Yes, there is more risk in a preferred stock than in a bond.

First of all, the issuing company can suspend the dividend payment on a preferred and continue as an operating concern... without being in default. Also, most preferreds are non-cumulative, which means that the issuing company has no obligation to make up missed payments in the future.

Secondly, if a company is forced to reorgainze, preferred shareholders stand in line behind all of the debtholders (but in front of the common shareholders).

And finally, preferred shares typically have no maturity date, so there is considerable inflation risk associated with these securities. If inflation and interest rates go up significantly, the share price of your preferreds will decline, and you may be stuck with a low-interest-rate security in perpetuity.

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Now, with all of that said, I think there is a place for preferreds in a portfolio, but I don't consider them a "core" holding.

Also, you will see "trust preferreds" trading on the exchanges. These are backed by debt, so they are safer than an ordinary preferred issued by the same company. Since they're backed by debt, they do have a maturity date, although they are generally very long-term instruments.

Regards,

Duane

....the long term odds favor the issuer, not the investor. If rates go down, they'll call them, leaving you with a pile of cash to reinvest at a lower rate. If rates go up, you are stuck with the lower rate (into perpetuity in the case of the Barclay's 8% Prr'd, I just got an email about). You are making long term interest bets against people who are smarter than you are.

A boring non-callable bond has no surprises (and a lower coupon rate). Sometimes you want a little boredom to go with your security. I personally do not feel able to suss out the way interest ways are going and so follow a bond ladder strategy.

And I wonder just how preffered most preffereds really are. The promise to get paid before the common stock holders may not be much consolation if the company nosedives ala Bear Stearns. You'll also want to read the fine print. The Barclays issue above reserves the right to defer coupon payments for 40 quarters if times get rough. That's a decade-long wait for your money, potentially.

Larry Swedroe's book, "The Winning Bond Strategy" makes a good case against preffereds and I highly recommend it for a conservative approach to fixed income investing. He's not (no one is) the last word, but his book was very compelling. 

 

 

kittydog2,

You make some very good points. Preferreds are not without risk.

For what it's worth, there are also debt securities that trade on the exchanges, much as preferred stocks trade. They're typically issued at 25/sh, although some are issued at differrent prices. They are easy to buy and sell, just as with a common stock. From an individual investor's point of view some are very liquid, with average trading volume in the hundreds of thouands of shares. Others, however, are very thinly traded (even seeing days with no trading for some issues).

Again, these are typically long-term maturities, and callable, so they suffer the same "rates fall, you lose; rates rise, you lose" problem. One can buy an issue that's trading below par and get a little protection against falling rates, though.

Regards,

Duane

It seems that every other day I am getting an offering for something paying 8% in perpetuity from a bank rated 3 *'s by Morningstar with the ominous bit in the fiancial health section about how Tier 1 levels of coverage are fine (AT THE MOMENT), but that conditions may deteriorate.

Anyone reading my posts will easily glean that I am a mid-level novice investor compared to most people here, but I still have to wonder:

Why are the banks giving me 8% with a lot of headachey add-ons and giving sovereign wealth funds 11% with less onerous restrictions and probably a nice lunch out as well?

Instinctively, I think it may be because yield-hungry light weights like myself have less knowledge and clout. But that doesn't mean we need to jump at every cookie. 

 

i own several preferreds and sleep well at night.  Have had a problem with a few (see my messages in the CEF board) but things have usually worked out. Duane raises a good point.  Instead of looking at traditional preferreds go to Quantumonline and look at trust preferreds. The trust usually buys company debt with the money they make selling  preferreds.  if the debt is called or the firm goes belly up then whatever receipts the holdings get from the sale of the debt (subordinated or unsubordinated)  goes to the preferred holders.Last i looked Bear Stern's trust preferreds are carrying an investment grade rating and paying 8% which is pretty much in line with other financials.

Hey Gerry, I'd like to sleep well at night too. Can you recommend some preferreds that you like or own?

Thanks,

Dick

Goood Afternoon Dick.

A couple i am looking at right now are Bear Stern offerings.  Think they are pretty safe since JPM stepped in to the picture. They are BSC-x which is a capital trust preferred and BSC-e which is a traditional preferred.  I've underlined the difference  cause I'm of the opinion that this difference could be important in order of payment if things go badly south. The assets backing the trust preferreds in this instance is junior subordinated debt. In my opinion (and I have not checked this out) these preferreds will be paid prior to traditional preferreds, since jr debt  has a higher priority than preferred stock. The prospectus states that if the debt is retired the proceeds must go first to the preferred stock of the "trust" and then to the common stock of the "trust".  So you are investing in a trust which holds only Bear Stern's debt, and not in Bear Stern's itself. From some of the postings on these boards i get the impression that some posters may not be aware of the difference.

Bear is paying 6.15% on the BSCprE vs 7.8% on the BSCprX so I assume the "X" will be called before the "E".  "E" is a traditional preferred and carries a lower rating BBB+ vs "X" which carries A-.  Both are paying in the neighborhood of 8%.  But  "E"'s market price is $38.60 for a 20% discount vs "X"'s price which offers only a 3.5% discount.  Both are nice kickers if called but paying $38.6 for a $50 payout is better than $24.13 for a $25 payout.Both ratings were issued in late 07 after the rating scandal hit the front pages. So i think both ratings are probably somewhat conservative compared to earlier issued ratings.

I am also looking at FRE and FNM fixed-floating traditional non-cumulative preferreds.  I love the terms.

Since most companies issuing preferreds are those who need large amounts of capital,e.g., financial, insurance and utilities with a minimal impact on the balance sheet I hate to go overboard on preferreds since I am getting real heavy in financials. So I'm holding back and reviewing further.

Only my opinion of course but that's my thinking as of this moment

 

Thanks for the input Gerry. I'll f/u w/ these & see where they fit.

Appreciate the response.

Dick