Preferred Stocks Offer a Better Way to Bet on Banks
One normally staid corner of the financial markets—preferred stock—has been rattled by the Silicon Valley Bank and Signature Bank seizures, and that has created opportunities for investors.
Preferreds are a senior form of equity whose dividends come before those of common stock. Preferred shares issued by banks, however, account for about two-thirds of the $400 billion market and the twin bank failures have highlighted the credit risk in these securities.
In fact, the preferreds issued by SVB Financial Group and Signature Bank, the failed banks’ parents, might have little or no recovery value. Trading in their New York Stock Exchange–listed preferred and common shares has been halted. And an unlisted SVB preferred issue aimed at institutional investors was fetching about 10 cents on the dollar late this past week over the counter.
While this is certainly worrisome, preferreds still offer a lower-risk way to invest in banks than common shares, and some pros say they now look especially appealing. After its 8.5% drop this month, the sector’s largest exchange-traded fund, the $12.4 billion iShares Preferred and Income SecuritiesPFF +0.43% (ticker: PFF), yields 6.5%. What’s more, preferreds issued by most banks now yield over 6%, a nice premium to the 3.7% on a 30-year Treasury bond.
“This is a great time to step into the market,” says Allen Hassan, head of preferred trading at Ziegler.
Preferreds have long been popular with retail investors because of their combination of relative safety, solid yields, and liquidity. Most are issued with a $25 face value and trade on the NYSE. There also are institutional preferreds, with a $1,000 face value, that mainly change hands over the counter.
Dividends on most preferreds are taxed favorably, like those on common stock. Companies are loath to miss preferred payouts because they can’t issue common dividends without first paying preferred holders. However, as equity, preferred has more risk than debt.
Newly issued preferred stock can be problematic; it can’t be redeemed at face value for five years, limiting the immediate upside, while the downside is unlimited. But now, many $25 face-value preferreds are trading under $20, making the risk/reward proposition far more appealing.
“There is uncommon value in the preferred market,” says Phil Jacoby, chief investment officer at Spectrum Asset Management, a preferred specialist. Yields are near their highest levels in more than 10 years, he observes, and spreads to yields on risk-free Treasuries are historically wide.
As for the risks, he takes comfort in federal regulatory support for banks on deposits and a new Federal Reserve program that lets banks borrow against their bond holdings.
Spectrum manages the Nuveen Preferred & Income SecuritiesJPS –3.39% closed-end fund (JPS), now trading around $6. It has an 8% yield, reflecting leverage, and changes hands at a 13% discount to net asset value.
His investment firm also runs the Principal Spectrum Preferred Securities ActivePREF –0.24% ETF (PREF), which focuses on institutional issues and yields 5%.
Individual investors might also want to consider the preferred stock of top banks, such as JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Morgan Stanley (MS). These and some others are considered systemically important financial institutions by Uncle Sam, and so carry more capital and are more strictly regulated than regional banks. And, lately, they generally have benefited from deposit inflows shifted from smaller rivals.
Preferreds from the country’s biggest bank, JPMorgan, offer the lowest yields—its 4.2% series M issue yields 5.6%. Bank of America preferreds, like the 4.25% series Q, yields almost 6%, while Wells Fargo and Morgan Stanley preferreds yield close to 6.5%.
(Some investors would rather buy big-bank common shares, currently yielding 3% to 5%, because they have more upside potential.)
Regional banks can offer larger payouts, but also more danger. Investors appear unperturbed about preferreds from Fifth Third Bancorp (FITB), Regions Financial (RF), and Cullen/Frost Bankers (CFR), which yield about 6.5%, only slightly more than some of their too-big-to-fail peers. Higher yields also are available on the preferred of New York Community Bancorp (NYCB), which is buying assets of Signature Bank. Its 6.375% preferred has fallen to $19.45 from $25 and yields 8.6%.
Then there’s First Republic Bank (FRC). It has inspired some of the worst jitters, even after a $30 billion deposit infusion from JPMorgan and 10 other large banks. Its common trades at $12.50, down 90% this month, while its preferred fetches about $6, well below its $25 face value.
Although it suspended its common payout, the bank is still paying preferred dividends. There’s risk here—big risk—but investors could benefit if the big banks inject equity into First Republic or if the preferred is converted into common shares on favorable terms.
That bet is suitable only for investors with cast-iron stomachs. Everyone else should stick with the biggest banks.