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The new USB PRAs: Still trading cheap to comps?

|Includes: U.S. Bancorp (USB)
US Bancorp (USB) in June closed an exchange offer on a convoluted capital instrument called an "Normal ITS". This was created in 2006 as part of a burst of innovative capital securities thought up by Wall Street firms - Normal ITS was a service mark of the now-defunct Wachovia Securities.  
Trading was halted on the NYSE after only a week, and remained halted for a month after problems with the allocation of shares in the exchange.  So the merits of the shares seem to have fallen off the radar screen.

The USB PRAs are depositary shares of USB preferred stock, with a dividend of 7.189% until the end of the 
Normal ITS remarketing period (some time between April 2011 and April 2012). The new instruments rank at parity to the existing USB PRH and PRL preferred stock. Each represents a $1,000 liquidation preference.

However, one can buy the PRAs at a discount to the most comparable preferred stock, USB PRHs, which are pari-passu and which bear a coupon rate of Libor +.60%, floored, just like the PRAs, at 3.5%.  The PRAs' voting rights and other legal matters have been amended to match those on the other USB preferred series.  The only material difference is that each of the PRAs' depositary shares has a liquidation preference of $1000, rather than the $25 that each of USB's existing preferreds bear.  However, the USB PRHs closed on Tuesday at exactly $21.73 - 86% of liquidation preference - whereas the USB PRA's closing price was 78.5% of face, even though it bears a higher coupon.

How should the USB PRAs be valued?   Until the remarketing date (no earlier than April 2011, no later than April 2012) the PRAs will bear a 7.189% coupon and during that time, since LIBOR is likely to stay low, the PRHs can be expected to pay 3.5%. Once 3 month LIBOR rises above 2.48%, the PRAs dividend will exceed the 3.5% floor and pay 1.02% over LIBOR.  Once the PRHs rate rises over its floor, the difference in the dividend on the two preferreds is equal to 0.42%.  So the value of the difference in dividends is equal to PV of the spread shown in the table below:  
 
 
Period
Period
Number
USB PRA
USB PRH
Dividend
Start
End
of Dividends
Dividend
Dividend
Difference
Present
Jul-11
4
7.189%
3.500%
3.689%
Oct-11
Oct-12
5
3.500%
3.500%
0.000%
Jan-13
Jan-13
1
3.688%
3.500%
0.188%
Apr-13
Apr-13
1
3.900%
3.500%
0.400%
Jul-13
Thereafter
  Perpetuity
4.115%
3.695%
0.420%
 
  
While USB can call the preferred at any time after April 201, they are most unlikely to do so unless they can replace them with other preferreds at a dividend rate of less than LIBOR +1.02%. Even the most conservative assumptions suggest that the USB PRAs should trade at a 7% premium to the PRHs, not at a discount.   If the remarketing period extends until June 2012, the PRAs should trade at an 10.5% premium.

If you own USB PRHs, you may prefer to sell them and move into the new PRAs - or if you have no position and want a riskless trade, one can buy the PRAs and sell short the PRHs and, at current rates, your cost of stock borrow will be much less than your added income. 


 


Disclosure: Long PRAs and short PRHs