Preferred Stock Investors Can Keep Up With
A period of increasing rates is
great for preferred stock buyers - the higher
coupons that come with increasing rates puts
more money in your pocket. But as rates go up,
prices for older, lower payers go down which can
be bad news for those intending on selling their
previously purchased preferred stock shares.
With the Fed increasing the federal funds rate
twice over the last five months – with
additional increases predicted to be on the
horizon – the technique that I describe here
allows preferred stock investors to turn the
known inverse relationship between rates and
prices to your advantage during such periods.
During periods of upward pressure on interest
rates, we often see what I refer to as “upgrade”
opportunities. Upgrading takes advantage of
market price disparities that tend to occur
during periods of increasing rates.
Increase income and
Upgrading involves selling a
lower-paying preferred stock that you own and
using the proceeds to buy a higher payer of
similar quality, keeping pace with increasing
rates, but for a lower price. The result is that
(a) your dividend income will increase and (b)
you will have cash left over.
There are literally dozens of such opportunities
with U.S.-traded preferred stocks right now.
All you need is a list of preferred stocks that
are similar to a lower payer that you own,
sorted by their current market price. I will use
data from April 26 to illustrate how upgrading a
lower-paying preferred stock is done.
Example: Wells Fargo’s
Series R Preferred Stock (WFC-R)
Let’s say that I own WFC-R from
Wells Fargo (WFC), which I purchased at par
($25) back when WFC-R was issued in 2013.
WFC-R is a non-cumulative, call-protected,
investment grade traditional preferred stock
currently paying a fixed quarterly dividend of
6.625 percent that qualifies for favorable tax
treatment (Qualified Dividend Income – QDI).
First, we need a list of preferred stocks that
are very similar to WFC-R. Preferred stocks have
a variety of characteristics so I want to be
sure that I am comparing apples to apples as
much as practical. Here is how I configured the
search engine’s 25 preferred stock
characteristics to find such a list:
The resulting preferred stocks
are all very similar to WFC-R: call-protected
for several years, are not convertible to any
other type of security, have a $25 par value,
are currently paying a fixed-rate dividend, pay
tax-advantaged (QDI) quarterly dividends, are
issued by U.S. companies and offer a Moody’s
investment grade rating.
Of the 954 preferred stocks and Exchange-Traded
Debt Securities currently trading on U.S. stock
exchanges, 83 meet the search results seen
Of these 83, I will use 10 here as examples to
illustrate how to upgrade a lower-paying
preferred stock. These preferred stocks are all
very similar and are issued by Wells Fargo, US
Bancorp (USB), KeyCorp (KEY), Edison
International/Southern California Edison (EIX),
JP Morgan (JPM), Allstate (ALL), First Republic
Bank (FRC) and Bank of America (BAC).
In this list of 10 preferred stocks, there are
23 upgrade opportunities. Can you spot them?
Here’s the trick
A table with no upgrade candidates, once sorted
by their current market price, highest to
lowest, will also show the dividend rates in
sorted order, highest to lowest.
But notice that that is not the case here. The
Div Rate column starts out okay—6.625 percent
down to 6.500 percent, then down to 6.125
percent and on to SCE-H’s 5.750 percent; so far,
so good. But then, after SCE-H’s 5.750 percent,
the next Div Rate is higher. We go from SCE-H’s
5.750 percent up to JPM-B’s 6.700 percent.
Bingo. WFC-R for JPM-B is our first upgrade
candidate. And all you need is a list of
preferred stocks sorted by market price (highest
to lowest) to spot them. Keep an eye on the
above table and I will walk you through the
upgrade of WFC-R to JPM-B.
If you own shares of WFC-R, which pays 6.625
percent, you could sell them for $29.73 and use
the proceeds to buy JPM-B at $27.70. JPM-B pays
a higher 6.700 percent dividend rate, increasing
your dividend income by 0.075 percent, plus you
will have $2.03 per share in cash left over.
Notice that in this upgrade you are paying
$27.70 for JPM-B.
Preferred stock investors should avoid
purchasing shares for a market price above the
security’s $25 par value. Purchasing JPM-B at
$27.70 exposes you to a potential capital loss
of $2.70 per share in the event that JP Morgan
calls JPM-B downstream.
But what if you were reimbursed for any
potential future capital loss in advance?
Remember, you have $4.73 per share in your
pocket right now from your sale of WFC-R (since
you originally paid $25 per share for your WFC-R
shares). That’s more than enough to reimburse
the $2.70 capital loss in the event that JP
Morgan calls JPM-B someday.
You have already been reimbursed for any future
capital loss on the JPM-B shares and will still
have $2.03 per share in cash left over, even if
they do so.
Results – something for
Here are the 23 upgrade opportunities from the
above list of 10 examples and the results from
Look down the Results columns
(far right) and notice how different upgrades
can appeal to different investors.
Those seeking to maximize their cash position
would focus on upgrade number 4 since it
improves their cash position by a whopping $2.56
Alternatively, investors looking to improve
their risk profile would favor upgrade #13 since
it trades in a Baa3 rated security (KEY-I) for
one with a higher Baa2 rating (ALL-E).
Lastly, investors looking to maximize their
dividend income would find upgrade number 16
appealing since it improves dividend income by
Each of these 23 upgrades involves trading in a
lower-paying preferred stock for a very similar
higher-paying security and each opportunity
leaves you with cash left over.
Using this simple technique can provide
preferred stock investors with a way to make
very beneficial adjustments to their income
portfolio during a period of increasing interest