Barrons on Preferred Stock
Barron's Article on preferred stock. Here is an excerpt. My comment & a link follows.
It Only Looks Like a Wipeout
By ANDREW BARY
Preferred stocks may harbor fewer risks, more rewards.
THE $400 BILLION PREFERRED-STOCK market rallied smartly in late 2008 on the implementation of the government's Troubled Asset Relief Program (TARP). But now it's gotten slammed, amid concerns that Citigroup and Bank of America could be nationalized, potentially impairing preferred shareholders..... The market is discounting a scenario that exceeds the Great Depression," says one fund manager....
....It's tough to predict what will happen to the embattled Citi and B of A; both may be forced to stop paying dividends on preferred shares if their finances deteriorate further. But plenty of bad news already is discounted in their shares......NOTWITHSTANDING THE RISKS, these preferred stocks appear to offer an attractive alternative to the banks' common shares, owing to super-high yields and a higher standing in their capital structures.
....Throughout the preferred market, many issues yield 10%-plus. "The market is discounting a default scenario that greatly exceeds the Great Depression," says Don Crumrine, the chairman of Flaherty & Crumrine, a Pasadena, Calif. investment firm that manages more than $2 billion in preferred investments. "While this may turn out to be true, it seems highly unlikely in view of actions already taken by U.S. and foreign governments.".....
......The preferred market was badly shaken in September by the bankruptcy of Lehman Brothers, which appears to have wiped out preferred-stock holders, and by the government's decision to take control of Freddie Mac and Fannie Mae in a way that left preferred holders facing scant recovery on their investments. Fannie and Freddie preferreds now trade for under five cents on the dollar.......
....In October, preferred investors applauded the government's move to invest $350 billion of TARP money in banks via preferred stock that was equal in standing to the banks' investor-owned preferred, and junior to hybrid securities like trust preferred. Bill Gross, a managing director at bond giant Pimco, wrote in November, "With Uncle Sam as your partner, default seems remote."
The fear now is of a Fannie/Freddie-type nationalization of Citi and Bank of America that similarly would impair preferred holders, not to mention owners of common stock. But the Obama administration has resisted the idea, with Treasury Secretary Tim Geithner saying recently, "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system."
Bank of America CEO Ken Lewis said Friday that the nationalization notion isn't even "a remote possibility" and that the bank doesn't need any more government money.
PREFERRED STOCK COMES IN two flavors: Traditional preferred shares are a senior form of equity that ranks above common shares but below corporate debt. Trust preferred technically is debt, ranking above the regular variety.
Until recently, investors didn't make much distinction between the two. One benefit of regular preferreds is that dividends are taxed at the preferential 15% rate for individuals, while trust preferreds' dividends are taxed like ordinary income. Trust preferreds now trade at higher prices than regular preferreds of the same company, because investors want to own securities that rank above the government's TARP investments.
The Bottom Line:
The outlook for financial companies admittedly is uncertain, but many preferred stocks offer sufficiently high yields that investors may profit. That's especially true now that Uncle Sam holds similar investments.
By ANDREW BARY
Preferred stocks may harbor fewer risks, more rewards.
THE $400 BILLION PREFERRED-STOCK market rallied smartly in late 2008 on the implementation of the government's Troubled Asset Relief Program (TARP). But now it's gotten slammed, amid concerns that Citigroup and Bank of America could be nationalized, potentially impairing preferred shareholders..... The market is discounting a scenario that exceeds the Great Depression," says one fund manager....
....It's tough to predict what will happen to the embattled Citi and B of A; both may be forced to stop paying dividends on preferred shares if their finances deteriorate further. But plenty of bad news already is discounted in their shares......NOTWITHSTANDING THE RISKS, these preferred stocks appear to offer an attractive alternative to the banks' common shares, owing to super-high yields and a higher standing in their capital structures.
....Throughout the preferred market, many issues yield 10%-plus. "The market is discounting a default scenario that greatly exceeds the Great Depression," says Don Crumrine, the chairman of Flaherty & Crumrine, a Pasadena, Calif. investment firm that manages more than $2 billion in preferred investments. "While this may turn out to be true, it seems highly unlikely in view of actions already taken by U.S. and foreign governments.".....
......The preferred market was badly shaken in September by the bankruptcy of Lehman Brothers, which appears to have wiped out preferred-stock holders, and by the government's decision to take control of Freddie Mac and Fannie Mae in a way that left preferred holders facing scant recovery on their investments. Fannie and Freddie preferreds now trade for under five cents on the dollar.......
....In October, preferred investors applauded the government's move to invest $350 billion of TARP money in banks via preferred stock that was equal in standing to the banks' investor-owned preferred, and junior to hybrid securities like trust preferred. Bill Gross, a managing director at bond giant Pimco, wrote in November, "With Uncle Sam as your partner, default seems remote."
The fear now is of a Fannie/Freddie-type nationalization of Citi and Bank of America that similarly would impair preferred holders, not to mention owners of common stock. But the Obama administration has resisted the idea, with Treasury Secretary Tim Geithner saying recently, "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system."
Bank of America CEO Ken Lewis said Friday that the nationalization notion isn't even "a remote possibility" and that the bank doesn't need any more government money.
PREFERRED STOCK COMES IN two flavors: Traditional preferred shares are a senior form of equity that ranks above common shares but below corporate debt. Trust preferred technically is debt, ranking above the regular variety.
Until recently, investors didn't make much distinction between the two. One benefit of regular preferreds is that dividends are taxed at the preferential 15% rate for individuals, while trust preferreds' dividends are taxed like ordinary income. Trust preferreds now trade at higher prices than regular preferreds of the same company, because investors want to own securities that rank above the government's TARP investments.
The Bottom Line:
The outlook for financial companies admittedly is uncertain, but many preferred stocks offer sufficiently high yields that investors may profit. That's especially true now that Uncle Sam holds similar investments.
My comment. One area that hurt my client accounts last year was owning preferred stocks. They have also been hit badly through January of this year. However, none of the preferred's that I own for clients has skipped a dividend payment and the preferred market has been rallying these past few days. While I think there is a possibility that some preferreds could default, I think that risk is becoming less likely. Still my preference would be to buy a preferred stock ETF at this point. We are currently long for clients the Powershares Preferred Portfolio Fund {Symbol PGX}. Its current SEC yield is is 11.45%. I currently think this is a better way to spread diversification and risk than purchasing individual preferred stock. Note however that except for tax harvesting purposes I have also not been a seller of my client's preferreds.
Please note that this is not a recommendation for investors to go purchase this fund as I do not know your investment parameters. You should simply use this as a point of reference in which to go out and do some additional research or speak to your own investment advisor. Nothing in this commentary should likewise be construed as anything other than opinion as preferred stocks and the PGX could decline in value and some preferred stocks could in fact default. There is no guarantee in this report of investment return. Likewise all information in this report has been taken from sources deemed to be reliable but cannot be guaranteed.
* Long BAC as an inherited legacy position for one client. Long C personally and for certain clients. Long PGX in client accounts. Long certain BAC preferreds for some client accounts. Please note these positions could change at any time. Information regarding PGX taken from Powershares.
Here is its link: http://www.invescopowershares.com/products/overview.aspx?ticker=PGX
http://online.barrons.com/article/SB123397130260259379.html (subscription may be required.)
posted by CR English at 10:39 AM
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