Preferred Stock Investing-The Good , The Bad and The In Between 2015 - 2020

[Running_Man]

So with rising rates and the Fed probably raising today makes preferred shares an easier buy for that part of the portfolio. We have done a round trip over the last year, interesting in whether next year is the year the pattern is broken for an up cycle in interest rates - bad for preferred share prices but good for increased income and decreasing chances of preferred redemptions.

 

[Mulligan]

So with rising rates and the Fed probably raising today makes preferred shares an easier buy for that part of the portfolio. We have done a round trip over the last year, interesting in whether next year is the year the pattern is broken for an up cycle in interest rates - bad for preferred share prices but good for increased income and decreasing chances of preferred redemptions.

Yes, almost every issue I own or owned is down to flat from a year ago. My strategy of rotating in and out of a group of illiquids on price movements really paid off. Im still up about 12% and had a blast trading. Kind of in hiding with a big slug of PFK owned, GDL-B, and lessor KYN-F. This will guarantee lower returns going forward unless I flip out. Plan to hide here and look for opportunities of long perpetuals going forward. Term dated features of above will keep them in a relative tight range.

 

[Mulligan]

Went even lower today...Buying a slug of GJO... Backed by an uncallable Walmart 7.55% bond, both the debt and trust maturing together in 2030. Libor plus .50% as this issue trades off the short end yield curve. Every Libor bump goes straight to the yield. Did stretch on long end also, with a 300 share purchase of PUK-. Goes exD next week so essentially a 6.66% yield backing out the divi.

 

[Slow But Steady]

Slow, good that you got more than me for the O Puts,

I feel quite comfortable with them, and should we get assigned, I will look at selling Covered Calls 2-3 times a year to supplement the dividend.

Had a small position beginning of this year, got a call exercised at $60 several months ago, watched as it hit $70 - but now its coming back into a reasonable buy range. So to get back in at around $54.50 is a nice situation for me.

Looks like 50/50 whether we get assigned on these O puts. I might just sell them if I get assigned. The recent interest rate environment won't help them any. I'll make a profit on the trade in either case.

 

[Running_Man]

EGXKP - Entergy Corp’s Arkansas subsidiary preferred is there any issues I should consider that would make this a non-wise addition to my preferred portfolio? I see it is 5 years past the call date and trades about 40 cents over the call price. With the recent run up in interest rates I think the call probability is falling.

Entergy’s high energy production cost has led to competition in their markets which has squeezed their profitability and held back their stock price over the last few years but the financials are solid for continued dividends. The common is yielding 5.1% and the preferred 6.35%.

The Arkansas subsidiary is a nuclear power sub so that is also a risk factor. Any comments would be appreciated

EDIT: After the fact I note this issue was called on September 16th, so in the words of Rosanne Rossanna Danna: Nevermind

 

[Coolius]

Looks like 50/50 whether we get assigned on these O puts. I might just sell them if I get assigned. The recent interest rate environment won't help them any. I'll make a profit on the trade in either case.

I covered for a very small profit a couple days ago when it shot up to $56.

Will be looking to sell again for January, probably with a lower strike price.

 

[Running_Man]

My other choice is a subsidiary of Southern Company - Alabama Power’s ALBMP. This is callable next year and is trading about 50 cents over the call price for a 6.3% yield. An advantage is that Alabama Power has a higher credit rating than Entergy’s Arkansas subsidiary. The price of this utility preferred has fallen from the 27 it traded at for quite a while up until September and with the recent rise in interest rates the likelihood of being called next October is dropping. With a 40 cent quarterly dividend the return if called would be about 70 cents or around 3 percent to the call date.

 

[Running_Man]

Went even lower today...Buying a slug of GJO... Backed by an uncallable Walmart 7.55% bond, both the debt and trust maturing together in 2030. Libor plus .50% as this issue trades off the short end yield curve. Every Libor bump goes straight to the yield. Did stretch on long end also, with a 300 share purchase of PUK-. Goes exD next week so essentially a 6.66% yield backing out the divi.

Let me know if I have this right, the advantage I see in these debt instruments is this is a place to hide short term money when rates are rising. As such as interest rates increase because you are paying about 20 on a 25 dollar par security you get a 25% boost every time the LIBOR increases, so that an increase of .5% increases your return on purchase price by .6250%. So that the faster interest rates rise the better these notes are. If you believe the Federal Reserve will increase interest rates 3 times next year for 0.75% and that the LIBOR will follow then your interest return will be increased by 0.9375%. Current yield on the instruments are 1.75% based on the current price so a reasonable expectation is a year from now they will be yielding 2.6875% based on $20.00. Additionally, in general since they will be redeemed in 14 years there is a theoretical $0.30 per year in price recovery that would come also a result of buying this pushing the current yield up another 1.5% to 3.25% and if baking in the 3 FED increases this would mean an expected 4.1875% a year from now. OF course the market will provide the $0.30 at unexpected intervals but it is rather certain to be paid by 2030. Being backed by Wal-Mart debt this is about as high a bond rating as could exist for this type of debt.

The downsides I see are your capital can fluctuate on these notes they have several times had rapid declines in price and then recovered and you have a long term note paying short term interest. Also the maximum yield payable is 7.5% which is 9.375% based on current price. A yield to maturity of 20 years for Walmart is currently yielding 3.39% so this issue is about 1/2 of the cash yield that could be earned from debt but with great interest rate increase protection as outlined previously.

Do I have this right?

 

[Mulligan]

Somehow I missed notifications here...Yes, you pretty much are figuring what I am. These issues usually trade on the low end of the yield curve. Libor keeps creeping up, so the yield will also. The liquidity or lack there of can cause price movements. For example, Friday it didnt even trade. I think there is about $13 million in trust certificates being backed by $13 million in Walmart 2034, 7.55% uncallable bonds. The 2030 backstop of a grade A bond like Walmart makes it a safe play long term. But yes price movements up and down will occur. If Libor gets to 2% I suspect upward movement in price will occur.
I also bought 500 shares of GYC, which is floored one unlike GJO which is not. Bought at $20.50 the 3.25% initial floor is actually 4% at my purchase price. Although since floor is there Libor must get above 2.60% to get any uptick in yield. So this issue could actually fall some more. But it has been hit pretty good already. If it goes into 18s I will buy 1000 more. It matures in 2034 and is backed in trust by an ATT 2034 maturity bond.

 

[Mulligan]

My other choice is a subsidiary of Southern Company - Alabama Power’s ALBMP. This is callable next year and is trading about 50 cents over the call price for a 6.3% yield. An advantage is that Alabama Power has a higher credit rating than Entergy’s Arkansas subsidiary. The price of this utility preferred has fallen from the 27 it traded at for quite a while up until September and with the recent rise in interest rates the likelihood of being called next October is dropping. With a 40 cent quarterly dividend the return if called would be about 70 cents or around 3 percent to the call date.

I never even paid attention to this one as its price was always so high. It really has sagged. These are the type I always like as they are trading like a call could come next year. However, if rates rise you are protected a bit from the storm. If it does get called, 3% isnt bad return on the fact you are chasing higher relative yield with nice price support below. Its more annoying than impactful, but I hate the fact SO likes to issue their newer preferreds with non cumulative features.
I doubt it would stop me from buying. Georgia and Mississippi are the more indebted nuke builders and power builders.
You do notice the preferred rating is higher from Ala. Power than the baby bonds issued by parent company? (SOJA) . It is probably suggesting its finances may be somewhat ring fenced from parent which would be a good thing.

 

[Mulligan]

My other choice is a subsidiary of Southern Company - Alabama Power’s ALBMP. This is callable next year and is trading about 50 cents over the call price for a 6.3% yield. An advantage is that Alabama Power has a higher credit rating than Entergy’s Arkansas subsidiary. The price of this utility preferred has fallen from the 27 it traded at for quite a while up until September and with the recent rise in interest rates the likelihood of being called next October is dropping. With a 40 cent quarterly dividend the return if called would be about 70 cents or around 3 percent to the call date.

Per May of last year Moodys...
The affirmation of the ratings and stable outlook of Alabama Power (A1) reflects the credit supportive regulatory environment in Alabama, a lack of capital expenditures for new generation over the next few years, and strong, stable financial metrics, albeit slightly below the our rating methodology guidelines for a high "A" rating with a three year average CFO pre-working capital to debt of 25.5%. Although there is a now a relatively wide four notch differential between the ratings of Alabama Power and Southern, Alabama Power relies minimally on the parent to maintain its financial conditions and maintains its own credit facilities and commercial paper program. Alabama Power's dividends to the parent in 2015 were $571 million, just over half of Georgia Power's 2015 dividend level of $1,034 million.

 

[Running_Man]

Yes, I am not a big fan of the non-cumulative as a rule and as such I put a rule in that no more than 30% of my preferred portfolio can be non-cumulative. I noticed that the preferred was rated very high, which I take as the assets of Alabama power do not have much in debt pledged against them.

As a sidenote in my most recent Value Line issue the potential gains for all stocks fell to 30% which is only 5% above the lowest reading I have ever seen and in keeping with the stock market tops of 2007 and 2000, though it is not a short term signal at all, as in both cases the market held up for months. So the potential off of this is either profits need to improve markedly or else the escape from ZIRP may be in trouble, in case of a large market drop interest rates will be cut as well, with where everything is resting it is going to be an interesting start to the year.

 

[Mulligan]

Preferred Stock Investing-The Good , The Bad and The In Between

Yes, I am not a big fan of the non-cumulative as a rule and as such I put a rule in that no more than 30% of my preferred portfolio can be non-cumulative. I noticed that the preferred was rated very high, which I take as the assets of Alabama power do not have much in debt pledged against them.

As a sidenote in my most recent Value Line issue the potential gains for all stocks fell to 30% which is only 5% above the lowest reading I have ever seen and in keeping with the stock market tops of 2007 and 2000, though it is not a short term signal at all, as in both cases the market held up for months. So the potential off of this is either profits need to improve markedly or else the escape from ZIRP may be in trouble, in case of a large market drop interest rates will be cut as well, with where everything is resting it is going to be an interesting start to the year.

And I also suspect the fact there is little power plant construction going on with them helps with the rating as Moodys implied. That rating is very high for a preferred. Construction generally is the only way a utility can get into trouble is with cost over runs and disallowance of recovery. When it gets down to it for many companies throwing the word "cumulative" in is of little value. As they more than likely go under anyways. For a monopoly utility though they could in theory get in trouble then recover and pay suspended dividends back in full.
I really do not have any real commitment to rates going forward. They could do anything here near term. I just spread my bets out a bit with GJO and GYC. If held to maturity they already will pay out higher yield than the underlying bonds will, but you have a lot of upside potential down the road if patient. I dont "have to have" yield so I can go this route a bit with some of the funds. I may consider buying a few hundred shares of Ala Power myself.

 

[Mulligan]

Preferred Stock Investing-The Good , The Bad and The In Between

Well I finally got in today on Alabama Power (ALBMP) with 600 shares at $25.30. Another big dump considerably more than ave daily volume. I didnt even try to squeeze them as the ask price was more than fair. I sold out of my GJO and GYC making 20 and 35 cents per share flip profit. Im just not constituted to hold much low income and wait for capital appreciation with an income issue. I looked through all my emails of trades. Wow, a lot of commission burning fees...But then I looked at buy and sell prices and it way more than made up for it in avoiding riding issues on the way down. My list has kind of moved around a bit, so here is what I have.
AILLL, AILNP, ALBMP, ASRVP (Kind of loaded up on this one the past month or so being my 3rd biggest holding), C-N, HE-U, PUK-, CTWSO, FIISO, CNLPL, KYN-F, and KCC....KCC quietly dropped down recently and I loaded back up on this one too.
Just noticed that for first time in a while, I do not own a reit preferred anymore. More accident than by design.

 

[Texas Proud]

The higher interest rates have affected the prices of my pref shares...

I used to have over $2K of 'gain', but that has been lowered to just over $400.... but, cannot complain as I am still getting the divis I was hoping for and plan to hold my main group....


As for my experiment on flipping and trying to boost yield... it seems to be going 'OK'... I had that one really bad trade early where I lost $1K... but have almost overcome that... I will be close to even or down a $100 or so after this last purchase is sold... and should go positive after that...

If you take out that one trade I am going at a 25% return on my money.... I was hoping for 15% which I might get even with the bad trade... the problem is that I am using thinly traded shares and they just do not move like I had hoped... the previous shares I had before this round had zero sales for a couple of days after ex-divi..... the bids were very low... but, they came back by the time I needed to sell where I did make a profit on the trip...

 

[Mulligan]

Well its good entertainment isnt it Texas! Looks like I will finish the year about up 13% for the year. All in preferreds. Did a lot of trading! Some was probably for amusement though. This past week I did some serious pruning selling off issues at small trading profits to buy about 3000 shares of PFK on a dump last week at $25.20 average. The safest of issues to hide out in. Its been a home base trading issue for me. Going forward this will restrict gains next year as this issue will yield about 4%. But my plan is to hide out here and collect monthly divis and then flip out when something has a sell off this year.

 

[Running_Man]

And so as we end the year the economic data is starting to show effects from the raised interest rates and rates have begun to recede, I am interested in seeing how the year starts out with rates. It would be best for the economy if we are able to leave zero interest rates behind, but there is still much economic work to do.

 

[Mulligan]

Preferred Stock Investing-The Good , The Bad and The In Between

And so as we end the year the economic data is starting to show effects from the raised interest rates and rates have begun to recede, I am interested in seeing how the year starts out with rates. It would be best for the economy if we are able to leave zero interest rates behind, but there is still much economic work to do.

There are several issues I have been in and out of that have receded a lot closer to par despite rates tapering a bit. Market is fearing calls. Some of these just may survive with a bit over current market rates. I am looking to get back in some of these for yield rate backside protection.

 

[Slow But Steady]

I just changed my AHT-G for AHT-D, after the G shares gained 7% in price. I sold the G shares for $23.16 and bought the D shares right at par.

Following Mulligan's suggestion, I also parked some cash in PFK yesterday.

 

[Slow But Steady]

You may recall that 3 months or so back, I picked up an additional half a bite of GWSVP at $25.42. Shortly thereafter, I entered a GTC order to sell the half bite for $26.42, and somebody took a few shares.

The order expired a few days back, and I re-entered it at 26.40. Lo and behold, yesterday right at closing somebody took the rest of them. So I got three months of dividends and pocketed 98 cents a share.

I also bought another few KCC yesterday at $28.85. Still looking to buy a few more with a GTC order.

 

[Mulligan]

Good trade, Slow! Dont blame you for taking profits and running. PFK, if it climbs more it will put us in a bind, to where you almost have to sell.
Im afraid if it rises a bit more and I sell, I will use the money to buy something I later regret, so I hope it quits rising!
I got some KCC shares a few weeks ago. I actually would buy more also at this price, but I have no tax free money space available. I did buy 100 shares of GAPWP at $101.75 today.

 

[brewer12345]

Stupid question: given that perpetual preferreds have very, very long durations, what is the risk management strategy for this stuff in a rising rate environment?

 

[Mulligan]

Stupid question: given that perpetual preferreds have very, very long durations, what is the risk management strategy for this stuff in a rising rate environment?

No that is an excellent question. In fact the question (if rates rise rapidly) is a lot better than the possible answers, ha! If one is really worried about capital loss from rate hikes here are the main options...
1) Term dated ones that mature in 3-5 years (most of these types of preferreds are actually "baby bonds". I have a huge slug right now in PFK that matures 4/2018 for capital protection and modest inflation protection. In this same vein you can buy at right price perpetuals certain to be called.. WFC-J is one example. 2) Buy the higher yielding riskier issues such as the 8%-9% issues. History has shown them to be more resilient to rate hikes. In fact in 2013 Taper Tantrum, high yielders snoozed through this. AHT-A is an example (though these types of issues will present a whole separate issue in themselves. 3) Buy adjustable issues preferably ones with Libor yield plus 4-5% kicker added to Libor. ALLY-A is one example.
I tend to just "whistle through the graveyard" though. I dont like straying far from utility preferreds and the relative higher yielding ones are stickier in price. For example GAPWP, I just bought today at $101.75. It dropped to around $100 during Taper Tantrum when 10 year last went above 3%. That is only about one divi loss in capital made up 3 months later. I can handle that...

 

[cooch96]

Oh dear, Mulligan. I think you just showed me a can of worms. I feel o have no choice but to open it.

Baby Bonds? A search shows these are formally called Exchange Traded Debts and are senior to Preferred Stocks in terms of payback precedence. Otherwise, they seem very similar. Is this correct? It sounds like you treat them the same as preferred stocks.

I tried to see how well they correlate to the equities market, but couldn't find anything. Can you, or some other savvy investor, point me in the right direction? Any other opinions and observations would also be appreciated.

 

[Running_Man]

Stupid question: given that perpetual preferreds have very, very long durations, what is the risk management strategy for this stuff in a rising rate environment?

I would think that in a rising rate environment the prices of these would fall while other holdings in your portfolio would rise and you would rebalance by purchasing more. One of the main reasons I would only recommend holding 5-10 percent in preferred stock.