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Preferred Shares Primer Needed
Old 06-07-2013, 02:36 PM   #1
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Preferred Shares Primer Needed

Hello, everyone...

I've decided to invest in preferred shares, but I've never done it before and I don't have a good understanding of that investment class.

I understand how investing in common stocks works and I understand how investing in bonds works. But not preferred shares. So I would appreciate any advice or a pointer to some "preferred shares for dummies" learning resource. (I could not find anything in the er-org archive.)

Questions and wonderments:

-- preferreds can have maturity dates but not necessarily?

-- what happens at maturity to a preferred?

-- preferreds can be called?

-- preferreds can trade like common stocks online or do you need to place orders (especially sell orders) through a broker?

-- can the issuer force conversion into common shares?

-- and who knows what else I don't know enough to ask!


Thanks for any help you can give.

Alex in Virginia
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Old 06-07-2013, 02:45 PM   #2
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I am sure others will answer your question much better than me...


But, without getting to much into the details.... the best thing that someone told me about preferred is you get the return of a bond with the risk of common stock... why go there


In truth, there are some that can be good.... some are convertible into common stock at a predetermined price... so there is an equity kicker involved...

To answer some of your other question...

Some can be called... it is in the docs if it can..

Some mature... again, look at the docs..

Some the company can force you to convert into common... (I do not think this is common, but this is just a guess on my part)...


On the downside... unless the docs prevent it.... the company can issue a LOT of debt that can impact the payment of your dividend.... not all pref stock have cumulative language.... IOW, if they miss a dividend, they do not have to pay it to you at a later date...

Also, in BK you are at a lower level... and if they loaded up on that debt, you will get zilch...
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Old 06-07-2013, 04:35 PM   #3
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I have about 4% of my NW in Preferreds and have been getting a good rate of return (~5-6.25%) as a result, which is why people buy them, and yes..when interest rates go up, the value of the Preferreds will go down, but they will still pay the same interest rate (coupon) and if they are ever called, they are called at Par. You can buy and sell them at VG for $37 each. You lose if interest rates go up and you sell them (like a bond).
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Old 06-07-2013, 05:22 PM   #4
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Originally Posted by Alex in Virginia View Post
Hello, everyone...

I've decided to invest in preferred shares, but I've never done it before and I don't have a good understanding of that investment class.


Alex in Virginia
Well that first sentence sounds like a recipe for disaster

Here's brief primer on them

Preferred Stocks, preferred stock, preferred dividends

I bought PFF ( an etf ) back 09 when it was being thrown away. I don't think I would buy it today.
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Old 06-07-2013, 05:47 PM   #5
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Well that first sentence sounds like a recipe for disaster
My first thought was "What a refined way to say 'Hold my beer and watch this.' "
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Old 06-07-2013, 07:40 PM   #6
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While investing in preferred isn't particularly dangerous, very often the devil is in the details, which is why you are probably better off using an ETF or mutual fund to buy preferred.

It is also important to understand that preferred funds have a very long duration so they are very sensitive to rising interest rates. Although I think much of that information is already baked into the price of preferred shares.

A terrific resource for preferred is quantumonline.com.

You can enter the stock underlying ticket symbol and it will show all of the companies preferred shares. For individual preferred shares it will provide a nice summary of all the relevant data. maturity dates, call data, tax treatment, cumulative or not.

Also handy links to the prospectus. I kinda of hate to say but you really should read/skim the prospectus before investing in preferred.

I didn't in the past, and I got lucky.
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Old 06-08-2013, 07:11 AM   #7
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Conventional preferred stock is perpetual. Some issues of preferred stock are redeemable - some are mandatorily redeemable and some are redeemable at the option of the issuer.

If a preferred is redeemable, the holder would receive the stated value of the issue when the issuer redeems the preferred.

Preferreds that are redeemable at the option of the issuer can effectively be called.

There are convertible preferreds. I would imagine that there are some convertible preferreds where the conversion to common is at the option of the issuer.

Preferreds can also be cumulative or not. With a cumulative preferred, any unpaid dividends accumulate and could ultimately be paid if the issuer later has the financial capacity to do so. Other issues are not cumulative, and if a dividend is not declared it is effectively skipped.
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Old 06-08-2013, 08:56 AM   #8
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I maintain some investments in preferreds, and as others have said, you have to look carefully.

A good majority of preferreds are issued by financial institutions and REITs, although a few others are by other industries/companies, the reason being that they are allowed to place preferred stocks in other areas of their balances sheets that don't impact debt:equity, debt:assets and other ratios. Most have par value of $25/share.

A few points:

Dividends are declared - One item which came up during 2008/2009 en-masse: A company is not obligated to pay a dividend on preferred stock or face a lawsuit, and it's not automatically distributed like a bond interest payment. That's why in press releases, you'll see the company state "and the board of directors declared dividends today of $x/share for the common stock, $y/share for Preferred Class A, and $z/share for Preferred Class G stock". That means that in bad times, they will halt the dividend.

A cumulative preferred stock is one that, if the board decides not to declare a dividend, will keep accruing the unpaid dividend like a taxicab meter. When the dividend is finally resumed, you'll get the unpaid dividends as well that have been accruing. Some preferred stocks have criteria that they can only suspend dividends for up to, say, 5 years before they have to pay it (or go into default on the preferred stock). If a preferred stock is non-cumulative, then if the board suspends the dividends, you're SOL until they resume them. Obviously, they would only do this in times of distress (like 2008/2009), but something to keep in mind.

Usually, I've seen most of the non-cumulative preferreds issued by banks, since they (used to be) are sometimes viewed as "safer" and can get away with this non-cumulative provision, but after 2009, many people are taking a closer look at the non-cumulative provision and might price them lower.

2 case studies on suspended dividends:
FBPRO
A bank in Puerto Rico, with a non-cumulative preferred. Trading at $21/share. It suspended the dividend in 2009, and went through typical bank anguish over the past few years. It's finances are getting stronger, and is returning to profitability. Based on the common stock financials, they look like they could be reinstating the dividends soon (next year or so). When they resume dividends, it'll be paying 8.35% off of a par value of $25/share. At the current price of $21, when the dividend resumes, it'll yield 9.94%, PLUS the market would likely price it to yield similarly with other preferreds at, say, $26+/share, with possible capital gains of $5/share.

Because the dividend is suspended, there are no guarantees when/if the dividend resumes. But like I said, based on their audited public financial statements, their fiscal health is much improved, and even if it takes 2 years to resume the dividend from now, that's a pretty decent return for what I perceive as a 'reasonable risk'. Your analysis and risk profile may vary.

FBS-a
Mid-range, privately-held bank in my hometown, but publicly traded preferreds. It suspended the dividend in 2009. It's owned by a family that runs a large local grocery store chain (i.e. deep pockets). Said family had to pony up a $100 million equity infusion into the bank in 2009/2010 to keep it afloat, so they're obviously committed to seeing it succeed. They expanded into California and were hit with various construction/mortgage loans that went bad. They cleaned up their balance sheet, sold branches in non-core markets (FL, CA) and finances are greatly improved. Their dividend is cumulative. It was trading in the $22s, with a yield at par of over 8% (trading at $22, the yield was over 9%, PLUS it had accumulated dividends of 2 years worth when I bought it). As the bank's finances have improved, the market is valuing the returned dividend as a more likely event, and has since ran up the preferreds to trade above $28.

Note that with a cumulative preferred that suspends dividends, when they resume dividends, there'll be a large one-time dividend of several dollars per share, which will cause the price to drop when it goes ex-dividend.


Call provision - make sure you factor in the call provision on existing shares. If a preferred stock has a callable date of September 2013, and it's trading at $27/share, realize that the company could redeem the stock in September 2013 at $25/share, and you just lost $2/share in capital. Oftentimes the market may price in this possibility with a slightly lower share price, but sometimes it's random and out of the blue. One way to guesstimate this is to look at their total preferreds outstanding. If a company has redeemed older preferreds with higher coupons, and their current preferreds outstanding have various coupon rates, odds are they're going to redeem the highest coupon first (if they are going to redeem it). But, you have to look at when they redeemed them - if it was back in 2003 when times were good, they may not have access to financing now like they did back then if their finances are still struggling. Look at when they redeemed their previous issues, and what the rates were, and what their current preferred rates are. And look at the health of the company.

I have personally experienced the frustration of buying a preferred at a price of, say, $26.50 or $27, only to have it redeemed at $25 6 months or a year later. It doesn't happen too often, but it can happen.

Also, companies can partially redeem preferreds. Your broker might partially call away some of your shares, leaving you with a partial position. So when you look at some preferreds, you might see that the share class was partially called in the past (hint: this is an indication that it could be called again in the near future, so factor that into what price you're willing to pay).


When I look at preferreds I might want to buy, I first look at the common stocks. If the company is somewhat healthy, and has decent financials, I might buy the preferred...but if their common stock is yielding almost as much as (or more than) the preferred, I'll just buy the common. This isn't as frequent these days with the recent equity run-ups, but 2-3 years ago, it wasn't that unusual to find common stocks (mostly REITs/banks) with common yielding as much as (or more!) than the preferreds. Yes, there is more risk of dividend reductions w/ the common - but I factored that into my analysis.
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Old 06-08-2013, 11:31 AM   #9
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Here is a posting by Larry Swedroe on preferred stock.

Why you should avoid preferred stocks - CBS News
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Old 06-08-2013, 12:09 PM   #10
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A lot of excellent posts here on the pluses and minuses of preferreds. IMO, they are a very specialized opportunistic class for people who enjoy digging into details. They are almost the opposite of the generally favored index, low costs, etc. crowd.

They seem to be gaining in popularity recently among people who are not particularly interested in investing, but feel that they need more income. Usually a situation in which it is wise to pass on by, or at least tread very carefully.

Ha
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Old 06-13-2013, 03:35 PM   #11
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Than you, everyone, for your very informative replies to my original post.

Shall we go the next step and look at the characteristics of a specific issue?

Consider a preferred share as follows: par value $25.00... bought at $23.00... yield at buy price 9.2%... not convertible... cummulative... callable after January 2018 at $25.00... (the specifics of the company's merits let's set aside for now).

To me, it seems like this issue avoids -- or at least minimizes -- the negatives that have been pointed out with regards to preferred shares while retaining the positive aspects of that asset class.

Comments?

Alex in Virginia
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Old 06-13-2013, 07:41 PM   #12
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Another thing to look at is whether it qualifies for 15% tax treatment. I use Quantumonline to look at this detail.
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Old 06-13-2013, 07:46 PM   #13
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Originally Posted by Alex in Virginia View Post
Hello, everyone...

I've decided to invest in preferred shares, but I've never done it before and I don't have a good understanding of that investment class.
Based on reading many of your other posts, this doesn't sound like you and I don't think you meant this literally..... but in case you did..... Don't invest in anything you don't understand.

Get the knowledge, try some purchases on paper or make some small trial purchases, then make the decision.

Heed the cautions expressed in the posts above.
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Old 06-14-2013, 09:14 AM   #14
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Originally Posted by Alex in Virginia View Post
Than you, everyone, for your very informative replies to my original post.

Shall we go the next step and look at the characteristics of a specific issue?

Consider a preferred share as follows: par value $25.00... bought at $23.00... yield at buy price 9.2%... not convertible... cummulative... callable after January 2018 at $25.00... (the specifics of the company's merits let's set aside for now).

To me, it seems like this issue avoids -- or at least minimizes -- the negatives that have been pointed out with regards to preferred shares while retaining the positive aspects of that asset class.

Comments?

Alex in Virginia

Using your criteria... yes, this looks good.... who wouldn't want a 9.2% yield...

Not using your criteria... it makes a big difference who is paying the dividends.... and the possibility that it could go BK....
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Old 06-14-2013, 10:21 PM   #15
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I have owned and watched preferred's for many years and still own several issues. Having lived with them through good times and bad, I've learned alot and am not nearly as uncomfortable with them as many people seem to be.

Regarding your specific issue, if it's not callable till January 2018, then it was likely issued in January 2013. During that time, rates on newly issued preferred's were between approximately 4.75% on the low end and as high as 9% on the high end. As usual, the quality of the company issuing the preferred directly effects the rate. 9.2% on a $23 cost makes the "coupon" rate on par of $25 close to 8.5%. Any company issuing preferred in January 2013 at 8.5% should be looked at very carefully regarding their ability to consistently pay that dividend over the next five years (or longer).

A second observation is that it's interesting to note the $23 cost. Those who watch these markets know that like the bond market, the price on these preferred's will fluctuate some with changes in interest rates and investor thinking. Most preferred's (both good and bad) took a beating over the past couple weeks due to fears of rising rates, etc.

Finally, like most have said, always do your best to research the issuing company prior to buying. One of the things I like to do is carefully check the performance of the common stock of the company. A company with a long history of paying regular (and sometimes increasing) common dividends is much more likely to pay the dividend on it's preferred, since most preferred dividends MUST be paid prior to any common. Also be very concerned with a company paying an unrealistic common dividend (that they may not be able to afford) that then issues preferred. There are always exceptions to these ideas, but it's a good place to start.
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Old 06-15-2013, 05:51 PM   #16
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I have owned and watched preferred's for many years and still own several issues. Having lived with them through good times and bad, I've learned alot and am not nearly as uncomfortable with them as many people seem to be.

Regarding your specific issue, if it's not callable till January 2018, then it was likely issued in January 2013. During that time, rates on newly issued preferred's were between approximately 4.75% on the low end and as high as 9% on the high end. As usual, the quality of the company issuing the preferred directly effects the rate. 9.2% on a $23 cost makes the "coupon" rate on par of $25 close to 8.5%. Any company issuing preferred in January 2013 at 8.5% should be looked at very carefully regarding their ability to consistently pay that dividend over the next five years (or longer).

A second observation is that it's interesting to note the $23 cost. Those who watch these markets know that like the bond market, the price on these preferred's will fluctuate some with changes in interest rates and investor thinking. Most preferred's (both good and bad) took a beating over the past couple weeks due to fears of rising rates, etc.

Finally, like most have said, always do your best to research the issuing company prior to buying. One of the things I like to do is carefully check the performance of the common stock of the company. A company with a long history of paying regular (and sometimes increasing) common dividends is much more likely to pay the dividend on it's preferred, since most preferred dividends MUST be paid prior to any common. Also be very concerned with a company paying an unrealistic common dividend (that they may not be able to afford) that then issues preferred. There are always exceptions to these ideas, but it's a good place to start.

I would be very surprised to see any preferred that does not have a clause in it that they have to be paid their dividends prior to any common dividend being paid.... do you know of any that allows it
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