Is this the time for Preferred Stock to shine?I’ve been thinking about preferred stock recently, and want to make a case for it here. (Not for preferred stock in genera but for preferred stock _right now_.)
I’d really like to hear feedback on how I’m thinking about this.
I know the common “Neither fish nor fowl” objection to preferred stock, but I submit that the current environment should make us realize that “neither fish nor fowl” are exceptionally great right now:
— Current interest rates are going to continue to pose headwinds against company margins, especially combined with possible future credit crunches.
— Even in the current environment, long-term bonds are still pretty poor solutions.
The current environment (historically medium-high interest rates with a reasonably hawkish fed and still above-average inflation) seems to make preferred stocks highly attractive.
The key piece here is that the combination of yield and timeframe give preferred stock substantially higher performance potential than bonds, and that performance potential is not substantially below the historical returns experienced in the stock marked _during times of similar interest rates_.
Preferred stocks act as a kind of semi-perpetual bond. The issuer may have the option of calling (redeeming) them from you, but typically this will lead to a windfall as the redemption price tends to be higher than than price of the bond. (Thus the company would do better to just buy back bonds on the open market rather than call them from reluctant buyers, but this itself will raise the value of your bonds if you want to sell them.)
A few points for comparison:
Yield on 10-year treasury bonds: 4.5%
Yield on 1-year treasuries: 5.5%
Yield on best GSE bonds: 6.4%
Current 30-day SEC yield for VANECK PREFERRED SECURITIES EX FINANCIALS ETF: 7.1
Current 30-day SEC yield for GLOBAL X VARIABLE RATE PREFERRED ETF: 7.65
Annualized total return SPY 1993-2011: 8.1
So preferred stock (either non-financial or financial) is crushing the long-term yields and even beats the short term bond options and is only slightly below the higher-variance S & P. (Note that the GSE bonds are not long-term, as they are full-coupon callable instruments.)
Even when (if) interest rates go down, the concomitant increase in price will mitigate the difference in performance between preferred stock and common.
There is also some opportunity in the variable-rate universe for extra windfalls as many variable-rate bonds that are currently in their fixed-rate regime will graduate to a high floating rate (often 10%+) that may prompt high-return redemptions.
For example, Invesco C preferred stock currently costs $19.21 a share and is set to transition to variable rate in December of 2024. At the present LIBOR rates, its yield will be ~10.8% when it does that, so if the company calls these bonds, it mean a 25% gain (on top of coupons). [Am I wrong about this, it seems amazing?]
Of course, preferred stocks do have risk associated to them, but investing in preferred stock funds mitigates much of that… and if the environment shifts to one where preferred stocks as a whole crater, then the common stock market is likely to have seen much worse.
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Those are excellent points, and I too find preferred stock to be somewhat attractive right now, at least conceptually (I only own a couple specific Preferreds at the moment, but I do look at others from time to time). The challenge with preferreds is that they don’t have nearly as much legal backing as bonds, if push really comes to shove… and that probably won’t matter, in 95% of scenarios, but when it matters it really matters… but they are also generally cut off from meaningful appreciation unless you can find a preferred that trades well below its par value (usually $25 per share).
So the whole sector is interesting, as a somewhat more promising income play, but it’s hard to trust the ETFs because they’re very likely just going to move off of interest rates over any 1-3 year period. If it’s just yield you’re getting, without the principal protection of bonds, there’s less comfort. I find specific sub-par preferreds to be a more interesting hunting ground lately, but haven’t added anything recently…. if folks have ideas of other preferreds that have some appeal I’d love to hear them — those adjustable preferreds are an interesting option, we also see some of those for the pipeline companies, I think EPD has some adjustable preferreds that are close to resetting to a higher rate, and I’ve been meaning to dig into that more deeply.
Great topic to consider, thanks!
As an example, Wales Fargo announced it would redeem all of its WFC/PQ shares in August, a month or so they were going to transition. So buying some a year or so out might be a pretty good strategy.
There is a screener here you can use to find examples: https://stockmarketmba.com/preferredstockscreener.php#
One tricky thing about the variable rate preferreds is that many of them define their floating-rate value in terms of LIBOR, which has recently been discontinued. This allowed Pennymac recently to essentially give its investors the middle finger and indicate that its stocks would simply not transition.
Three Variable Rate preferred bonds that look promising are:
(For the analysis below I’m pretending interest rates in the future are 3.5%, but in the end it may not matter a lot. In all cases these are expected to be highly advantaged compared to the market in the future, so they likely get redeemed regardless of the interest rate.)
MITT/PC
AG Mortgage Investment Trust, Inc. 8.00% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred
Transitions September 24
$19.51 per share (= current yield of 10.25%)
Tied to LIBOR, so risk of shenangians.
If they switch to floating rate, it would probably be around $2.5 per share in a year, so definitely going to be redeemed.
Return would then be ~5.5/19.51 + 10.25 = 39% return
WAL/PA
Western Alliance Bancorporation ADRs of 4.250% Fixed-Rate Reset Non-Cumulative Preferred, Series A
Currently at $16, so high appreciation opportunity between now and September 2026.
Tied to 5-year treasury note (not LIBOR)
Current yield 6.55% [$16/share]
If 5-year notes are down to, say 3.5% by 2026, it will pay a yearly dividend of $1.73, and in that environment I would it would be effectively redeemed.
If so, that’s 24%+ annualized return (3/16 for NAV growth + 6.55 current yield)
I don’t know how this will be complicated by a possible purchase by AG Mortgage Investment Trust
ABR/PF
Arbor Realty Trust 6.25% Series F Fixed-to-Floating Rate Cumulative Preferred
Currently $19/share [yield = 8.17%)
Transition is in October 2026 based on SOFR.
A SOFR of 3.5% would lead to a future dividend (variable rate) of 8.9%
Assuming redemption, target return is 2/19 + 8.17% = 18.7%
(This stock is tanking though…)
I’ve been looking at BCE preferred, Canadian telecom. Trading significantly under par at ~$15, likely to go back to over $20 once rates drop.
I’m thinking if rates get cut/slashes, they will likely keep preferred whole, or I could be wrong!
I’m also interested in preferred over common, because I’m not a fan of stock manipulation and short games and hoping to see less of that with preferred. Likely more comfortable dollar cost averaging on preferred then on commons.
Thoughts?