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Debt, CFA, Portfolio Manager, preferred stocks
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Last week I wrote an article on Banco Santander (STD) in which I laid out the case for investing in the equity of the bank, in which I concluded:

Bottom line: Santander is well positioned to grow within Spain when the economy recovers (yes, this is longer-term) and will continue to grow in the rest of its higher growth markets in the interim. I believe that the bank is in a better position than most of its peers and is not confronted with the same issues its US counterparts were/are since the financial crisis. The bank has solid capital levels and decent return figures although its equity is trading at approximately 50% of book value. Ultimately, I believe that this bank's stock presents value in the near to long-term given its exposure to high growth markets and what I believe is manageable exposure to Europe.

The responses to the article were great and we had a pretty robust discussion in the comment field in which many readers pointed out the risks of the equity. When you see value in a company or sector, and there are parts of the capital structure that are too risky for an investor or portfolio, naturally you tend to look somewhere else in the capital structure to see if that represents value as well. Essentially, we look for an alternative way to gain exposure higher up in the capital structure while still producing strong current income and the potential for capital appreciation. In Banco Santander's case, I thought the preferred might be interesting.

My first thought was that we might see Royal Bank of Scotland (NYSE:RBS) (articles here and here) value in the preferred stock, but this was not to be (both good and bad I suppose as it means the bank is not a basket case, but their preferreds aren't as cheap either) as the preferred stock in Santander had held on pretty well.

There are a couple of choices when looking at Santander's preferred stock (preference shares):

Santander Finance, 6.80% Series 4 (STD-A)

Santander Finance, Float Rate Series 6 (STD-B)

Santander Finance, 6.50% Series 5 (STD-C)

Santander Finance, 10.5% Series 10 (STD-E)

Santander Finance, 6.41% Series 1 (STD-I)

The table below summarizes the various series of preferred stock and shows current prices and yields:

(click to enlarge)

The above table should explain why an investor should be considering Banco Santander S.A.'s preferred stock - mostly below par and significant yield.

The first thought an investor might have is "will the dividend be suspended (as was the case in certain RBS and Lloyds preference shares)"? Turning to the prospectus', the following is stated:

Distributions on the preferred securities are not cumulative. Distributions may not be paid in full, or at all, if the Guarantor does not have sufficient Distributable Profits or if the Guarantor is limited in making payments on its ordinary shares or on other Preferred Securities issued by the Guarantor in accordance with limitations contemplated in the Spanish banking capital adequacy regulations. If Distributions for any distribution period are not paid by reason of the above limitations, investors will not be entitled to receive such Distributions (or any payment under the Guarantee in respect of such Distributions) whether or not funds are or subsequently become available.

and further:

Payment of cash distributions in any year on the preferred securities is limited by the amount of the Distributable Profits of the Guarantor for the previous year, and to any limitations that may be imposed by Spanish banking regulations on capital adequacy for credit institutions, as determined in accordance with guidelines and requirements of the Bank of Spain and other Spanish law as in effect from time to time. Distributions shall not be payable to the extent that:

  • the aggregate of such Distributions, together with [A] any other distributions previously paid during the then-current fiscal year (defined as the accounting year of the Guarantor) and [B] any distributions proposed to be paid during the then-current Distribution Period, in each case on or in respect of Preferred Securities would exceed the Distributable Profits of the immediately preceding fiscal year; or
  • even if Distributable Profits are sufficient, if under applicable Spanish banking regulations relating to capital adequacy requirements affecting financial institutions which fail to meet their required capital ratios on a parent company only basis or on a consolidated basis, the Guarantor would be prevented at such time from making payments on its ordinary shares or on Preferred Securities issued by the Guarantor.

This is the same type of language that was used in the RBS "must Pays"

Preferred Descriptions

STD-A

  • Rating Baa2/BBB-
  • Distributions: Distributions are payable quarterly in arrears on February 21, May 21, August 21 and November 21 in each year.
  • Coupon: 6.80%
  • Call Date: Currently callable with 30 days notice.
  • Prospectus

STD-B

  • Rating Baa2/BBB-
  • Distributions: Distributions are paid quarterly on 3/5, 6/5, 9/5 & 12/5 to holders of record on the record date which will be the 15th calendar day prior to the payment date,
  • Coupon: The floating rate will be reset on the first day of each distribution period and will be equal to the three-month LIBOR plus 0.52% but will not be less than 4.00%,
  • Call Date: 3/05/2017
  • Prospectus

STD-C

  • Rating Baa2/BBB-
  • Distributions: Distributions are payable quarterly in arrears on January 31, April 30, July 31 and October 31 in each year.
  • Coupon: 6.50%
  • Call Date: 1/31/2017
  • Prospectus

STD-E

  • Rating Baa2/BBB-
  • Distributions: Distributions are payable quarterly in arrears on March 29, June 29, September 29 and December 29 in each year
  • Coupon: 10.50%
  • Call Date: 9/29/2014
  • Prospectus

STD-I

  • Rating Baa2/BBB-
  • Distributions: Distributions are payable quarterly in arrears on March 11, June 11, September 11 and December 11 of each year
  • Coupon: 6.41%
  • Call Date: Currently callable with 30 days notice.
  • Prospectus

Bottom line: The dividends are safe on the preferred as long as Banco Santander S.A. has distributable profits, which is very likely (even RBS did during their worst days). Should an investor not want to buy in to the equity slice of the capital structure, the preferred stock slice of the capital structure is extremely enticing as well. The yield at cost and the potential for capital appreciation are attractive and warrant consideration for an income/growth portfolio. The most attractive issue in the complex is the Series 10 STD-E. While they do trade above par, the yield-to-call is a healthy 8.90% and it is the largest and most liquid issue of the preferreds.

Source: Banco Santander - Preferreds Are Attractive