Monday, March 22, 2010

The Almost Perfect Income Stocks

Income investors are always searching for the perfect investment. Although such an investment may not exist, there may be investments that are close. One type of stock that you don't hear much about is the Adjustable Rate Preferred Stock or ARPS, also known as a Floating Rate Preferred Stock or FRPS.

First, let's look at what a preferred stock is. It is an income paying stock, usually issued for $25 per share, which pays out a set dividend. The preferreds have no growth potential, unless they are convertible into common stock. If a company goes out of business, the bonds are paid off first, then the preferred stockholders, and then if there is anything left, the common stockholders.

The ARPS have other benefits over the regular preferreds. If interest rates in general go up, the rate on the preferred also goes up. The payout rate is generally based on the three-month LIBOR rate plus a specific percentage amount. LIBOR is the London Interbank Offered Rate, which is based on interest rates at which banks borrow unsecured funds from each other in the London wholesale money market, and is published by the British Bankers' Association on a daily basis. The three-month LIBOR is currently 0.26%.

Many of these ARPS preferreds even have minimum interest rate payouts, below which the rates won't drop. So if rates drop, the investor will also be protected on the downside, with the interest rate floor. Some of the ARPS are fixed-to-float preferreds, which means that the interest rates are fixed for a period of years, then floating after a particular date.

In addition, most of these preferreds are eligible to receive the beneficial 15% tax rate, after the required holding period. has developed a list of almost 20 of these Adjustable Rate Preferred Stocks in the form of an Excel spreadsheet, which can be downloaded, sorted, and changed. The database contains extensive information including the company, the Yahoo Finance symbol, the Standard & Poor's stock symbol, the par value (call price), minimum interest rate, the floating rate calculation, the maximum rate if any, the first call date, the current yield, and whether the dividend is cumulative or non-cumulative.

Cumulative means that if the company runs into financial difficulty and is unable to make payments for a while, the unpaid back dividends on the preferreds must be caught up and paid to the preferred shareholders before any payments can be made to the common shareholders. Non-cumulative means that the dividends do not accrue.

Many of these ARPS have call features, which means that on a particular date, the issuer has the right to buy back the preferred stock at the call price, usually $25 per share.

The ARPS preferreds will fluctuate but because of the variable rate feature, they shouldn't fluctuate as much as regular preferreds. But these fluctuations can create opportunities, as many of the ARPS are trading below their $25 par value issue price.

An example would be the Goldman Sachs Series C Preferred (GS-PC), which was issued at 25 per share, and is currently trading below 24. Please note that the Yahoo Finance stock symbol is shown, which may be different from the ticker your brokerage firm uses. (The S&P symbol would be GS-C.) The shares came out at a yield of the three-month LIBOR rate plus 0.75%, subject to a minimum yield of 4.00%, or a dollar a share per year. The dividends are non-cumulative. The stock has a call date of 10/31/2010, and based on the current price, the stock yields about 4.17%.

Currently, the LIBOR rate is around a quarter of a percent. So in the Goldman Sachs example, if interests rates rise and the LIBOR rate jumped up to 5%, then the yield would be adjusted to 5.75%.

Another example is MetLife Preferred Series A (MET-PA), also issued at 25, and issued with a yield calculated at the three-month LIBOR rate plus 1%, subject to a minimum yield of 4.00%. The stock has a call date of 9/15/10. Based on the current price of the stock, the yield is 4.23%.

Remember that even though these ARPS should be more stable than regular preferreds, they can still drop in value as you can see from the current prices for many of them. Since they were hammered during the market crash, many haven't fully recovered, and there may be some interesting prospects worth looking into.

For a detailed list of adjustable rate preferred stocks, go to

Author does not own any of the above.


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