Friday, September 25, 2009

Advantages and Disadvantages of Equity Preferred Floating Rate Securities

Last Revision 10/13/2011: SNAPSHOTS OF TRADES 2009 TO DATE AT THE END OF THE POST:

I have discussed floating rate equity preferred securities throughout this blog. I thought that it would be helpful to summarize what I view as their primary advantages and disadvantages. Of the ones that I am about to discuss, I currently own, as of 10/13/2011, METPRA, GSPRA, GSPRD, BMLPRH, BMLPRJ,  SCEDN, STDPRB, MSPRA, HBAPRF, HBAPRG AND ZBPRA. All of the securities listed below have a $25 par value. First I will list the basic float provision and guarantee for each of these securities. The first figure is the guarantee and the second number is the float provision, and the firm pays whatever rate is the highest of those two numbers (prospectus links highlighted in Blue) :

METPRA: 4% or 1% over 3 month LIBOR METLIFE INC
AEB: 4% or 7/8% over 3 month LIBOR www.sec.gov
ZBPRA: 4% or .52% over 3 month LIBOR www.sec.gov
BMLPRG 3% or .75% over 3 month LIBOR Prospectus Supplement
BMLPRJ 4% or .75% over 3 month LIBOR Final Prospectus Supplement
BMLPRH 3% or .65% over 3 month LIBOR Final Prospectus Supplement
BMLPRL 4% or .50% over 3 month LIBOR Term Sheet
BACPRE 4% or .35% over 3 month LIBOR Bank of America Corporation
GSPRA 3.75% or .75% over 3 month LIBOR 424(B)(2)
GSPRC 4% or .75% over 3 month LIBOR 424B2
GSPRD 4% or .67% over 3 month LIBOR 424B2
HBA Prefix Has Been Changed to HUSI
HBAPRF 3.5% or .75% over 3 month LIBOR Form 424(b)(5)
HBAPRD 4.5% (with a 10 1/2% cap) or .81% of the highest of T Bill, 10 Year Constant Maturity Treasury Rate or 30 Year Constant Treasury Rate www.sec.gov
HBAPRG 4% or .75% over 3 month LIBOR www.sec.gov
UBSPRD 1% over 1 month LIBOR (no guarantee) www.sec.gov
MSPRA 4% or .7% over 3 month LIBOR www.sec.gov
USBPRH 3.5% or .6% over 3 month LIBOR e424b2
STIPRA 4% or .53% over 3 month LIBOR Final Prospectus Supplement
SANPRB 4% or .52% over 3 month LIBOR www.sec.gov (Symbol changed from STDPRB)
ORHPRB 3.25% over 3 month Libor) e424b5     CALLED  Oct 2010
SCEDN (floating rate, effective 4/30/2010) 1.45% over the highest of 3 Month LIBOR; 10 year or 30 U.S. Treasury CMT Prospectus Supplement (partially called June 2012: Item # 1: Partial Redemption SCEDN

The 3 month LIBOR rate can be found each day at the WSJ market data page, and it is currently at .66%. WSJ.com I am not going to discuss UBSPRD due to its lack of a guarantee. When evaluating these securities, it is important to keep in mind the historical 3 month LIBOR rate, since the current period is at the very low end of the historical range. A link to historical 3 month LIBOR rates is as follows: LIBOR Rates History (Historical)

The securities that start with the symbol BML were originally issued by Merrill Lynch and are now Bank of America obligations. HBAPRD, HBAPRF, HBAPRG are issues from the American subsidiary of HSBC. MSPRA is from Morgan Stanley. GS is Goldman Sachs. SANPRB is from Spain's Santander. AEB was issued by the Dutch insurance company Aegon.   METPRA is from MET LIFE. SCEDN is from Southern California Edison. STIPRA is an issue from Suntrust Bank.

The prospectuses of all of these securities are linked at the free site, registration required, QuantumOnline, which also lists the current ratings. Preferreds eligible for the 15% Tax Rate Table - QuantumOnline.com


Advantages:

1. Qualified Dividends: According to QuantumOnline, the dividends paid by all of these floaters currently qualify as qualified dividends. The benefit of that classification to wealthy Americans may change under the current Administration. My 2008 1099 did list the entire dividend paid by AEB, METPRA, and GSPRA, all that I owned in 2008, as qualified subject to the maximum 15% for a U.S. taxpayer.

2. Inflation and Deflation Protection: The guarantee provides a measure of protection against deflation or low inflation afforded by a fixed rate coupon bond, whereas the float tied to 3 month LIBOR affords some inflation protection. Inflation or Deflation: Bond Alternatives/ Inflation, the primary enemy of a fixed coupon bond, will cause short rates to rise. With a rise in the short term LIBOR rate, the interest paid by the floaters will rise. These securities became very attractive during the 4th quarter of 2008 when their prices were marked down to extreme discounts to par value. Since the dividend is calculated based on the constant $25 par value, the dividend yield increases to the investor as their purchase price goes down, and many of these securities traded near, or in some cases, below 75% discounts to par value during one or more of their recent meltdowns. I have noted in this blog a couple of times when AEB fell below $3 a share. By purchasing at a discount to par value, the investor juices both the guaranteed and floating rate yield. At a $3 purchase cost, by way of an example, AEB would have had a guaranteed yield of 33.33%. If 3 month LIBOR increased to 5% during the applicable period, then the yield at that cost would be 48.96%. A 5% LIBOR, historically speaking, is not unusual.

Many of these securities have risen in value over the past few months. Anyone reading this blog would have seen those opportunities discussed frequently.

3. Cumulative: AEB and HBFPRD are the only ones listed above with cumulative dividend features, so that is a plus just for those two.

4. No Cap on the Dividend: Unlike the synthetic floaters, another frequent topic of discussion, the equity preferred floaters do not cap the dividend at a certain interest rate (typically 7.5% to 8% for Synthetic Floaters), except that HBAPRD does have a 10 1/2% cap. Thus, if 3 month LIBOR rose to 15% then they would have to pay that rate plus the applicable percentage over that rate. I say this with the following caveat. I have yet to find a cap provision in one of the prospectuses. The absence of a cap would make these securities more sensitive in hyper inflationary environments, such as experienced in the U.S. in the late 1970s and early 1980s.

Disadvantages:

1. NON-CUMULATIVE: Except for AEB and HBFPRD, all of these securities listed above are non-cumulative. If the company fails to pay a dividend, and its actions are legal under the prospectus, the dividend is just gone forever. In that respect, the preferred shareholder is in the same position as a common shareholder who has their dividend eliminated by the company. The main limitation preventing an elimination of the preferred dividend is the payment of a dividend on a junior security. The only security junior to an equity preferred is common stock. As soon as the company eliminates the common stock dividend, the preferred shareholder is in an enhanced danger of losing their dividend too. This may or may not happen. I own shares in AEB, a floating rate preferred issue from Aegon. Since Aegon announced the elimination of a common dividend last year, it has continued to pay its preferred dividends. Moreover, as I interpret the prospectus, Aegon could not eliminate the dividend on one equity preferred and pay another. All securities within the same class have to be treated the same. This is relevant where the government has taken a stake in an equity preferred issue.

2. Low Priority: In the event of a bankruptcy, it is unlikely that an equity preferred security will have any value. The most recent equity preferred floating rate security to go to zero was LEHPRG, a issue from the now bankrupt Lehman Brothers. The failure of Lehman Brothers, and the annihilation of the Fannie and Freddie equity preferred shareholders, placed a strong downside bias to virtually all equity preferred securities for months. Nothing strikes fear into investors more than starting to worry about a security going to zero.

Generally, I prefer to hold these securities in a taxable account, and I now intend to hold the synthetic floaters in retirement accounts. The synthetic floaters pay interest.

The Aegon floater is unique in its cumulative feature and the obligation to pay interest on any optional deferral (see p. S-4: www.sec.gov  However, it has eliminated its common dividend, which places payment of the preferred dividend in an enhanced danger of deferral. My last add of AEB was in a retirement account, though my larger position is in a taxable account.

3. No Maturity Date: I view this as the main disadvantage. These securities are perpetual obligations. I much prefer buying bonds with a fixed maturity at a discount to par value, so that I can make money by receiving the interest payments and by capturing the spread between my cost and par value at maturity. It is conceivable that one of the equity preferred securities might be called at par value, but I view such a chance as remote. It most likely would occur when there was a huge and prolonged spike in short rates at a time of an inverted yield curve.

This discussion is not intended to be a substitute for my earlier, far more detailed discussions of these securities. Those discussions are linked in my Gateway Post for floating rate securities.
Floaters: Links in One Post

SNAPSHOTS OF REALIZED GAINS AND LOSSES IN EXCESS OF $30 FOR SECURITIES MENTIONED ABOVE, 2008 TO DATE:

2008:
2008 HBAPRF +$232.99
2009

2009 BMLPRG 50 SHARES + $166.48

2009 BACPRE 40 SHARES +$137.18

2010

2010 AEB 150 SHARES +$772.04
2010 AEB +81.11

2010 BMLPRH +$363.48 AND BMLPRJ +$50.16

2010 GSPRA 50 SHARES +$45.58
2010 HBAPRD 50 SHARES +$153.03

2010 REGULAR IRA METPRA 50 SHARES +$492.52

2010 MSPRA 150 SHARES +$962.87

2010 ORHPRB REDEEMED 50 SHARES +$137.52
2010 STDPRB +265.01

2010: STIPRA +227.61 

2010 USBPRH 50 SHARES +$128.08

2010 ZBPRA 100 SHARES +1,099.21

2010 IRA ZBPRA +$201.53
2011


2011 TAXABLE ACCOUNT AEB 100 SHARES +$1,142.51

2011 ROTH IRA AEB 100 SHARES +$1,213.76

2011: BMLPRG +$51.58 BMLPH +$56.08 BMLPRL +$114.11 
2011 GSPRD 50 SHARES +$41.07
2011 STDPRB +$143.16
2011 STDPRB +$ 37.03
2011 STIPRA +$36.57

2011 USBPRH 30 SHARES +$95.68 
2012


2012 BMLPRJ 50 Shares +$90.98
2012 HBAPRG 50 Shares +$176.08
2012 GSPRD 50 Shares +$79.58
2012 SCEDN 9 Shares Partial Redemption +$142.56
2012 METPRA 100 Shares +1283.99
2012 GSPRD 50 Shares +$42.47

2013
MSPRA (2 Transactions) Total Gain=$147.66

2013 SANPRA 50 Shares +$124.58
2013 Roth IRA 100 GSPRD $219.25
2013 100 GSPRD +$257.24
2013 ROTH IRA SANPRB 50 Shares +$225.47
2014


2014 USBPRH 50 SHARES +$70.09
2014 HUSIPRF 100 Shares $48.96
2014 BMLPRJ 50 Shares +$40.08
2014 STIPRA 50 Shares +$67.57
2014 Roth IRA SANPRB 50 Shares +$105.01
2014 MSPRA 50 Shares +$34.48
2014 AEB 50 Shares $49.98
2014 MSPRA 100 Shares +$116.98
2014 Roth IRA MSPRA 100 Shares +$37.48


Total as of 7/29/14: +$11,752.05

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