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Summary

  • Income investors can receive a very nice income stream from Capital One's newest issue.
  • With the stock market yielding around 2%, this issue triples the market.
  • Capital One is a very strong, stable issuer, making this attractive.

Investors in large banks stocks like Bank of America (NYSE:BAC) and Citigroup (NYSE:C) have had a tough go of it this year. Dividends are hard to come by, and capital gains have been equally elusive. However, there are alternatives if you want exposure to large banks but want a steady income stream, as opposed to the thrill-a-minute, income-starved common stock. In this article, we'll take a quick look at one of those alternatives, Capital One's (NYSE:COF) newest preferred issue.

The Series C is a new preferred that offers investors exposure to the financial giant without the inherent risk of owning common stock or the company's below-market dividend. The Series C is a perpetual preferred, meaning it has no stated maturity date. However, COF has the option to redeem the Series C at any time after September 2019, or just over five years from now. Whether COF will redeem the Series C is anyone's guess, but as long as you don't pay more than the issue price, it can only mean you're getting your money back and more. In the mean time, you'd collect dividends for five years.

Speaking of the price, the Series C was issued at $25, and sports an annual dividend of $1.56. This is good for a coupon yield of 6.25%, admittedly on the low end of preferred yields, but given the strength and stability of the issuer, you'd expect the yield to be lower. Since trading began, the Series C has drifted down a bit $24.45, bumping the current yield to 6.4%. This would represent the principal risk to owning the Series C; higher interest rates could sink the price of this and other preferred issues, meaning capital losses could become significant over time. I see default risk as virtually zero, so the only way to lose money on this issue is if rates shoot higher. If you're a preferred investor, you've got to learn to live with that.

Unfortunately, the Series C, like virtually any other bank preferred, isn't cumulative. That means COF could potentially stop paying dividends on the Series C, and would not be obligated to make them up. Cumulative dividends are a very nice backstop for income investors, but with COF, the risk of repayment default is pretty much nothing. Some investors won't take on preferreds that aren't cumulative, but in this case, with a very strong issuer, I believe that may be a bit short-sighted.

A positive characteristic of the Series C is that it is eligible for the preferential dividend tax treatment. This means that investors can hold the Series C in a taxable account, and the consequences are likely to be muted. REIT preferreds, for example, aren't eligible for the favorable dividend tax treatment, and this can hinder the ability of certain investors to hold preferreds in a taxable account. However, the Series C could be a good option for retirees who need the money coming from a taxable source. Either way, this is a huge positive.

There are plenty of preferreds that have much higher yields than the Series C, but I still like it for certain investors. Those who want a steady income stream that is still triple the S&P 500's yield from a very strong issuer can do much worse than COF's Series C. The favorable tax treatment is icing on the cake, providing flexibility to both taxable and retirement account investors alike. If you need a nice source of income for years to come and you want a very low-risk issue, take a hard look at the Series C from Capital One.

Source: Capital One Is Paying You 6.4% With Its Newest Issue