem it for less than that. In that case, you'd be subject to capital losses. This is something to consider as any debt instrument, particularly one with no maturity date, is going to have interest rate risk. If rates rise and you hold the Series L, you could theoretically be called out of your position for a loss. This is something to understand and consider before you hold any preferred stock, the Series L included.
There are also some other things to consider with the Series L. First, the issue is non-cumulative. This simply means that dividends are not guaranteed in any way. We are all fully aware of the bailout Citi needed during the crisis and if something catastrophic were to happen again, Citi would be under no obligation to continue to pay dividends on the Series L. This means that you could theoretically buy the Series L and never receive a single dividend. In practice of course, this is ludicrous as Citi is in infinitely better shape than it was during the crisis but it is something to keep in mind. I don't think Citi would miss a dividend payment on any preferred unless it was on the brink of bankruptcy so I'm not concerned; some investors understandably don't like non-cumulative issues though.
On the plus side, since the Series L pays dividends and not interest, the distributions are eligible for the preferential dividend tax treatment. This means that for certain investors, the after-tax yield of the Series L is materially higher than it otherwise would be. This can be a significant boost to someone who is holding the Series L for current income, such as a retiree. Of course, if you hold the Series L in a retirement account, it doesn't matter.
Now that we've gotten through all of the disclaimers, what does the issue actually look like? I mentioned the issue price of $25 earlier; that is the price of the depositary shares that trade on the stock exchange as the full Series L shares were issued at $25,000 per share. Each share is entitled to quarterly dividend payments totaling $1.71875 per year, good for a coupon yield of 6.875%. As of this writing, the Series L has not begun trading yet so you have the chance to get into the Series L on the IPO if you wish to do so. An exact date of when the issue will begin trading isn't known until it begins trading on the NYSE. However, it will be within thirty days of February 12th, per the prospectus linked above.
The Series L offers investors a chance to get into a great yielding income security from a global brand that is a household name on the IPO. Citi has come a long way from its darkest days during the crisis and I believe this preferred will make shareholders a lot of money in the coming years. If you are looking for a relatively safe, high-yielding income security that has favorable dividend tax treatment, you can do much worse than the Series L.