Fixed Floating Preferred Shares Income Investors Should Consider

Includes: AHL, BAC, C, FNFG, JPM, PNC, USB
by: Valuematters

In the continuing search for yield, individuals are well served to consider preferred stocks. I recently wrote an article about some variable rate preferred securities, but the focus of this article is fixed/floating preferred shares. In general, these work as two stage securities where the first stage is a fixed yield (fixed as it relates to par value) for a certain number of years. The second stage is a floating rate that is typically some function of LIBOR (i.e. LIBOR plus X percent). The second stage works similar to the variable rate shares I wrote about in the previously mentioned article.

An interesting detail about most of these securities is that they are typically callable by the issuer at the date where the stock would change from a fixed rate to a variable rate. The redemption features could work as an anchor around that call price as the stocks approach the call date. In other words, there will be a push and pull between the yield over LIBOR (which in some cases is substantial) and the redemption price. The main characteristics of these securities are shown below in both the table and subsequent write up of each security, which is grouped by issuer (as different websites use different symbols for preferred stocks, below I have used the yahoo finance symbols).

Fixed-Floating Preferred Shares
Shares Fixed Yield on Current Price Fixed Yield on Par Current Price Floating Adjustment to LIBOR Redemption Date
ALLY-PB 9.25% 8.50% $22.98 6.24% 5/15/2016
ALLY-PA 8.46% 8.13% $24.00 5.79% 2/15/2016
AHL-PA 7.20% 7.40% $25.70 3.28% 1/1/2017
C-PJ 8.30% 8.50% $25.59 5.87% 3/30/2015
C-PN 7.07% 7.88% $27.85 6.37% 10/30/2015
FNFG-PB 7.90% 8.63% $27.28 7.33% 2/15/2017
JPM-PZ 7.91% 8.00% $25.29 4.12% 5/15/2013
JPM-PB 7.18% 7.20% $25.07 4.46% 12/22/2014
PNC-PL 9.06% 9.88% $27.26 6.33% 2/1/2013
PNC-PP 5.90% 6.13% $25.94


USB-PN 5.78% 6.00% $25.94 4.86% 4/15/2017

Ally - Ally offers both the series A (ALLY-PB) and the GMAC Capital Trust I (Ally-PA), which are very similar offerings. ALLY-PB has distributions of $2.125 per share (8.5% on par value) and a redemption price of $25 per share, at the issuer's option on or after 5/15/2016. After 5/15/2016 these pay LIBOR plus 6.243%, but they are currently yielding 9.25%. The Ally-PA is basically the same except they pay $2.03125 (8.125% on par), pay a spread over LIBOR of 5.785%, and the floating rate kicks in on 2/15/2016. Currently these are yielding 8.46%.

These are by far the most risky on the list, but also offer the higher return. Ally doesn't have an underlying (i.e. common stock) that you can see in order to have a better feel of how the market views the business. What I typically will do with all sorts of preferred stock investments is try to get a feel not just what I think of the underlying business, but also what the market thinks. That is, if you are looking at a higher yielding preferred stock, but the underlying common is only yielding maybe 2-3%, it implies that the market doesn't see the common at a significant risk of a cut (which should in theory make the preferred that much safer). Nonetheless, the Ally shares offer the potential for good returns from both the yield characteristics, as well as the potential for some of the risk premium to come out of these as the business or financial condition improves, but they do come with significant risks.

Aspel Insurance (NYSE:AHL) - Aspel Insurance offers the AHL-PA, which offers a 7.401% fixed rate (on par) until 1/1/2017, at which point they change to a variable rate of LIBOR plus 3.28%. These are non-cumulative and have a $25 par value, which also serves as the redemption price (at issuer's option) on or after 1/1/2017. At the current price the yield is 7.20%.

I find that the underlying stock is a reasonably safe company, however at the current price I am not sure how attractive the preferred shares are. Perhaps if short term rates make a dramatic increase in the near term these could have some small capital gains left, but if rates don't make much change I have a hard time seeing much potential for gains. Additionally, I would see the risk being to the down side, with the risk being rates staying low and the share price having to adjust to compensate for the small spread over LIBOR (relative to current yield). I don't see any immediate decline as the call date is not until 2017, but the point is something to watch.

Citigroup (NYSE:C) - Citigroup has two securities, the C-PJ and C-PN, both of which have a par value of $25 per share and are callable at that price (the PJ on or after 3/30/2015 and the PN on 10/30/2015). The PJ offers a fixed yield on par of 8.5% (current yield of 8.3%) that will change to a floating rate of LIBOR plus 5.87% on the redemption date. The PN offers a fixed yield of 7.88% (current yield of7.07%) that will change to LIBOR plus 6.37% on the redemption date. The C-PJ and C-PN currently yield 8.03% and 7.07%, respectively.

In an attempt to see where these might trade once trading with a floating rate yield, we could compare to a floating rate security currently in the market, either from Citigroup or a close competitor. I didn't see any pure floating rate securities from Citigroup, but we could compare perhaps to a Bank of America (NYSE:BAC) floating rate preferred stock. Not that BAC is a perfect comparison, but it is probably close enough to have an idea where these might trade. The BAC-PE shares are a pure floating rate security with a floor (discussed a bit more in the article referenced earlier) yield of 4% on par, but they currently yield a little over 5%. If the interest rate environment is similar in 2015 it will mean that when these convert to a floating rate they will basically be paying LIBOR plus about .4%. Given this and using the BAC-PE as a benchmark it could imply a price for each of the Citigroup shares that is significantly higher than the current price. However, these are callable at $25 per share so that could work as an anchor against the rising price.

First Niagara Financial Group (NASDAQ:FNFG) - First Niagara has the preferred B series shares (FNFG-PB) which have a fixed yield of 8.625% yield on a par value of $25 per share. This fixed yield is offered until 2/15/2017 after which these turn into a floating rate yield of LIBOR plus 7.327%. As well, on the same date these are also redeemable by the issuer at par value. These currently yield around 7.90%.

If you want to judge the FNFG-PB based on the common shares there are some points that indicate some level of safety to the preferred dividend, starting with the fact that the common shares pay $.08 per share dividend. Additionally, during the last financial crises the company didn't cut the dividend. On the opposite side however, is the fact that the company did cut the dividend in early 2012 from $.16 per share to $.08. As well, the company has recently raised capital and is far from a sure bet.

JP Morgan Chase (NYSE:JPM) - JPM offers two similar securities that fit within the concept of this article and they are JPM-PZ and JPM-PB. The JPM-PZ has a par and redemption value of $25 per share and offers an initial yield of 8% ($2.00 per share). On or after 5/15/2013 the company has the right to redeem these, but also on that date the distribution will change to LIBOR plus 4.12%. The current yield is 7.91%. JPM-PB has the same par value and the same functional aspects as the PZ, but offers a 7.20% yield on par (current yield of 7.18%) and has a spread of LIBOR of 4.46%. The company can call these shares at a value of $25 per share on or after 12/22/2014. Both of these do have a maturity, with the earliest being 2039.

Both of these offer reasonably high current yields, but both offer floating rates that are significantly less than the current fixed yield. Obviously, that is driven from incredibly low LIBOR rates, but none the less the floating rate would imply a significant drop in the yield versus the fixed rate. My concern is that this could cause a slow decline in the price (to get the floating rate yield in line with the market) as these approach the call date. Again, it doesn't make these bad investments, only that they need to fit the specific goals of the investor and fit with the investor's interest rate expectations.

PNC Financial Services Group (NYSE:PNC) - PNC has the F series (PNC-PL) and the P series (PNC-PP) which both are callable at a par value of $25 per share. The F series offer a 9.875% yield on par until 2/1/2013 at which time they change to a LIBOR plus 6.330% yield. The P series pays a 6.125% yield on par until 5/1/2022 at which time the yield changes to LIBOR plus 4.0675%. Both of these shares are redeemable on the same date that the yield changes from a fixed yield to a floating one. The F series and P series currently yield 9.06% and 5.90%, respectively.

US Bancorp (NYSE:USB) - US Bancorp has the G series preferred shares (USB-PN) which have a 6.00% fixed rate yield on a $25 par value until 4/15/2017 after which time they have a yield of LIBOR plus 4.86125%. On the same date that these change to a floating rate yield these also become redeemable at par by the issuer. These currently yield 5.78%.

As you can see from the above I don't exactly see anything here I am in love with. However, perhaps these could fit in to someone's portfolio that has different objectives and requirements. I will tend to lean towards something that gives me some yield and some potential capital gain, even if it could mean I end up getting called out and having to put that money back to work. As such, I would be looking to buy most of these if I can get them at or below par. I would also be looking to buy these, particularly those with a relatively lower adjustment over LIBOR (the ones around 4%), at a price where the floating rate yield makes sense. For example, the JPM-PB I would expect to yield between 4% and 5% (as a floating rate instrument), so that could mean a price around $24 makes sense. Again, I believe these should be on everyone's watch list, but whether they are "investable" at the current price is more a matter of the individual investor preferences and expectations.

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

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