Preferred Stocks - FInancials

December 24, 2007
Getting the Red-Carpet Treatment
By ANDREW BARY
December 24, 2007

Preferred stocks, which are senior to common, trade onthe New York StockExchange. Most have a facevalue of $25, but now couldsell below that. Holders could profit if the issues areredeemed at $25.


WITH FINANCIAL FIRMS LIKE Freddie Mac, Fannie Mae and
Washington Mutual (WM) seeking to shore up their balance sheets in the
face of rising loan losses, the market for preferred stocks has grown active.
Fannie Mae (ticker: FNM) recently issued $7 billion of preferred, while
Freddie Mac sold $6 billion and WaMu $3 billion. These issues join an
estimated $250 billion of outstanding preferred stock, a form of equity that
is senior to common stock but ranks below corporate debt. Preferred
typically carries fixed interest rates, and some issues are convertible into common shares.
Investors are likely to find increasing opportunities in the preferred market, as yields on many issues have
risen about one percentage point since summer, reflecting the sell-off in financial stocks. As the table
nearby shows, preferred stock issued by companies such as Citigroup (C), Freddie Mac (FRE),
Lehman Brothers (LEH) and Merrill Lynch (MER) now yields 7.5% to 8%, while 30-year Treasuries
yield only 4.5%. In addition to higher yields, these securities sport credit ratings of A or better from both
Moody's Investors Service and Standard & Poor's.
Preferred stock generally is sold with a face value of $25 a share, though most
securities now trade below $25. In the case of Fannie and Freddie, we have
listed their most recent issues, which initially were priced attractively, and now
trade above $25. Investors might do better to buy older preferreds from Fannie
and Freddie, some below $25, and others below par value of $50.
There are two types of preferred: the more common trust preferred, which
technically is debt, and regular preferred, which counts as equity. Trust is senior
to regular preferred, but the advantage of regular to individuals is that dividends
are taxed at the beneficial 15% dividend tax rate, while trust is taxed at the full
marginal-income-tax rate.
It can be tough to tell which is which. The recent Freddie Mac 8.375% issue
and the Fannie Mae 8.25% are regular preferreds. "Many times people buy the
wrong instrument," says Robert Willens, an accounting and tax expert at
Lehman Brothers. Firms like Merrill Lynch track the market and distinguish
between the types, both of which trade on the New York Stock Exchange.
Issuers generally can redeem their preferred stock in five years at $25. The advantage to buying preferred
that trades for $20 or $21 is that it carries yields similar to those of higher-priced issues, but doesn't have
the redemption or call risk. Investors in lower-priced preferreds can count on getting nice yields for a
long period, and if the preferred eventually is redeemed at $25, they stand to make a tidy profit.
The danger with all preferred stock is that troubled issuers
stop paying dividends, and companies in extreme straits
sometimes default. Short of financial catastrophe, however,
issuers generally pay their preferred dividends, even if they
cut or eliminate dividends on common shares.
YIELDS ON NYSE-LISTED bonds issued by companies like Comcast (CMCSA), Ford (F) and
General Motors (GM) also have risen in recent months. GM has a series of exchange-traded bonds with
a face value of $25, but with the company under financial pressure and carrying junk-grade credit ratings,
its bonds have fallen lately. The 7.25% issue due in 2041 (XGM) trades at about 16, for a yield of
11.52%; the price is equivalent to 64 cents on the dollar for a standard $1,000 bond. Although GM faces
numerous challenges in coming years, it has struck a labor agreement that will reduce its health-care
obligations significantly.
GM also has several Big Board-listed
convertible bonds that offer an
attractive alternative to the company's
common. The $4 billion 6.25%
convertible (GPM) trades for about 21,
for a yield of 9%. This convert offers a
trade-off: Investors get a lower yield
than on GM's non-convertible, or
"straight" debt, but can exchange the
convert for GM common. The 6.25%
issue converts into GM common at
$47 a share, well above the stock's
current quote of $26. As GM stock
rises, its convertibles also tend to rally.
The yield on debt issued by GM's
finance unit, General Motors
Acceptance Corp., now majorityowned
by the investment firm
Cerberus Capital Management, has
risen amid concerns about GMAC's
mortgage exposure and worsening
credit trends in auto loans. GMAC
debt now yields more than 10%.
THE YIELDS ON PREFERRED
STOCK ISSUED BY real-estate
investment trusts such as Vornado
Realty Trust (VNO), SL Green
Realty (SLG) and Taubman Centers
(TCO) also have increased recently,
reflecting concerns about a weakening
real-estate market. Vornado's preferred
is yielding more than 8%, versus 4% on the common. The preferred lacks the common's upside potential,
but is attractive for yield-seeking investors. It ranks ahead of Vornado common, which has a market
value of $13 billion.
Nearly all major securities firms and many major banks have issued preferred stock. Our table shows a
sampling, but issuers ranging from Bear Stearns (BSC) to HSBC (HBC) rightfully merit inclusion.
The preferred shares of Fannie Mae, Freddie Mac,
Washington Mutual and certain REITs all look
enticing. So do the bonds of Comcast, Ford and
General Motors.


Those looking to bet on a revival of battered Washington Mutual, the country's largest thrift, might
consider its recently issued convertible preferred that carries a dividend yield of 7.75%. The convertible,
now trading around $931, below its $1,000 par value, can be exchanged for WaMu common at $21.25 a
share, a premium to Friday's price of $14. This issue was sold for $1,000, rather than the usual preferred
price of $25.
Hurt by rising loan losses, WaMu recently slashed its common dividend by 73% to an annual rate of 60
cents a share, for a current yield of 4%. WaMu could eliminate its preferred dividend if its financial
situation gets dire, but it will need to pay preferred holders if it wants access to equity capital.
Assuming banks and securities firms remain solvent and interest rates don't rise sharply, preferred stock
could prove rewarding for income-oriented investors. For those with more stomach for risk, GM, GMAC
and Ford bonds with double-digit yields also look enticing.
E-mail comments to: editors@barrons.com1
URL for this article:
http://online.wsj.com/article/SB119828503633446177.html