In today’s low interest-rate environment, it is hard enough to put together a diversified fixed-income portfolio that provides both adequate yields and acceptable credit risk. When corporations decide to call their preferred stock or debt securities, it only makes things more difficult. On Wednesday of this week, JPMorgan Chase will be redeeming nearly $5 billion of trust preferred securities. According to its Form 8-K filed on April 9, 2013, the trust preferreds being called are the following:
- J.P. Morgan Chase Capital X, 7.000%, Series J, $1 billion face amount, ticker JPM-PrJ
- J.P. Morgan Chase Capital XI, 5.875%, Series K, $1.075 billion face amount, ticker JPM-PrK
- J.P. Morgan Chase Capital XII, 6.250%, Series L, $400 million face amount, ticker JPM-PrX
- J.P. Morgan Chase Capital XIV, 6.200%, Series N, $600 million face amount, ticker JPM-PrY
- J.P. Morgan Chase Capital XVI, 6.350%, Series P, $500 million face amount, ticker JPM-PrP
- J.P. Morgan Chase Capital XIX, 6.625%, Series S, $562.5 million face amount, ticker JPM-PrS
- J.P. Morgan Chase Capital XXIV, 6.875%, Series X, $700 million face amount, ticker JPM-PrW
- Bank One Capital VI, 7.200% Preferred Securities, $100 million face amount, ticker JPM-PrO
If you are one of the unfortunate holders of those securities who will now have extra cash you would like allocated to fixed income, what should you do with the money? As you may have suspected, your options aren’t great. To get yields in the 5.875% to 7.20% range in the corporate bond market, you will need to both extend duration and drop down the credit quality scale. In the world of preferred stocks, while you can find coupons equal to those on the called JPMorgan Chase securities, you will struggle to find those types of yields at today’s prices (dividend amount divided by current price). Moreover, you will struggle to find a variety of preferred securities trading under the price at which they can be called, also known as the liquidation preference.
So what will you do now? Will you succumb to the siren song of “Stocks yield more than the 10-year Treasury”? After all, everyone “knows” stocks only go up over the undefined “long-term,” right? Incidentally, if the stock market is forward looking, pricing in everything which is known to market participants, and market participants “know” that stocks will go higher over the “long-term,” at what point does the market price in all future appreciation? Now back to the issue of finding replacements for the called JPMorgan Chase securities.
Replacing JPMorgan Chase Securities
Assuming you are interested in keeping your allocations relatively constant, below are a few preferred stock possibilities within the financial industry. But keep in mind that the next time the financial industry (or a specific company) experiences a slowdown, the preferred stocks will likely sell off. Furthermore, if benchmark interest rates were to rise in a significant way, the preferred stocks mentioned below would also likely experience a sell off.
- JPMorgan Chase 5.45%, Series P, with a non-cumulative annual dividend of $1.3625, paid quarterly, in arrears. The preferred stock has no maturity date (perpetual) and is callable on any dividend payment date on or after March 1, 2018 at a price of $25 per depositary share. Additionally, there is a conditional call in the case of a “Capital Treatment Event” as described in the prospectus supplement. The ticker symbol is JPM-PrA. It is currently trading at $25.41 and yielding 5.36%.
- The Bank of New York Mellon 5.20%, Series C, with a non-cumulative annual dividend $1.30, paid quarterly, in arrears. The preferred stock has no maturity date (perpetual) and is callable on any dividend payment date on or after September 20, 2017 at a price of $25 per depositary share. Additionally, there is a conditional call in the case of a “Regulatory Capital Treatment Event” as described in the prospectus supplement. The ticker symbol is BK-PrC. It is currently trading at $26.04 and yielding 4.99%.
- Citigroup 5.80%, Series C, with a non-cumulative annual dividend $1.45, paid quarterly, in arrears. The preferred stock has no maturity date (perpetual) and is callable on any dividend payment date on or after April 22, 2018 at a price of $25 per depositary share. Additionally, there is a conditional call in the case of a “Regulatory Capital Event” as described in the prospectus supplement. The ticker symbol is C-PrC. It is currently trading at $25.55 and yielding 5.68%.
JPMorgan Called Preferreds
In addition to the risk of future selloffs in the prices of these preferreds, investors should operate under the assumption that a perpetual preferred might never be called. If the price of a perpetual preferred moves against you, and the preferred is never called, there is the possibility of owning a security that, on a mark-to-market basis, is permanently underwater. This is unlike an individual bond, which will mature at par. I would also like to draw attention to the fact that the three aforementioned preferred stocks are non-cumulative. This means that in the event a dividend is not declared and not paid, the corporation will have no obligation to pay in the future prior accrued but unpaid dividends. Also, investors should take note that each of the three preferreds described above are trading over the price at which they can be called.
Given the risks associated with these preferreds and the fact that the JPMorgan trust preferreds being called this week all have maturities in the 2031 to 2077 range, if you own any of the called securities and are looking to immediately replace the lost income, you might consider longer-duration senior unsecured corporate bonds. This would essentially be swapping one long-term fixed-income security for another. You can currently find a few corporate bonds trading under par on the secondary market, with what I would characterize as moderate credit risk, yielding 5% to 7%. If you are willing to purchase notes trading over par, the choices are far greater.
Another possibility is to make an investment through Lending Club, the online platform that brings together borrowers looking for loans at more attractive rates than those offered by banks with investors looking to diversify into shorter-term fixed-income instruments at enticing yields. With the possibility of earning higher yields through Lending Club than were paid on JPMorgan’s redeemed trust preferred securities, investors could even consider reinvesting only a portion of their returned capital. For example, if you were earning 7% on a $10,000 investment in the JPMorgan Chase, Series J, security, you would be paid $700 per year. To earn $700 on an investment in Lending Club with a net yield of, say, 10%, would require just a $7,000 investment. You could then take the extra $3,000 and do with it as you please. Naturally, any investment has risks, and Lending Club is no different. Before making such an investment, you should spend a sufficient amount of time researching the ins and outs of Lending Club and peer-to-peer lending.
Having your fixed income securities called can certainly be a frustrating experience. This is especially true in today’s ultra-low interest-rate environment. With yields near historic lows and corporate bond spreads starting to look rich, it is understandable that fixed-income-oriented investors start to look elsewhere. If you aren’t interested in shifting your fixed-income allocation into stocks and are frustrated with the current prices on preferred stocks and corporate bonds, you may have to explore other options such as Lending Club. Or course, there is another possibility I didn’t discuss in this article: wait in cash. That can be the hardest thing to do but sometimes also the smartest.
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