Long Only, Value, Contrarian, Bonds
Contributor Since 2009
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Since starting my blog back in October 2008, almost 2000 mostly long posts ago, I have discussed equity preferred floating rate stocks with minimum coupons.
I have an old post that discusses their advantages and disadvantages: Advantages and Disadvantages of Equity Preferred Floating Rate Securities
In this post, I am going to discuss in this post the Morgan Stanley Non-Cumulative Preferred Series A (MS.PA:NYSE) stock.
SA does not have quotes for preferred stocks and there is no uniform symbol use among brokers or financial websites:
MS-PA: Yahoo Finance
MS-A: QuantumOnline.com (free site, registration required) and TD Ameritrade
MS.PA Wall Street Journal
MS_PA OR MS PRA: Vanguard
Snapshot of Trade:
I now own 200 shares in taxable accounts.
This last purchase was made in an account where I am averaging up.
The prior purchase was made in 2011. Bought 50 MSPRA at $16.6 (September 2011).
Security Description: The Morgan Stanley Non-Cumulative Preferred Series A (MS.PA) is an equity preferred stock that pays non-cumulative and qualified dividends at the greater of 4% or .7% above the 3 month Libor rate on a $25 par value. Prospectus The current coupon is the minimum 4% rate which is likely to remain the applicable coupon for two or more years. At a $19.87.24 total cost per share, the yield would be about 5.03% currently.
If a non-cumulative preferred dividend is legally eliminated, it is just gone. The non-cumulative dividend can not be eliminated unless the issuer first eliminates a common share cash dividend.
If a cumulative preferred dividend is legally omitted, it has to be paid before common shareholders can receive a cash dividend. A common share cash dividend must be eliminated before the issuer can defer a cumulative preferred stock dividend.
An increase in the minimum 4% coupon will occur when the 3 month LIBOR rate is over 3.3% during the applicable computation period. If the that rate was then 6%, the coupon would then become 6.7% and the effective yield would increase to 8.28% at a constant total cost per share of $20.24.
The 3 month Libor rate will be anchored near zero for as long as the Federal Reserve continues ZIRP: Chart: 3 Month LIBOR based on U.S. Dollar
An equity preferred stock will be senior only to common stock. The prospectus does contain a standard "stopper" provision that would prevent Morgan Stanley from paying a cash dividend to the common shareholders and eliminating the MSPRA dividend. (see pages S-2 to S-3; S-14 to S-15). Once the common dividend is eliminated, there would be nothing legally that could stop MS from eliminating the MSPRA dividend.
I believe that this security is currently rated at Ba3 by Moody's and BB by S & P, both junk ratings.
Morgan Stanley is currently paying a small common stock dividend. Once that dividend is eliminated, MS could eliminate the non-cumulative equity preferred dividend. MS Dividend History
However, as a practical matter, it would be unwise for MS to eliminate the MSPRA dividend to preserve capital. If you were an institutional client, what kind of message would such an elimination send to you?
For an investment bank, dependent on customer confidence in its financial viability, the only practical course would be to pay the preferred stock dividend until the company does a Lehman Brothers.
A failure to pay prior to a bankruptcy filing could easily cause that result as clients flee. MSPRA went ex dividend for its quarterly distribution on 9/26/14. MSPRA is being priced by the market below other equity preferred floaters that pay the greater of a 4% coupon or a lower spread to the 3 month Libor than MSPRA.
Those stocks include the following:
SunTrust Banks Perpetual Non-Cumulative Preferred Series A (STI.PA)
Zions Bancorp Floating Rate Non-Cumulative Perpetual Preferred Series A (ZB.PA)
Santander Finance Preferred S.A. Unipersonal Non-Cumulative Floating Rate Preferred Series 6 (SAN.PB)
Prior Trades: I have bought and sold this security several times, as noted in my blog. My last trade discussed there was a purchase of 100 shares shortly before the last quarterly ex dividend date. Item # 3 Bought Back 100 MSPRA at $20.24 (10/4/14 Post)
The largest gain was on a 100 share lot purchased in 2009: Bought 100 MSPRA at $12.88 in May 2009-SOLD 100 MSPRA at $21.43 (January 2010)
Bought 50 MSPRA at $15.7 (May 2010)-Sold MSPRA at $18.50 (July 2010)
Bought 50 MSPRA at 19.71 (January 2011)-Pared 50 of 250 MSPRA at $20.8 (January 2013)
Added 50 MSPRA at 19.54 (January 2011)-Sold 50 of 200 MSPRA at $22.04 (March 2013)
Total Realized Gains MSPRA=$1,203.08 ($1,168.6 in prior trades, snapshots at Item # 5, Bought 50 MSPRA at $19.25-ROTH IRA)
Rationale and Risks: The main advantages of this type of security are as follows: (1) the security pays qualified dividends when purchased in a taxable account and (2) provides a measure of deflation/low inflation and problematic inflation in the same security.
The deflation/low inflation scenario is addressed by the minimum coupon, while the protection for problematic inflation involves the LIBOR float activation. By buying at a discount to par value, I juice the yield in both scenarios.
With the Jihads being practiced by central banks against savers worldwide, short term rates are likely to remain low, irrespective of the inflation rate until the central banks start to raise their short term benchmark rates, with the U.S. Federal Reserve being the most important and the leading practitioner of financial repression.
When and if central banks allow rates to rise, and assuming inflation has become a problem too, then this kind of security could start to increase its coupon in response.
I really view this kind of security as providing some protection against unexpected and problematic inflation.
With inflation trending under 2% for an expended period time, and the 3 month LIBOR staying below 3.3%, then this security becomes relatively unattractive given its 4% coupon compared to other higher coupon equity preferred stocks issued by Morgan Stanley.
The minimum yield on MSPRA is about 5.03% at a total cost of $19.87.
I could have bought a MSPRG that pays non-cumulative and qualified dividends at the per annum fixed coupon rate of 6.625% on a $25 par value. Prospectus MSPRG and MSPRA are in pari-passu (same place in the capital structure)
MSPRG was available for purchase at $25.45. Assuming that was the total cost per share, the yield would be about 6.51%.
The question that I ask is whether it is worth around 1.5% per year to have the inflation insurance of the floater. Each investor can decide that issue for themselves. Inflation certainly does not look like a problem for the foreseeable future, but investors probably told themselves the same thing back in the early 1960s.
In effect, the investor is paying an insurance type premium in accepting a lower rate now for MSPRA than a fixed coupon preferred stock. If that premium is close to 1.5% or less, then I will consider adding the floater, particularly since I became of age as an investor during a period of problematic inflation and am consequently very sensitive to its dangers.
For MSPRA, the 3 month LIBOR rate would have to rise above 3.3% during the applicable computation period to trigger a higher coupon than 4%. Historically, before the current extended period of financial repression, a 4% or 5% three month LIBOR rate was not uncommon. (move left cursor all the way to the left to get data going back to 1986: 3-Month LIBOR)
MSPRA will at least produces a current real rate of return of over 3%, before taxes, based on the currently forecasted inflation rate embodied in the ten year TIP price.
At a total cost per share of $19.87, the dividend yield with the minimum 4% coupon is about 5.00+% as noted above.
I discuss the advantages and disadvantages of this kind of security in Advantages and Disadvantages of Equity Preferred Floating Rate Securities. Given the many disadvantages, I view non-cumulative equity preferred stocks issued by financial institutions with some disfavor.
While these securities are classified as part of a firm's equity, I view their bond characteristics to be more dominant than their equity features. From an individual investor's viewpoint, the equity features of MSPRA include the qualified dividend, the non-cumulative feature, and the perpetual term of the security.
Unlike common stock, however, the owner of MSPRA does not have an equity interest in the business and really only has the dividend.
Non-cumulative equity preferred stocks issued by financial institutions are hyper-sensitive to perceptions about the firm's creditworthiness.
During the Near Depression, it was common to see this type of security, with a $25 par value, sell at less than $10 per share. (e.g. Bought BMLprg at $8.8; Bought 100 ZBPRA at $7.8).
Generally, I would expect the senior unsecured note owners to recover less than 25 cents on the dollar in a BK. Owners of more junior securities, including trust and equity preferred stocks, will most likely be wiped out completely. The Lehman equity preferred shareholders were left holding a worthless pieces of paper. Lehman had a floating rate equity preferred stock that was traded on the stock exchange (formerly under the symbol LEHPRG).
I started to invest in some of these securities during the Near Depression when they could be purchased at greater than 50% discounts to their $25 par values. The downside risk is zero as shown by what happened to those unfortunate souls who owned LEHPRG, a Lehman equity preferred floater, that is now worthless of course.
An equity preferred stock is only superior to common stock. It will be junior in the capital structure to all bonds. Given that low priority, the non-cumulative dividends paid by most of them, and the highly leveraged balance sheets of financial institutions issuing them, there will be no recovery in a bankruptcy for an owner of an equity preferred stock. Investors realized that would be the likely outcome and will behave irrationally when there is a whiff of a possible financial collapse. (a 75% chance of bankruptcy when a rational number would be less than 10%).
This type of security can be extremely volatile in price, as shown by my trading history, and by a long term chart. MS.PA Interactive Stock Chart This stock fell to below $8 during the Near Depression period. I first bought shares at $12.88.
The two year low was on 12/30/11 at $14.71 and the high was $23.46 hit on 5/17/13. I do not regard that price action as rational. And, anyone investing in this sector just has to deal with it.
The decline in MSPRA's price after Lehman's failure was not irrational, but was borderline irrational when I first bought MSPRA in May 2009.
Periodically, these stocks will hit an air pocket. I am just use to it.
I discuss an example from August 2011: Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities I was able to buy Santander's floater at $13 during that one, and still own those shares.
A few weeks later, yet another downdraft, and I picked up HBAPRG at $16.18 (HSBC's US operation). Bought 50 HBAPRG at $16.8
One of my earlier discussions about embracing their volatility in a trading strategy is discussed in a May 2009 post. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock
So, volatility and risk are just known hazards. Know what you are buying, its history and characteristics.
My last purchase of the common shares was discussed in this post: Bought 50 MS at $14.98 (9/5/12 Post) The current consensus E.P.S. estimate is for $2.43 in 2014 and $2.93 in 2015. MS Analyst Estimates
Last Earnings Report: Morgan Stanley Reports Third Quarter 2014
Future Buy/Sells: With inflation quiescent, and the 3 month Libor rate a long way from triggering an increase in the 4% coupon, the equity preferred floaters are relatively unattractive now. I buy them as part of bond strategy due to their sensitivity to rising rates. In the last analysis, I do not see the 3 month Libor rising over 3.3% for several years, but I may be wrong, and the market may be wrong in predicting low inflation numbers decades into the future, as reflected in the current break-even spreads embodied in the 10, 20 and 30 year TIPs.
Given the low coupon for the foreseeable future, I have adopted a trading mentality for these securities. I would consider selling my highest cost shares, bought earlier at $20.24 when and if the price goes over $21 and then wait to see whether I can buy those shares back at below $20 after collecting a few dividends. Snapshots of realized gains in this category can be found in the Gateway Post for Equity Preferred Floating Rate Securities=$11,752.05.
Disclosure: The author is long MS.
Additional disclosure: SA does not recognize preferred symbols. I am long MSPRA. Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.