This is shaping up to be a brutal year for banking stocks. But a deeper look may highlight an opportunity for income-seeking investors to cash in on the banks.” privileged inventories.
But the S&P 500 SPX,
The banking group’s shares fell 9% from Aug. 16 to Sept. 6 and are down 23% for 2022 (excluding dividends), according to FactSet. It appears that investor concerns about a slowdown in the capital markets industry, as well as a possible recession and subsequent credit losses, are outweighing enthusiasm for wider interest rate margins.
In a note to clients on Sept. 7, Odeon Capital analyst Dick Bove wrote that this bleak environment for bank common stocks highlighted an opportunity in preferred stocks. He used JPMorgan Chase Corp.’s JPM.
JJ preferred stock series as an example.
“Currently, investment banking is under significant pressure, while traditional banking is doing quite well,” Bove wrote, explaining his “hold” rating on JPMorgan Chase common stock. But he believes it “makes sense” to move away from the risk of big bank stocks and “buy banking benefits that are sold at a discount”.
Of the JPMorgan Chase Preferred Stock Series JJ discussed here, Bove wrote: “The dividend is very safe in almost any predictable economic environment.
Preferred stock terminology
Anyone can buy a preferred stock if they have a brokerage account.
If you are not familiar with preferred stock, we should start with some definitions.
A preferred stock differs from a common stock in that its owner has no voting rights. Preference shareholders also have preference over common shareholders in the event of a company being liquidated. A simplified pecking order in bankruptcy and liquidation is bondholders, then preferred stockholders, then common stockholders.
A company can have several issues of preferred stock. Investors buy preferred stocks for dividends, just as they would buy bonds for interest income. Preferred dividends are usually paid quarterly.
More definitions — all are important:
Par — This is the price at which a preference share is issued. It is usually $25, but can be $100 or another price. Par value is similar to the face value of a bond. It is what the investor will be paid if the preferred stock is redeemed by the issuing company. Just as the market values of bonds fluctuate, the prices of preferred stocks fluctuate, usually in the opposite direction of interest rates in the economy. In the current environment, with interest rates rising, many preferred stocks are trading at discounts to par.
Coupon — Stated return on a preferred stock, based on par value.
Dividend rate — Reported yield multiplied by face value. JP Morgan Chase’s Preferred Stock Series JJ was issued on March 10, 2021, at $25 par value with a 4.55% coupon. The annual dividend is $1,375.
Current performance — The annual dividend rate divided by the current market price. JP Morgan Chase’s Preferred Stock Series JJ closed at $19.65 on September 6. This resulted in a current yield of 5.79%.
Date of call — The date on which the issuer can decide whether to redeem the preferred stock. The issuer may redeem all or part of this preferred series at any time beginning on such date. If interest rates are significantly lower than they were when the preferred stock was issued, the issuer is likely to redeem.
Expiration date — The date on which the preferred series will be fully redeemed. These days, most preferred stock is “perpetual,” meaning there is no expiration date, although there usually is an expiration date. The JPMorgan Chase Series JJ Preferred Stock is a perpetual preference with a call date of June 1, 2026.
Cumulative/non-cumulative — An issuer of preferred stock may be forced to suspend its dividends on one or more preferred series if it experiences financial difficulties. If a preferred stock is cumulative, the suspended dividends will accrue in arrears and be paid later when (or if) the dividend is reinstated. Banks issue non-cumulative preferred stock because regulators want to have the flexibility to suspend dividends and never repay them in the event of severe financial or economic distress. It is very rare for an investment grade issuer to miss a preferred stock dividend payment.
The ins and outs of preferred stock
Preferred stocks are for investors looking for income. They are not designed to be growth investments. That 4.55% coupon on JPMorgan Chase Preferred Stock Series JJ might not have been very attractive when the shares were issued at $25 on March 10, 2021. Again, on that date, the 10-year US Treasury TMUBMUSD10Y,
they had a yield of 1.53%. The 10-year yield was 3.50% on September 6.
So the current yield of 5.79% for an investor who bought JP Morgan Chase Preferred Stock Series JJ at the discounted price of $19.65 on September 8 is attractive.
And that discount could mean a lot of gravy down the line. After that call date of June 1, 2026, JPMorgan Chase can redeem the shares at any time, and likely will if the bank no longer needs that capital or if it can replace the financing with a rate below coupon 4 .55% (plus underwriting costs).
So, if interest rates eventually move significantly lower from here, JPMorgan Chase Preferred Stock Series JJ will likely trade much higher than its September 6 closing price of $19.65. Shares can be sold at any time.
If the preferred stock is redeemed on or after the call date, the bank will pay $25 per share, which means if you collect them at $19.65, your profit will be $5.35 per share, or 27%, plus of the dividends you have received by receiving throughout the year.
There are many other examples of preferred stocks out there that trade at a discount, or for those with higher coupons, you might think it makes sense to trade at a premium. Ask your investment advisor or call your broker for more information.
For investors looking for income, preferred stocks are worth considering.
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Hear Ray Dalio at MarketWatch’s Best New Ideas in Money Festival on September 21st and 22nd in New York. The hedge fund pioneer has strong views on where the economy is headed.