Closing Prices 12/31/15:
This basket was last updated here: Update For Exchange Traded Bond And Preferred Stock Basket As Of 12/18/15 - South Gent | Seeking Alpha
The following table includes only exchange traded securities. I do not have a table showing my existing $1,000 par value bonds bought in the bond market.
Basket as of 12/31/15: +.6%
This basket is now being managed for income with a hope that I will not lose money on the shares. The opportunities for capital appreciation occurred in the Near Depression period, and its aftermath, when these types of securities were slaughtered in price.
Examples of Exchange Traded Bond and Equity Preferred Stock Categories:
Senior Unsecured Baby Bonds:
Junior Baby Bonds:
First Mortgage Bonds:
Trust Certificate-Junior Bond
Trust Certificate-Synthetic Floaters with Minimum Guarantees
Fixed Coupon Equity Preferred Stock: Non-Cumulative
Fixed Coupon Equity Preferred Stock: Cumulative
Floating Rate Equity Preferred Stock with Minimum Guarantees: Non-Cumulative
Fixed to Floating Rate Equity Preferred Stock: Non-Cumulative
ETFs That Own Exchange Traded Bonds and Equity Preferred Stocks:
PowerShares Variable Rate Preferred Portfolio ETF (NYSE:VRP)(do own and can buy in my Schwab account commission free)
Market Vectors Preferred Securities ex Financials ETF (NYSEARCA:PFXF)(do own and will buy in my IB account only)
I have discussed the foregoing categories in several vintage posts.
1. Bought Back 50 BMLPRG at $18.01:
Trade Snapshot ($1 Commission):
Security Description: The Bank of America Floating Rate Preferred Stock (BML.PG:NYSE) is an equity preferred stock that pays qualified and non-cumulative quarterly dividends at the greater of 3% per annum or a .75% float over the 3 month Libor rate on a $25 par value. Prospectus Supplement The applicable rate now is of course the 3% minimum. When and if the 3 month Libor rate exceeds 2.25% during a relevant computation period as defined in the prospectus, then the Libor float would become the applicable rate.
Current Yield Based on 3% Minimum Coupon and $18.01 price=4.16%
This type of security combines in one security a measure of deflation/low inflation protection through the minimum coupon and problematic inflation through the Libor float. The value of those provisions increase as the market price declines below the $25 par value.
I have bought BAC equity preferred floating rates stocks on numerous occasions and have taken profits in all of them.
In the Appendix section below, I have links to posts discussing trades of BMLPRH, BMLPRJ, BMLPRL and BACPRE. Those are what I call functionally equivalent securities. All of them are equity preferred stocks that pay qualified and non-cumulative dividends on $25 par values with BAC being the responsible party.
It would be fair to say that I am in a trading mode for this type of security given the current low coupon yield.
As to BMLPRG, I first bought shares at $8.8: Bought BMLprg at $8.8 (5/20/2009 Post) That price highlights the risks. I last sold shares at $17.39 back in March 2011. So I have not missed much of anything by trading that one. At the $8.8 price, the 3% minimum coupon provided about a 8.52% yield.
A problem is simply that investors have a hard time seeing a float activation in the future, which is understandable after seven years of ZIRP, even though the historical average 3 month Libor rate is probably over 5% range before the Near Depression period. I did not compute that number but just eyeballed this chart:
The Libor rate only goes back to early 1986.
When banks no longer trust one another, the spread between the LIBOR and equivalent treasury bill rates can spike in a big way as shown by the Near Depression period which also involved apparently some price fixing of the Libor rate by big banks, BBC News - Timeline: Libor-fixing scandal Some may even argue, without fear of being contradicted by informed investors, that those banks bear an uncanny resemblance to another recognized criminal enterprise known as the Mafia without the violence.
As Thumper said, "If you can't say something nice, don't say nothin' at all" YouTube So, I am not saying anything else about the big banks here.
The average annual Libor rate would be higher if there was data for the period from the late 1960s through 1985 when the 3 month treasury bill skyrocketed in yield due to problematic inflation.
This security was originally issued by Merrill Lynch and became a BAC obligation after its acquisition of ML.
See generally, Advantages and Disadvantages of Equity Preferred Floating Rate Securities (9/25/2009 Post)
Stopper Clause and Priority Ranking:
An equity preferred stock is senior only to common stock in the capital structure and junior in priority to all bonds including trust preferred stocks which are junior bonds.
The equity preferred stock's preference right over BAC common shares is enforced by a Stopper Clause that basically prohibits BAC from eliminating the non-cumulative preferred dividend while using cash to buy common stock or to pay a dividend to the common shareholders.
The Stopper Clause in the BMLPRG is summarized as follows in the Prospectus:
It would be legal for BAC to eliminate the common share dividend and then eliminate the non-cumulative preferred stock dividends. However, BAC could not pay one equity preferred stock dividend while paying another, as those issues have the same claim on income and are in pari passu with one another.
Current Yield Differential in Favor of BAC's Fixed Coupon Preferred Viewed as an Insurance Cost Against Unanticipated and Problematic Inflation:
Is the extra current yield from a Bank of America fixed coupon preferred stock worth it to the investor? The additional yield could be as low as
I look at this spread as an annual insurance premium paid for unexpected inflation. Am I willing to pay per year in order to have the unexpected inflation protection 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 1960s.
So what are the odds that inflation and interest rates will rise significantly from current levels, causing the fixed coupon security to go down in value and the float provision of the floater to be activated as the relevant coupon amount?
If the 3 month Libor rate was 6% during the relevant computation period, BMLPRG's coupon would become 9.37%, and that coupon would be applied to a much lower cost per share. And, would BMLPRG then have a higher price per share than $18.01?
I would expect BMLPRG to be selling somewhere near its $25 par value in this hypothetical, while would likely IMO to sink below $20. So that is what I mean by labeling the current yield spread between those two securities as an insurance premium which may be lost like all of the insurance premiums that I have paid for auto, health and home insurance, or become valuable depending on the largely unknowable future (my house burns down or I have a collision with a newly minted neurosurgeon with 4 small children who is rendered a paraplegic for life)
In effect, the investor is paying an insurance type premium in accepting a lower rate now for BMLPRG than a BAC fixed coupon preferred stock. Both have identical credit risks. Both are non-cumulative.
If that premium is 2% or less, then I will consider adding the floater, particularly when the prevailing interest rate environment provides an incentive for the issuer to redeem the fixed coupon preferred stocks and that redemption significantly lowers the yield.
Another important issue for me is that the fixed coupon preferred stock will go down in value with the rise of problematic inflation. Put another way, that kind of security has no inflation protection.
I started to invest during a period of problematic inflation and am consequently very sensitive to its dangers. Or, as the sage philosopher Justin Timberlake once said, "What Goes Around...Comes Around" - YouTube Yes, inflation will be back after this most recent hiatus. The only question is when.
Comparison with Fixed Coupon BAC Preferred Stocks:
BAC has several fixed coupon preferred stocks including the following:
Bank of America 6.204% Non-Cumulative Preferred Series D (BAC.PD:NYSE): Current yield 6.05% at $25.6/Yield-To-Call=-2.5%
Bank of America Non-Cumulative Preferred Series 6.5% Series Y (BAC.PY:NYSE): Current Yield 6.04% at $26.92/Yield-to-Call 4.45%
Yield-To-Call assumes that the issuer will redeem at par plus accrued dividends when it is legally able to do so. I used this website for the Yield-To-Call ("YTC") information. The YTC will be negative when the security is trading above par value and is past its call date. BACPRD has a negative YTC given its $25.6 price and an optional call date on or after 9/14/11. Prospectus
BACPRY has an optional call date on or after 1/27/2020: Prospectus
If there was no optional redemption, then BACPRY would provide about a 1.88% per annum current yield advantage over BMLPRG, assuming no increase in BMLPRG's minimum 3% coupon. However, if BACPRY is called on 1/27/2020, then BACPRY's yield advantage shrinks to .29% per annum.
YTC has to be considered when make a choice between the fixed coupon preferred and the floater. Sure, the fixed coupon preferred has a higher current yield but could have a much lower actual yield when and if the issuer exercises its optional redemption right.
And, another important consideration is how much appreciation potential is there in a fixed coupon preferred stock selling at over par value with an optional redemption right reserved by the issuer compared to the floater selling at a deep discount to par value.
Increase in BMLPRG's Coupon:
Another possible scenario is that BMLPRY will not be called in 2020 since a rise in inflation and interest rates make that an undesirable option for BAC.
How high would the 3 month Libor need to rise before providing an equivalent current yield?
For BMLPRG, the 3 month LIBOR rate would have to rise above 2.25% during the applicable computation period to trigger a higher coupon than 3%.
At a total cost of $18.01 per share, BMLPRG would produce a 6.05% coupon at about a 3.61% three month Libor rate: 3.61% + .75%=4.36% coupon divided by $18.01=6.05%. A rise above 3.61% would result in BMLPRG having a higher current yield than BACPRY using an all-in cost per share of $26.92 and no redemption by BAC.
If short term rates stall below 2.3% and intermediate and long term rates rise, then the 4% minimum coupon will not look too good and this security probably would go down in price more than a BAC fixed coupon preferred. Maybe I need to quit predicting the future.
BMLPRG will at least produces a current real rate of return of about %, before taxes, based on the currently forecasted inflation rate embodied in the ten year TIP price which is low. I would say absurdly low but that is just another future prediction that may end up being way off.
2. Added 100 VRP at $24.21 (Commission free in Schwab account):
I originally bought this ETF in my Fidelity account where I had to pay a brokerage commission. I would just refer anyone interested in variable rate "preferred" securities to this earlier: Income And Risk Assessment Balancing-Bought 100 Of The ETF VRP - South Gent | Seeking Alpha
This fund does have a significant weighting in junk securities. Most of the variable rate preferred stocks issued by financial institutions are rated junk including the BAC, GS, STI, SAN, ZION, and MS floating rate equity preferred stocks. The ones issued by HSBC USA are rated BBB- by S & P and Baa2 by Moody's according to quantumonline (e.g. HUSIPRF).
Sponsor's Website: Invesco - Product Detail
The fund owned the following GS and BAC equity preferred floaters as of 10/31/15:
Series 4 was originally issued by Merrill Lynch and now trades under the BMLPRJ: Final Prospectus Supplement
Series 5 was also originally issued by Merrill Lynch and now trades under the symbol BMLPRL. Term Sheet
GSPRJ and GSPRK are fixed-to-floating rate equity preferred stocks. I recently discussed here buying back 50 of GSPRJ: Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 10/30/15 - South Gent | Seeking Alpha (scroll to 1. Bought 50 GSPRJ at $24.75)
I also currently own GSPRD.
The fund also owns the BAC Capital Trust XIV Series G which is a floating rate junior bond with a 4% minimum coupon.
As of 10/31/2015, the fund had a 42% weighting in bonds, mostly junior bonds, and a 57.2% weighting in equity preferred stocks.
Distributions: This fund pays monthly dividends at a variable rate. The sponsor calculates the 12 month distribution rate at 5.07% as of 12/28/15.
Holdings: Invesco-Holdings (96 securities)
I will probably sell the 100 share lot bought in the Fidelity account when and if I have a profit.
3. Paired Trade: Sold 50 GSPRJ at $25.67 and Added 50 GSPRD at $19.95:
Profit GSPRJ: $43.98
Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 10/30/15 - South Gent | Seeking Alpha ( Scroll to 1. Bought 50 GSPRJ at $24.75)
GSPRJ: The Goldman Sachs Group Inc. Fixed-to-Floating Preferred Rate Stock (symbol-GS.PJ) is a fixed to floating rate equity preferred stock issued by Goldman Sachs. GSPRJ will pay qualified and non-cumulative dividends at 5.5% per annum on a $25 par value. The 5.5% fixed coupon rate will be applicable from the issue date to, but excluding 5/10/23. PROSPECTUS SUPPLEMENT DATED APRIL 18, 2013
On or after 5/10/23, GS has the option to redeem this security at par value plus any accrued dividends. If the security is not redeemed, the coupon transitions to a floating rate on 5/10/23. The floating rate would be a 3.64% spread to the three month Libor.
The GSPRJ current yield at a $25.67 price is about 5.36%.
GSPRD: GSPRD is a floating rate equity preferred stock issued by Goldman Sachs. As such, it will be junior in priority to all bonds and senior only to common stock. This equity preferred stock will pay non-cumulative and qualified dividends at the higher of 4% or .67% above the 3 month LIBOR rate on a $25 par value. Prospectus Dividends are paid quarterly. The 4% coupon is likely to be the applicable rate for several years due to the Fed's Jihad Against the Saving Class.
The current yield at a $19.95 price is about 5.01%.
If GS eliminated its common and equity preferred dividends to "preserve capital", GS would not be able to survive in my opinion. Big money customers, who had not already deserted the company, would be falling over one another trying to get their money out of GS. So I would not anticipate a dividend elimination on its non-cumulative preferred stock short of bankruptcy.
Another opinion pertinent to this security is that the owners of the GS common, equity and trust preferred stocks would all be holding worthless securities in the event GS ever does a Lehman. The owners of the senior debt would likely receive something, but would still be in a world of hurt if that debt was bought anywhere near current prices.
When investors are skittish about financial institutions, as now, their non-cumulative equity preferred stocks are subject to bouts of volatility. Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities (August 2011 Post); Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock (May 2009 Post) In the August 2011 post referenced above, I mentioned the price action in several equity preferred stocks the previous day. For example, the U.S. Bank floating rate equity preferred stock, USBPRH, was bought at $18.12 when the price range that volatile day was $17.12 to $21.01. That security is now trading consistently over $22. U.S. Bancorp Dep. Pfd. (Rep. 1/1000 Interest in a share of Non-Cum Perp Pfd Series B), USB.PH So what can you say except that this kind of volatility can present opportunities and a need for Maalox and chill pills.
Comparisons to GS Fixed Coupon Equity Preferred Stocks:
The coupon rates on GS fixed coupon preferred stocks are higher, though the actual current yield will depend on the total cost paid for the stock. Goldman Sachs Group Inc. 6.2% Series B Non-Cumulative Preferred Stock (NYSE:GS.PB) and Goldman Sachs Group 5.95% Non-Cumulative Preferred Series I (GS.PI)
GSPRI Yield= 5.71% at $26.07
GSPRB Yield= 5.94% at $26.1
Rationale: Why would I swap a higher yielding non-cumulative equity preferred stock issued by GS for a lower yielding one? There are several reasons.
1. Capital Appreciation Potential Differential: GSPRJ was selling at a premium to par value and GSPRD was bought at 20.2% discount to its $25 par value. IMO, GSPRJ has little further upside whereas GSPRD narrow that discount gap under the right circumstances. GSPRD did trade near $24 in 2013 and at $26 prior to the Near Depression (use ten year chart: Goldman Sachs Group Preferred Series D Interactive Stock Chart)
2. Current Yield Differential Negligible: I am not giving up much in current yield. I calculate the differential at .35% per annum.
3. Float Yield Potential: The owner of GSPRJ, as I have pointed out, may never receive the floating rate when the security transitions from a fixed coupon to a floating rate in 2023. The owners of GSPRD would receive an increase in their coupon when and if the 3 month LIBOR rate exceeded 3.33%. While that is not going to happen anytime soon, the automatic trigger of the float provision due to the onset of higher than expected inflation is worth the insurance premium representing the current yield differential in my opinion.
This brings me up to 200 GSPRD shares.
Prior Round Trip GSPRD Trades:
Total GSPRD Trading Profits: +$639.51
Prior Round Trip GSPRJ Trades: Item # 2 Sold 50 GSPRJ at $24 (4/12/14 Post)(profit snapshot=$45.08)-Item # 4 Bought 50 GSPRJ AT $22.78 (11/12/13 Post)
I will discuss buying 2 RRD $1,000 par value bonds in my next update. I have frequently traded RRD bonds, either in the trust certificate form of ownership or in the bond market. I will also discuss then buying 50 shares of two newly minted exchange traded bonds issued by BDCs: PBB and TCRZ.
BMLPRJ: greater of 4% or .75% over 3 month LIBOR Final Prospectus Supplement
Sold 50 BMLPRJ at $21.14 (3/5/15 Post)-Item # 2 Bought 50 BMLPRJ at $20.25 (1/19/2015 Post); Sold 50 BMLPRJ at $21.05 April 2014-Bought: 50 BMLPRJ at $19.93 (October 2012); Sold 100 BMLPRJ at $19.55 (February 2012)(no snapshot since the gain was less than $30; Profit =)- Item # 4 Bought 100 BMLPRJ @ 19.32 (February 2011); Item # 5 Sold 50 BMLPRJ @ 18.73 (October 2010)-Item # 4 Added 50 BMLPRJ at $17.74 (August 2010); Item # 2 Sold 50 BMLPRJ at $19.25 (September 2010)-Item # 7 Bought 50 BMLPRJ at 18.50 (August 2010); Item # 1 Sold 50 BMLPRJ at $18.9 (February 2012)- Added 50 BMLPRJ at $16.8 (February 2012)
BMLPRH: greater of 3% or .65% over 3 month LIBOR Final Prospectus Supplement
BMLPRL: greater of 4% or .50% over 3 month LIBOR Term Sheet
BACPRE: greater of 4% or .35% over 3 month LIBOR Bank of America Corporation
There are some advantages in going with the lower minimum coupon issues: (1) the float activates sooner; (2) the upside potential is higher given the greater discounts to par value; and (3) the current yield based on constant cost numbers will surpass the yield of the higher cost one when Libor rises above a sum certain calculable at the time of the trade. Then as Libor rises about that point, the yield differential expands and I would expect better price performance due to compensate for the yield differential. I will frequently do the later calculation
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. A failure to perform due diligence only increases what I call "error creep". Stocks, Bonds & Politics:ERROR CREEP and the INVESTING PROCESS. 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.
Disclosure: I am/we are long VRP.