It is becoming ever harder to secure attractive returns with preferred stocks. That’s because companies are calling higher-rate preferreds and issuing new ones with lower rates (the corporate equivalent of refinancing one’s mortgage). Several of my recommendations have been called. I have replacements (see below).
Here are the yields from recent preferred stock offerings. A month ago Wells Fargo issued a 5.25 percent series P. At about the same time, JPMorgan issued JPM-D at 5.5 percent and BB&T issued BBT-F at 5.2 percent. The days of receiving 6 or 7 percent from investment-grade preferreds has ended.
A 5.5 percent return on a fixed-rate security is not exciting. While overall interest rates are expected to stay low for a few more years, there will come a time when a 5.5 percent return on a preferred is not only unattractive, it will be risky. As interest rates rise, the price of existing fixed-rate preferreds will suffer.
What is an investor seeking income from preferreds to do? I’m concentrating client portfolios in adjustable-rate preferreds. We aren’t alone. In my Jan. 24 column, “Profiting From a Rising Rate Environment,” I recommended Goldman Sachs Series D preferred. This adjustable-rate security currently yields 4.3 percent and has appreciated 11 percent since that article! Perhaps a better value is HSBC-USA Adjustable Rate Series D. This investment-grade security is tied to the Treasury market. It currently pays 4.4 percent and its dividend will increase when Treasury rates rise significantly.
I’m also buying high rate REIT preferreds that trade near or below par and are not yet callable. Two securities that I’ve been accumulating for client accounts: Annaly Capital Management 7.5 percent Series D and Armour Residential REIT 7.875 percent Series B. The latter trades near its $25 par and is not callable until 2018.
The prices of the higher-yielding preferreds are tied more to the health of the issuing company rather than the direction of interest rates. Even if rates rise some, securities that yield over 7.5 percent will still be attractive. Bottom line — yes, it is getting difficult to find income from preferreds, but there are still opportunities to do well.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.