A normally reputable corner of the financial markets – preferred stocks – has been rocked by the seizures of Silicon Valley Bank and Signature Bank, and that has created opportunities for investors.
Preferred stock is a senior form of stock that pays dividends ahead of common stock. However, preference shares issued by banks make up about two-thirds of the $400 billion market, and the bankruptcies of the two banks have highlighted the credit risk of these securities.
In fact, the preference notes issued by SVB Financial Group and Signature Bank, the parent companies of the failed banks, may have little or no recovery value. Trading in its preferred and common shares listed on the New York Stock Exchange has ceased. And an unlisted SVB preferential issue, aimed at institutional investors, was fetching around 10 cents on the dollar over-the-counter late last week.
While this is certainly a concern, preferred stocks still offer a lower-risk way to invest in banks than common stocks, and some pros say they’re looking particularly attractive now. After falling 8.5% this month, the sector’s largest exchange-traded fund has hit $12.4 billion
iShares Preferred and Income Securities
(Ticker: PFF), gives 6.5%. Furthermore, the preferred securities issued by most banks are now yielding over 6%, a nice premium over the 3.7% on a 30-year government bond.
“This is a great time to get into the market,” said Allen Hassan, head of preferred trading at Ziegler.
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Preferred stocks have long been popular with retail investors for their combination of relative safety, solid yields, and liquidity. Most are issued with a face value of $25 and are traded on the NYSE. There are also $1,000 par value institutional preferred stocks that change hands primarily over the counter.
Dividends on most preferred shares are taxed favorably like those on common shares. Companies are reluctant to give up preferential payouts because they can’t issue ordinary dividends without first paying the preferential holders. However, as equity, preferred stock carries a higher risk than debt.
Newly issued preferred stock can be problematic; It cannot be redeemed at face value for five years, limiting the immediate benefit while the downside is unlimited. But now many $25-par preferred stocks are trading below $20, making the risk-reward proposition far more attractive.
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“The preferred market offers unusual value,” said Phil Jacoby, chief investment officer at Spectrum Asset Management, a preferred specialist. Yields are near their highest levels in more than 10 years, he observes, and spreads to risk-free government bond yields are historically high.
As for the risks, he finds solace in federal regulatory support for banks on deposits and a new Federal Reserve program that will allow banks to borrow against their bond holdings.
Spectrum manages the
Nuveen Preferred & Income Securities
closed-end fund (JPS) now trading around $6. It has an 8% yield, reflecting leverage, and changes hands at a 13% discount to net asset value.
His investment company also runs the
Principal Spectrum Preferred Securities active
ETF (PREF) that focuses on institutional issuance and has a yield of 5%.
Retail investors should also consider the preferred stocks of top banks like JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Morgan Stanley (MS). These and a few others are considered by Uncle Sam to be systemically important financial institutions and therefore have more capital and are more tightly regulated than regional banks. And of late, they’ve generally benefited from deposit inflows that have been relocated from smaller competitors.
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Preferred stock of the country’s largest bank, JPMorgan, offers the lowest yields — its 4.2% Series M issuance yields 5.6%. Bank of America’s preferred stocks, like the 4.25% Series Q, yield nearly 6%, while Wells Fargo and Morgan Stanley preferred stocks yield nearly 6.5%.
(Some investors would rather buy common stocks in big banks, which are currently yielding 3% to 5%, because they have more upside potential.)
Regional banks may offer bigger payouts, but also more risks. Investors appear unfazed by preferred shares of Fifth Third Bancorp (FITB), Regions Financial (RF) and Cullen/Frost Bankers (CFR), which are yielding around 6.5%, just marginally more than some of their peers, which are too big to fail. Higher yields are also available from New York Community Bancorp (NYCB) preferred stock, which buys Signature Bank assets. Its 6.375% preferred is down from $25 to $19.45, returning 8.6%.
And then there’s
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Bank of the First Republic (FRC). It’s caused some of the worst jitters, even after a $30 billion deposit infusion from JPMorgan and 10 other big banks. Its common price is trading at $12.50, down 90% this month, while its preferred price is trading around $6, well below its $25 face value.
Despite suspending its joint payout, the bank still pays preferred dividends. There’s a risk here — a big risk — but investors could benefit if the big banks inject equity into First Republic or if the preferred shares are converted into common shares on favorable terms.
This bet is only suitable for investors with cast-iron stomachs. All others should stay with the largest banks.
write to Andrew Bary at [email protected]
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