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Not So Preferred: Higher Rates Clobber Perpetual Preferred Shares

Interest-rate sensitivity leaves preferreds vulnerable to further selling if the 30-year bond yield continues to rise. But one Wells Fargo issue looks unusually attractive.


Certain preferred-stock issues have been crunched so far this year, falling about 10% in response to the rise in long-term interest rates.

The selloff reflects the perpetual maturity of many preferreds, which makes them acutely sensitive to rate changes. Public Storage’s 4.9% preferred issue (ticker: PSA, preferred E), for instance, trades at $22.67, down 9% since year end. Its yield has moved up to 5.45% from 4.93%, Bloomberg data show. Vornado Realty Trust ’s 5.25% issue (VNO, preferred M) is off 11% so far this year to $23.23 and now yields 5.69%. Many preferreds are traded on the New York Stock Exchange. Their tickers can vary based on the data source.

The yield on the 30-year Treasury bond, a benchmark for perpetual preferreds, has risen about 0.40 percentage point this year to 3.14%. If rates decline, the Vornado and Public Storage preferred issues should rally. But they likely have more downside if rates continue to rise. Each has a face value of $25.

Most preferreds have fallen less sharply than the Public Storage and Vornado issues, with the leading exchange-traded fund, the iShares U.S. Preferred Stock ETF (PFF), down about 3% to $37 so far this year.

The ETF’s better showing reflects one of the quirks of the preferred market, which is dominated by major banks –

JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C ). Nearly all preferreds are callable five years after issuance at the face value, or $25 a share for the most commonly issued preferred.

The call feature is an unattractive aspect of preferred stock, giving the securities limited upside and a lot of downside. Because of the rate risk, Barron’s ranked preferreds near the bottom of our list of income-oriented investments for this year (see “Hungry for Income? The Best—and Worst—Yield Plays for 2018,” Dec. 16, 2017).

Banks haven’t been issuing many preferreds in the past year or two. As a result, many preferred issues have above-market rates and trade at a premium to their face value. These issues tend to be valued based on a yield calculated to their call dates. The call feature limits upside in bond bull markets, but also reduces downside in bearish environments.

For example, JPMorgan has a 6.7% issue (series T) that is callable in early 2019. Its price is down 3% to $26.15 this year, still comfortably above its call price of $25. Its effective yield to the call date is around 2%, according to Bloomberg, as the 6.7% dividend rate will be offset by the likely price decline, assuming the bank redeems the issue next year.

Barron’s has highlighted the appeal of Wells Fargo’s unusual 7.5% series L preferred – a convertible issue originally sold by Wachovia, which Wells bought during the financial crisis. The issue trades at $1,267 for a yield of almost 6%, about a half percentage point higher than many other large bank preferreds. The price is down about 3% so far this year.

The issue trades well above its face value of $1,000 but is callable only if Wells Fargo common stock, now around $56, rises to $156. And even then, the issue is callable only at a 30% premium, which is above the current price, according to Bloomberg data.

Email: editors@barrons.com

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