Commerce Bancshares (NASDAQ:CBSH) recently issued a new preferred yielding 6%. Commerce plans to use the $150 million in proceeds to repurchase common stock. Commerce Bancshares is a midwest bank operating in Kansas, Missouri, Oklahoma, Colorado, and Illinois. The bank currently has a market cap $4.4 billion.
So why am I not a fan of the preferred?
Well, the company is making plenty of cash. In FY 2013, the Commerce Bancshares had nearly $340 million in free cash flow. So covering the dividend payments on the new preferred is not an issue at all. Rather the issue is that investors can find better yields for stronger companies.
When analyzing fixed-income investments such as preferreds, you don't just want to look at a companies ability to pay distributions, but investors must also look at comparable securities. Even when buying an income investment, investors want to make sure they get a good deal as well.
So what makes Commerce's new preferred a bad deal?
Let's observe some of the other bank preferreds that exist out there. I picked two new bank preferreds that were just issued a couple weeks ago.
|JPMorgan (NYSE:JPM) Series W||6.30%||$217.71B|
|Capital One (NYSE:COF) Series C||6.25%||$47.40B|
JPMorgan and Capital One both have higher yields on their new preferreds than Commerce Bancshares. Now just to clarify, just because a bank is larger, doesn't necessarily means that it's safer. We learned this from the financial crisis.
I have often worked with underwriters that price new issuances for fixed-income securities. The underwriters typically price securities based around the credit quality of the underlying company as well as the market demand for said security types.
In this situation, Commerce Bancshares has a BBB rating from S&P. JPMorgan also has a BBB rating as well. Capital One has a BB+ rating.
JPMorgan, which is one of the largest financial institutions in the world, has a higher yielding preferred than Commerce Bancshares. Both companies have similar credit ratings. So it would make more sense from a risk standpoint to go with JPMorgan's preferred.
Capital One does have a lower rating, but mainly due to the fact that it has a sizeable credit card portfolio. It's not purely a banking institution, the credit card portfolio is considered higher risk. However, given the stability of the company's revenue, there is still less risk than the rating implies. If we look at Capital One's revenue, it has grown from $18.5 billion to $24 billion in the last three years. By comparison, Commerce Bancshares revenue has declined from $1.1 billion to $1.06 billion in the last three years.
I believe it's best if investors avoid Commerce's new preferred due to the fact that there are better opportunities out there. Investors should use a similar comparative analysis when analyzing other fixed-income securities. Corporations are trying to take advantage of income investors due to this yield starved environment. Don't fall for these traps. Be sure to properly allocate capital to income investments.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.