1. Pared 50 METPRA at $18.3 Today in IRA (see disclaimer): In my second post after starting this blog in October, I discussed METPRA in detail, a perpetual and non-cumulative preferred stock. In the U.S., this kind of security is sometimes called a traditional or an equity preferred stock. It is listed as part of the firm's equity, unlike the European hybrids which are listed as debt on the balance sheet while considered equity for regulatory purposes. I was drawn to METPRA back in October 2008 because it was selling at a substantial discount to its $25 par value, which juiced both the guaranteed and the floating rate in this instrument. Along with a prior sale of 50 shares of METPRA, I am now close to playing with the house's money for this security with my remaining 150 shares, taking into account the dividends paid since I first acquired shares last Fall and my profits.
I have mentioned previously that I prefer buying securities that pay qualified dividends in a taxable account, and securities that pay interest taxed at the highest marginal rate in a retirement account. (see, e.g. my comment to Cathie in today's post: Common Sense View of European Hybrids/Sold PICO at $33.06/) I ended up with 100 shares of METPRA in my traditional IRA since I had some funds available and the price had fallen to an absurdly low level. Averaged Down on POM/Added To METPRA/
While this type of security is deemed by accountants and lawyers to be part of Met Life's equity, the owner has no equity interest in the business. If a firm made an offer to acquire Met Life at a premium, that offer would be directed to the common shareholders. To understand what can happen, I previously gave an example of what happened to the equity preferred shareholders of Innkeepers, a hotel REIT, after it was acquired in a leverage buy out. The common shareholders received a premium for their shares, and the preferred shareholders now have a stock trading at a few cents on the dollar in what is called the Grey Market and their dividend in deferral. Late Friday Buys: LNC and GXP
So, it always important to understand what you own. METPRA is more like a bond than equity. The equity characteristic of this security embodies all of the undesirable aspects of common stock, such as its perpetual nature and non-cumulative dividend, without the desirable feature of Met's common shares, an ownership stake in the business. The preferred stock does have priority over the more junior common stock in bankruptcy and in its superior claim to dividends. For the owner of METPRA, and I still own 150 shares after the sell today, the superior claim simply means that the common dividend has to be eliminated before the preferred dividend.
I think that my discussion of this security was a good one back in October and I thought that I would copy part of it here:
"Met Life has a preferred stock issue that also took a beating last week along with common stock. The symbol is METPRA, or MET-PA at yahoo finance or MET.PRA at Marketwatch. The par value of this preferred issue is $25 with no maturity date. As of last Friday, 10/3/2008, it closed at $9.8 per share. The floating rate provision requires Met to pay the greater of 4% or 1% over three month LIBOR (the London Inter Bank rate). For 100 shares, the annual interest payment at the guaranteed rate would equal $100 (.04% x 25 par=$1)
The coupon is calculated on the par value. However, when you purchase the security at $9.8 for example, the effective guaranteed yield at that price is 10.2% ($1 divided by 9.8 cost=10.2%). Thus, a purchase at last Friday's closing price excluding a brokerage commission would give you a guaranteed yield of 10.2% paid in quarterly installments. .........
For purposes of illustration only, I would like to assume what effect a 3 month LIBOR rate at 5% would have on the MET LIFE floater. The rate would then rise to 5% + 1% or 6%. A 6% yield on a $25 par value bond like investment would yield $1.5 per share in interest per 1 share annually or a 50% increase over the guaranteed rate. Now, you need to do a calculation of the effective yield at a $9.8 cost per share. This is done as follows: $1.5 interest divided by $9.8 cost=15.3%. Of course, this yield will go up when the cost goes down; and the yield will go down when the cost goes up.
The downsides that I considered prior to making a purchase can be summarized as follows. First, the security has no maturity but Met Life could redeem the security at par value plus accrued interest in the event the float rate becomes too onerous for it which could happened with a prolonged spike in short term rates and an inverted yield curve, where Met Life could refinance with a longer dated maturity and save money. When purchasing a bond or bond like investment I always prefer issues that have a fixed maturity date. Second, this is a non-cumulative issue, which means that any interest payment missed does not have to be paid later. If missed it becomes like an eliminated common stock dividend where the company has no legal obligation to pay an eliminated dividend in the future. Generally, for non-cumulative preferred stock dividends, the company can not pay any common stock dividend and reduce or eliminate the preferred stock dividend. That is, if a common stock dividend is paid in any amount, the preferred dividend would have to be paid in full. Also, any elimination of a non-cumulative preferred stock divided would invariably be linked to a major solvency type issue. Bankruptcy in all likelihood would be just around the corner. So in many circumstances the importance of cumulative versus non-cumulative would not be material. Nonetheless, it is always better to buy a cumulative preferred stock which requires any missed payment to accumulate, sometimes with interest, and payment is not discharged short of bankruptcy. Third, a preferred stock only has preference rights in bankruptcy to assets over the common stock holders. The Lehman preferred stock issues are now worthless in that investment bank's bankruptcy. The most secure debt in the event of a bankruptcy is secured debt, like a mortgage on a building, then senior debt, then junior debt-sometimes called junior subordinated debentures, then preferred stock and lastly common stock. So the METPRA is just above common stock in this pecking order. It is however difficult for me to imagine now a bankruptcy for MET LIFE and this security does give you the benefit of a guaranteed rate plus protection in the floating rate provision in the event the short term LIBOR rate increases." LIBOR AND THE MET LIFE FLOATING RATE PREFERRED STOCK
I can not stress enough the importance of understanding what you own. A period of time needs to be spent reading the prospectus: METLIFE INC The first few sentences of most prospectuses might give you important information about the security, as does this one from Met Life. You find out quickly that it is non-cumulative and the circumstances that are required before the dividend is eliminated by the company. A perpetual bond like security with a non-cumulative dividend and a low priority in the capital structure (which is how I would describe METPRA) is something that I dislike for those reasons. It is at the start part of a disfavored asset class, which means an active trading strategy will be used for the security. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock Trading Rule for Disfavored Asset Class: Sold BDNPRC and Late Buy of Just 30 Pico Managing Risk for Each Security in the Asset allocation Those factors alone will cause me to turn cautious when buying it, requiring a substantial discount to par, and then limiting my exposure to relatively small sums. Since I have a more favorable view of Met Life as a company than most of the equity preferred stocks that I have bought during their meltdown phases last Fall, I am consequently more inclined to keep some shares even with a handsome unrealized profit in them due to the yields at my cost and the inflation/deflation protection provided by this kind of security when purchased at a substantial discount to par value.
2. Large Percentage Gains in Disfavored Asset Classes: One aspect noted by many long time readers, who have been reading my blog for months, rather than a few here and there, is that my largest percentage gains have come from what I view as the riskiest assets since I started writing this blog. You can stay at that kind of party too long. In fact, I think that my largest percentage gain has come from a REIT cumulative preferred, GRTPRF, bought last fall at $2.9, a $25 par value and a 8.75% coupon, which I still own after some paring. GRTPRF: A WALK ON THE WILD SIDE/ KTN add My yield is 75% per annum at my cost, with more than enough profits to pay for what is left, several quarterly coupons already received and a closing price today of $15.72. GRT-PF: Summary for GLIMCHER RLTY PFD F Large percentage gains, with many doubles, have been realized in the European hybrids and other REIT cumulative preferred issues.It is important to understand the securities, their many disadvantages over other securities, and to realize when the risk justifies the reward. Even as late as a few months ago, it was possible to buy a security like a cumulative preferred issue from S L Green at more than a 50% discount to par value and and a yield greater than 16%. Now, would I think the risk of buying SLGPRC is worth it at $20, and the answer is not for me. REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & disadvantages
Maybe it is for you. But, to take the risk, you need to understand and fully appreciate the risk that you are taking with the European hybrids, particularly now, and with other securities like equity preferred stocks which have many disadvantages to them which need to be fully appreciated by individual investors prior to making an investment in them. Advantages and Disadvantages of Equity Preferred Floating Rate Securities
Another ridiculous source of percentage gains for me this year has been my Lottery Tickets. For someone like me, this is a per se disfavored asset class. Yet, I have had some of my largest gains ever over short periods of time in some of these issues, like CBG or NADX, with several issues doubling in price quickly, like DRAD and SBGI. LOTTERY TICKET PURCHASES: LINKS IN ONE POST This does not mean that I am about to change the amount invested in those purchases, currently limited to just $300 per position, because I fully appreciate the risk that I am taking and realize that I have been mostly lucky over the past few months with them. All of these types of issues, the European hybrids, non-cumulative preferred stocks, REIT preferred stocks and my Lottery Tickets, have an enhanced risk profile attached to them for a variety of reasons. With enhanced risk, there comes more of an opportunity for gains, which I have mentioned many, many times in connection with the hybrids, and also enhanced opportunities for serious percentage losses.
Maybe for new readers I need to quote a few sentences from a post in April about the ING hybrids:
"The danger in investing in any of these securities is apparent. First, ING has eliminated the common share dividend, the security blanket for a preferred shareholder. Second, ING has been hit hard by the credit crisis. In some of the above linked posts I have discussed the Dutch government's first effort to stabilize this large financial institution. ....
I have successfully reduced my risk by trading the positions at a profit, so that I now hold the lowest cost shares using FIFO accounting which is my custom for securities viewed as having an enhanced risk to them. An individual investor has to become knowledgeable about these risks in my opinion in order to make an intelligent decision whether or not to buy, how much capital to expose given the balance of risk/reward, and the method to be used to manage the risk. That judgment can not be made for you....." ING Preferred Stocks: Links in one Post
Added 10 P.M 8/31: I thought that I would attach a comment that I just made in the comment section of another post which is apropos of this discussion:
"I would add to my observations that an investor is invariably faced with a large number of choices among alternative investments. I will go anywhere and buy anything. No matter how much money you have, there is always a question of a capital allocation. Do I buy this security or that security. For example, if I told a reader that you could buy an investment grade senior bond with a yield to maturity greater than the Aegon or ING hybrids, junior securities with unlimited rights of deferral provided certain preconditions are met, which have no maturity dates, which would you choose, taking into account that investment grade bond is senior in the capital structure, with no right of deferral, and has a promise attached to it to pay the principal back whereas the hybrids carry no promise to ever pay the principal back and come with an enhanced threat of deferral caused by at least two conditions, the absence of a common dividend and the EC newly announced policy of burden sharing. Or would a gamble on the recovery of the common shares be a better use of the capital. It was not long ago that I owned the common of ING, selling the shares for over $30 and I could have bought those shares back recently at just $3. At least with the common, I have an equity share in the business. Or do I forget about that and buy my Baby Berkshire shares back that I just sold. The capital allocation decisions are certainly thick with choices." (Comment to: Common Sense View of European Hybrids/Sold PICO at $33.06/)
Or maybe I need to forget about all of that and buy a condo in South Florida overlooking the Atlantic.