PREFERRED
STOCK NEWS
Preferred
Stock Buyers Change Tactics for Double-Digit
Gains
An increase in
interest rates has been two weeks away for
the last two years. Tapering out of their
Quantitative Easing program did not produce
the rate increase that the Fed had hoped for
and so far the Fed’s use of their overnight
reverse repurchase agreements has not pushed
up the federal funds rate either (see “Preferred
Stock Buyers - Be Sure You're Watching The
Right Indicator”, September 22,
2014).
Dramatically falling oil prices throughout
the fourth quarter of last year have reduced
inflation pressure, delaying, once again,
any hope of a rate increase. On December 18,
2014 Fed chair Janet Yellen stated that the
Fed “…could continue to be patient,” a
comment that produced a 400+ point uptick of
the DJIA.
Low rates have decimated savers, with bank
CDs hovering around 1 percent. And after
years of Quantitative Easing, soft loan
demand and new reserve obligations, banks
now have a whopping $3 trillion in excess
reserves beyond today's regulatory
requirements. Capital One even floated a
proposal last year to start charging for
deposits. In short, banks do not want your
money.
For preferred stock investors, downward
pressure on rates means upward pressure on
prices. The average price of the highest
quality preferred stocks (cumulative
dividends, investment grade ratings, etc.)
closed 2014 at $25.98, about a dollar above
these securities’ $25 par value, producing
an average current yield of 6.61 percent on
December 31.
(Sources: preferred stock data,
PreferredStockInvesting.com; excess
reserves, "Federal Reserve weighs options
on how to raise US rates",
Financial Times, May 25, 2014)
Protecting your
principal during a period of high prices
The par value
of a preferred stock ($25 per share in most
cases, and in all cases used here) is the
amount that shareholders will receive if the
issuing company redeems (buys back from you)
your shares, regardless of today’s market
price and regardless of your original
purchase price.
It is for this
reason that many preferred stock investors
seek to purchase their shares for a market
price below $25. Doing so adds a layer of
principal protection to your investment
since you will realize a capital gain in the
event of a future call, on top of the great
dividend income that you earn in the
meantime.
Principal protection
case study: JP Morgan’s JPM-B preferred
stock
As I have
written to you many times over the years
(see “Preferred
Stock Buyers: Time To Change Tactics For
Sub-$25 Purchases”, July 14, 2014),
during periods of upward pressure on prices,
such as what we have seen for some time and
are likely to continue seeing for several
more months, savvy preferred stock
investors, armed with a web browser and an
online trading account, can frequently
purchase shares at wholesale (sub-$25)
prices when new preferred stock issues are
being distributed to the market.
83 percent of
the non-convertible preferred stocks issued
during 2014 (54 of 65) were introduced to
the market by their underwriters using a
temporary trading symbol on the wholesale
Over-The-Counter (OTC) stock exchange.
Subscribers to our
CDx3 Notification Service receive
an email alert that includes the temporary
OTC trading symbol whenever a new preferred
stock begins trading on the wholesale OTC
exchange.
The reason
that underwriters use the OTC to distribute
new preferred stocks shares to the market is
speed. They are out a bunch of cash and they
want to get it back as quickly as possible;
they are not going to wait days or weeks for
the NYSE or other retail exchange to get
around to assigning the permanent trading
symbol.
Depending on a
variety of factors, underwriters typically
pay about $24.25 per share to the issuing
company in exchange for the newly minted
preferred stock shares. For example, the
underwriters of JP Morgan’s JPM-B, issued on
January 27, 2014 offering a 6.7 percent
dividend, paid $24.21 (see
JPM-B prospectus, page 1).
The
underwriters, now out the cash ($823 million
in the case of JPM-B), are very anxious to
sell the new shares to dealer/brokers and
use the OTC exchange for these trades. A
temporary OTC trading symbol is set up for
these wholesale orders (JMXXL in the case of
JPM-B).
Dealer/brokers
typically pay $24.50 to $24.75 per share and
are just as anxious to sell the new shares
quickly. Turnaround speed is what is
important here. In the case of JMXXL, the
OTC opening price was $24.75. Savvy
preferred stock investors with an online
trading account were able to purchase JMXXL
shares for less than $25 per share until
JMXXL was transferred to the NYSE retail
exchange on February 7, 2014 as JPM-B.
These are
shares of the very same preferred stock that
today’s retail buyers are paying $26.42 per
share for (December 31, 2014).
2014 results - how
you would have done using the OTC
So how did
buying shares during OTC distribution work
out for preferred stock buyers during 2014?
The black
diamonds on this chart show the average OTC
opening price for preferred stocks
introduced during the indicated month. The
gray diamonds indicate today’s (December 31,
2014) average market price for the same
securities. Notice that in all cases, the
black diamond (average OTC open price) is
lower than the gray diamond (average price
today).
To isolate the
price behavior of OTC purchases from
geopolitical events, 13 preferred stocks
issued by domestic upstream oil producers
and Greek shipping companies have been
excluded from this analysis (see note at the
bottom of the graphic).
The table below the chart presents the data.
Looking at January, there were two new
preferred stocks introduced that were
distributed to the market using the OTC. The
average opening price on the OTC when these
two securities began trading was $24.73 per
share. Because prices increased throughout
2014, the current average market price of
those same two securities is $26.04,
providing an average gain of $1.31 per share
to those who purchased their shares last
January when these preferreds were
introduced on the OTC.
In other
words, the future market price of these
January issues would have to drop more than
$1.31 per share before preferred stock
investors who purchased their shares using
the wholesale OTC exchange would start to
lose principal. That gives those inclined to
sell time to act in the event of a future
price drop.
Look at the
average OTC open price column and compare
those values to the average December 31
prices for the same preferred stocks. The
overall average OTC open price during 2014
was $24.89 while the overall current market
price is $25.60 per share.
And don’t
forget about the dividends. The two January
issues, purchased for an average price of
$24.73 per share, offer an average coupon of
7.6 percent and have paid dividends each
quarter throughout 2014. Looking at the
far-right column, the average effective
annual return on December 31, 2014, when
considering the gain and dividends from
these two preferred stocks, was 13.67
percent.
What’s next?
During a
period of high prices, most of your
preferred stock positions will be showing
significant, but unrealized, capital gains.
Preferred
stock investors who are interested in
cashing in the those capital gains can sell
their shares for retail, then use the
proceeds to buy shares of a new, similar
preferred stock while it is being introduced
on the wholesale OTC exchange—sell for
retail above par; buy back in for wholesale
below par.
The OTC
exchange provided a very powerful tool for
savvy preferred stock investors throughout
2014 and is likely to continue doing so for
many months to come.
Subscribers to our
CDx3 Notification Service receive
an email alert that includes the temporary
OTC trading symbol whenever a new preferred
stock begins trading on the wholesale OTC
exchange.
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