The Preferred Way To Get A Variable-Rate Yield

Includes: BAC, GS, HSBC, MET
by: Valuematters

If you are looking for some yield, but are concerned about the potential for rising rates, you might consider some floating rate preferred securities. In general, the way these securities work is to have some minimum level interest rate they will pay and then to have some adjustment factor over LIBOR. For example, a floating rate preferred could be structured to yield the greater of 1% over LIBOR (3 month LIBOR) or 4%. The benefit of these floating rate securities is they keep pace with LIBOR, which historically has kept pace with the federal funds target rate. So if the Fed starts to raise rates, I expect to see floating rate securities see higher dividends being paid out.

In the table below I have highlighted 6 floating rate preferred stocks, from 4 different issuers (different websites use different methodologies for the symbols on preferred stocks…below I have used the symbols in the same way as Yahoo Finance). Floating rate securities are typically issued by financial institutions, and in this case that is no exception. The issuers I am focused on are Goldman Sachs Group (NYSE:GS), Bank of America (NYSE:BAC), HSBC (HBC), and Metlife Inc (NYSE:MET). All of these securities are non-cumulate, redeemable (all happen to be past the redemption date), and yielding somewhere between 4% and 5.5%. With rates being where they are, all of these are paying out their floor level dividend.

Variable Rate Preferred Stocks
Symbol (Yahoo Finance) Current Yield Using Floor Rate Yield on Par Using Floor Rate Add-on Factor Current Price Par Value (per share)
GS-PD 5.26% 4.00% .67% $19.00 25
BAC-PE 5.17% 4.00% .35% $19.35 25
BML-PG 4.37% 3.00% .75% $17.16 25
HBA-PF 4.33% 3.50% .75% $20.21 25
HBA-PG 4.71% 4.00% .75% $21.23 25
MET-PA 4.33% 4.00% 1.00% $23.09 25

GS-PD - These are issued by Goldman Sachs and they offer a minimum rate of 4% (on par value), and using this minimum rate these shares offer slightly above 5% in terms of current yield and would offer this same payout or LIBOR plus .67% going forward (which ever is higher). From May 24th 2011 the issuer has the right to redeem these at a liquidation value of $25 per share, plus any accrued and unpaid dividends. You can see the prospectus here.

BAC-PE - These are issued by Bank of America and they are similar to the GS-PD above, in that the minimum yield is 4% (on par), the current yield is slightly above 5%, and they have a liquidation preference of $25 (redeemable since 11/15/2011). These would pay the greater of 4% (on par) or LIBOR plus .35%. The prospectus can be found here.

BML-PG - Issued by Merrill Lynch (now part of Bank of America) these offer a slightly lower minimum rate at 3% (on par value) and the current yield is a little above 4%. They will pay the minimum 3% or LIBOR plus .75% going forward. Similar to the other securities, they are redeemable (since 11/28/2009) with a liquidation preference of $25 (plus accrued and unpaid dividends). You can view the prospectus here.

HBA-PF & HBA-PG - Both of these are issued by HSBC and are effectively the same securities, with the main exception being the floor interest rate. The F series has a floor of 3.5% and the G series 4%, and both series have a current yield above 4%. Each will then pay the greater of the floor level rate or LIBOR plus .75% going forward. Both of these are redeemable and past the initial redemption date. As well, the liquidation value is $25 per share for each. You can view the prospectus for the F series here and the G series here.

MET-PA - The final issue listed is from Metlife, a large insurance company. That alone makes it a little different than the others in that the other securities listed are all banks (although, GS is also a different breed). These offer a floor level yield of 4% and currently yield a little above that. They will pay the greater of that 4% (on par) or LIBOR plus 1%. They are redeemable at a liquidation preference of $25 per share. You can view the prospectus here.

The most important factor if you are considering these securities is how comfortable you are with the health of the underlying issuer. If you believe that even in times of economic stress Goldman Sachs, HSBC, Bank of America, and Metlife can and will continue to pay the dividends, then these could be of interest. If you have concerns about the staying power of the issuer, then you would likely want to stay away.

Relative to a fixed rate preferred stock from the same issuer these variable rate shares will offer a lower yield. That is part of the trade off to receiving a dividend that could grow. All of these are callable at 25 per share, which in theory offers some level of potential capital gain, should they be called. All of these are non-cumulative, which basically means the issuer isn't obliged to pay any previously unpaid dividends. If I am comfortable in the ability of the issuer to pay the dividend in times of stress, then I would prefer to accept a slightly higher yield and take the non-cumulative stock.

During the late 2008 and early 2009 part of the financial crisis, some of these dropped significantly. I don't know that how these will react to more bad news from Europe, but I would suspect there could be a good opportunity to pick up a good variable-rate yield. I believe these deserve consideration for investors looking for yield.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article should not be taken as investment advice, and is for informational purposes only.