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Hello All,

I have a few questions about preferred stocks and I'd appreciate any help that folks could offer. (Or maybe someone could point me to a good websource that answers many of these questions? I've googled some things up, but you never know how factual things are on the internet...)

As I understand it, preferred stocks are issued at a par value (commonly $25) and with a set dividend. After a set term they can be called by the issuer.

My questions:

1. When looking at a preferred stock, how can you determine its par value? How can you determine its time to maturity? (I'm sure that this is the wrong term, since these aren't bonds; but frankly, I don't know a better term.) These must be SEC disclosed and available on EDGAR databases?

2. As I understand it, preferred stock gets its dividend payed preferentially, before common. Also, the dividend is guaranteed. If the company can't pay the dividend, they can let it lapse, but must make these missed payments at a later date. Is this correct? (I also understand that this isn't true for ALL preferred issues, just MOST. (?)

3. Once a preferred stock reaches "maturity", it can be called by the issuer at its original par value. But, what I'm not clear on, is how this affects the dividend. Is the dividend of a cumulative preferred still guaranteed past this date, or does it float once "maturity" is reached?

4. What is the general frequency with which preferreds are called? How much does this vary from comapny to company (probably a lot). Are there instances in which they can be voluntarily (or involuntarily) converted to common, rather than paid in cash.

Lots of questions, I know. I apologize in advance for the length. Thanks for your help.
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No. of Recommendations: 11
The best source of information on preferred stocks is QuantumOnLine.com. Enter the ticker symbol and up comes complete information including call price and date. For more detail read the original prospectus for the issue. Sometimes call provisions can be complex with different call prices on different dates. The QuantumOnLine listing has a link to the original prospectus. (But note the bond ratings shown there can be out of date.)

Most preferred stocks do not have a maturity date. They continue forever until called. If there is a maturity date, it will be in the prospectus.

The preferred stocks that must make up missed dividend payments are called cumulative preferred stocks. Some issues now allow the company to omit payment of dividends for specified periods in bad times, but I have not heard of any that actually did this. Usually an omitted dividend is very bad for stock price.

Usually when an issue is called, all of the shares are called in. So there are no further dividends. The offered amount for the call is usually for the call price and dividends to that date.

Partial calls where some but not all shares are called are possible, but rare. Then often they tender for the shares. So those who decide to sell get paid, while others keep their shares. Then the original terms still apply to remaining outstanding shares. The dividend continues as before. No it does not float.

The call provision essentially gives the issuer the right to refinance the "loan" represented by the preferred shares. When interest rates fall, the issuer can refinance at lower cost. So he will likely call the issue as soon as other cheaper funding sources come available. If interest rates go up, it would cost him more to refinance, so he does not call even if he could. Similarly if his bond rating goes down making borrowing more costly or business times make it more difficult to get financing, the issuer is less likely to call.

Otherwise, the decision to call a preferred stock is very much like refinancing your mortgage. There are some costs involved. And you might rather wait if you think rates will be lower next year than this year. Similarly, the issuer may have a series of other preferreds or bonds out there. Then he will probably use available funds to call the most costly ones first.

So frequency of calls varies with the condition of the market. Right now, calls are not so common. Two years ago with rates low and financing easily available they were common.

Not to worry about asking questions. Ask away if you have more or if these brief comments require explaining.
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paul - check out that nice green star!
when did you get that?
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Yes, Dr. Tarr. Indeed, that green star is shiney and new. Not even broken in good. But give it time. I'm sure a few dents will appear.
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This is a really good website. Thanks.

I'll try and educate myself some from it, but I'm sure that I'll have some more questions.

Thanks again...
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Alright Paul, since you were so helpful before, I’ll hit you with some more questions. No good deed goes unpunished...

I’m interested in looking at preferred of companies in dire straights. Because of their income, they seem like a safer option than common shares, but their convertibility means they retain the greater potential upside of common equity in a recovery. Here’s one as an example: Ford preferred S shares. They are currently yielding at 45%, and trading at only a slight premium to common (just under $8 to $2 and change for common). The extremely high yield, coupled with the capability to convert these to common in the long term seems attractive. But, I’d like to make sure that I understand how these things work. I’d appreciate any corrections, or a simple affirmation, if I’m correct (not terribly likely I’m afraid, LOL)

Here’s their description and vital statistics from QuantumOnline:
***************************************************************************************************************
Symbol F-S CUSIP: 345395206
Description from quantumonline:

Ford Motor Company Capital Trust II, 6.50% Cumulative Convertible Trust Preferred Securities, liquidation preference $50 per share, guaranteed by Ford Motor Co. (NYSE: F), redeemable at the issuer's option on or after 1/15/2007 at $50 per share plus accrued and unpaid dividends, maturing 1/15/2032, distributions of 6.50% per annum are paid quarterly on 1/15, 4/15, 7/15 & 10/15 to holders of record on the 15th day prior to the payment date. The preferred shares are convertible any time at the holder's option into 2.8249 common shares of Ford Motor Co. (NYSE: F), an initial conversion price of $17.70 per common share. The company has the right, at any time, to defer interest payments for up to 20 consecutive quarters (see IPO prospectus for details). The trust's assets consist of the 6.50% Junior Subordinated Deferrable Interest Convertible Debentures due 1/15/2032 which were purchased from the company using the funds generated from the sale of the trust preferred securities. See the IPO prospectus for further information on the convertible preferred securities by clicking on the ‘Link to IPO Prospectus’ provided below.

issuance date: 1/02
coupon rate: 6.5% ($3.25 per annum)
callprice: $50
convertible to 2.8249 F common shares (call date 1/15/07)
conversion price: $17.70
maturity date: 1/15/2032
***************************************************************************************************************

Here’s what I think I understand:

1. first, these are cumulative securities. So, while a dividend can be skipped, it rolls over to the next quarter, and must eventually be paid to the shareholder of record.

2. dividends can be skipped for 5 years, but accrue. I assume that these accrued dividends are paid to shareholders of record at the date that they are finally paid. So, if they skip two years, whoever is holding these securities will receive ($3.25 x 2) + $0.81, or $7.31 per share held.

3. They can be converted at any time to 2.8249 common shares (even if the common shares are not $17.70; that was simply their value at the issuance date in January of ’02, correct?). So, if F common advance faster than the preferreds and it’s worthwhile, you can convert at any price, right?

4. For preferred stocks, you do not pay any partial interest to the current holder at the time of purchase (i.e. you don’t owe them a prorated portion of the current dividend). This is not true of bonds, right? You pay the current holder the prorated portion of that quarter’s coupon, right?

5. I also assume that any deferred dividends will only be recovered if you hold until they are finally paid. They are lost if you sell. Conversely, if the dividends are currently deferred and you buy the stock, you do not owe the seller those deferred dividends, right?

6. These shares are currently yielding at 45%, and haven’t deferred at all. I verified this through my brokerage account by viewing a historical dividend chart. Is there an easier way to check this than historical charting? Does quantum online, or anyone else track deferrals and defaults? Could there be any advantage to looking at cumulative issues that are currently deferring dividends, or is that just flat out dangerous? It seems likely that no one would skip a payment on these instruments until they were at death’s door.

7. In the case of companies that might be looking at federal assistance, there’s been some sabre-rattling demanding that participating companies should be required to suspend their dividends. This has been resisted so far, but “the tides are changing” after this election. How would preferred issues fall into this? They aren’t equity, so these aren’t technically dividends, right? They’re more like a bond coupon, aren’t they? My take is that they could not force suspension of preferred stock dividends.

8. Are orders filled through brokers just like any other stock, or are trading commissions different? (this probably differs from broker to broker, but what the heck, I thought I’d ask anyway).

Finally... I’m not used to thinking about income investing. I’ve always stuck to common stocks. How often do defaults occur? What happens when they default (as far as your account is concerned)? Does their value just fall to zero, and that money vaporizes? Thankfully, I’ve never had a stock that went to zero. I’m just not sure of the mechanics with bonds. Does a default leave you high and dry? You certainly retain some legal rights as a bond holder. Does your broker enforce those legal rights, or do you have to do so individually?

I hope that this makes some sense. Thanks in advance, and apologies for the length...
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Your questions exceed my expertise and experience. So let me answer them as best I can and let others jump in to add or make corrections as they feel appropriate.

First, note that you are talking about a trust preferred issue. "The trust's assets consist of the 6.50% Junior Subordinated Deferrable Interest Convertible Debentures due 1/15/2032." Your preferred is a derivative. Its only income source is this debenture. And the issue is carred on Ford's books as a debenture. In bankrupcy court or in liquidation it stands ahead of common shareholders and other preferred shareholders to get paid, but behind other bonds, any bonds that have specific assets pledged to back them (like mortgage or equipment bonds), and claims by suppliers, employees, and other creditors.

The odds are quite high that in a bankruptcy, Ford will have too little assets to pay everyone. So you may be lucky to get pennies on the dollar. Yes, they will pay dividends while they can to stay out of bankruptcy as long as they can, but once in bankruptcy, your dividends will stop. So this is a bit like gambling. You might be OK, but bankruptcy court might wipe out this issue.

Yes, the issue is cumulative and you will get paid if Ford survives and this issue makes it too. But that is not a sure thing by any means.

"Does quantum online, or anyone else track deferrals and defaults?" There are professional investors who specialize in defaults, but I know of no individual investorz who do that. If you are an attorney specializing in bankrutcy, you probably have many opportunities. But for individuals, representation in bankruptcy court usually wipes out your investment. So usually you sell for whatever you are offered. After bankruptcy filing that is often half of the market price before the filing.

Yahoo Finance records dividend history back for at least 10 years. Click on their historical stock price service and then select dividends for the period of interest.

"They can be converted at any time to 2.8249 common shares (even if the common shares are not $17.70." Yes, they are par value $50/share. So 2.8249 shares per pfd share gives you $17.70/sh. I presume this is lawyer language. Your cost is probably still based on what you paid for the pfd shares. So I don't think it is meaningful to those who convert shares. Captial gains does not change. Of course payments change from interest to dividends.

"For preferred stocks, you do not pay any partial interest to the current holder at the time of purchase." This is correct. And in bond trader language this is indicated by the phrase "traded flat." Otherwise, when purchasing a bond, you would be billed for a portion of the interest between the last payment date and your date of purchase (but then you receive the next full intreest payment). Securities traded flat theorically cost more just before payment date to account for the coming payment.

I think your point 5 is correct, but I have no first hand knowledge of that.

I agree with your arguement in point 7, but there is no guarantee that Congress or a bankruptcy court will agree. This is clearly a risk.

"Are orders filled through brokers just like any other stock, or are trading commissions different?" Assuming the preferred stock has a ticker symbol and is publically traded my experience is yes they trade at the same commissions offered by discount brokers on other stock trades. The exception might be on pink sheet listings where someone makes a market in a thinly traded issue. Bid ask spreads can then be wide causing you to pay more for your purchases, but its the spread not the commission you worry about. The lower commission of trust preferred issues is their major advantage over bonds which you purchase from the bond desk of your broker and are notorious for wide spreads.

Defaults are not so common, but when they happen with large companies they make big news. That is what is happening with the US auto industry right now. They are likely to fail unless a bailout is arranged. Usually a trust preferred in a major company reporting profits is a great investment. And when they have listed common stock, their troubles if any are easy to follow in stock reports, news, etc. But once you know they are in trouble, investing in a losing company is very risky. Sometimes when a failing company takes steps to correct their problem and recovers, their preferred takes a while to recover. Then you can do very well betting that the company will come through it OK. This has happened for me with Xerox and Hercules. But you can also get your fingers burned.

A better opportunity right now is BUD stock. It is to be sold to InBev for $70/sh to close around end of the year. You can still buy the stock for under $65 and recently it has been as low as $58. Some think the deal will fall through for weak financing, but I'm betting it will close as planned. That I think is a better risk. And you can make 15% or so on your money in months.
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Thanks for the reply, and I’ll bother you some more. I don’t think I’m going to run out and buy these, but this has opened up a line of questions, and I think that I’d be well served by gaining a better understanding...

“First, note that you are talking about a trust preferred issue. "The trust's assets consist of the 6.50% Junior Subordinated Deferrable Interest Convertible Debentures due 1/15/2032." Your preferred is a derivative. Its only income source is this debenture. And the issue is carred on Ford's books as a debenture."

From my web browsing, here’s my understanding: This preferred is issued by a Ford subsidiary. That subsidiary holds Ford bonds yielding 6.5%, as well as deposited common shares. It’s sole purpose is to facilitate the trust. Nothing is collateralized, and all debt is subordinate. So, in a legal sense these hold the bankruptcy rights of bonds, but those right are inferior to senior debt.

“In bankrupcy court or in liquidation it stands ahead of common shareholders and other preferred shareholders to get paid, but behind other bonds...”

I did find this in the prospectus. It also seems that this puts a limitation on the dividend as well? Ford cannot pay a dividend if any senior debt is in default (they’d have to preferentially default on any junior debt first, correct?). However, they must eliminate any other preferred dividend before they can eliminate dividends on the S shares, since the S shares are really bonds held in trust, right? I would think though, that this requirement would only apply with regard to a default. Suspension with accrual would not be default, since it's within the rights of Ford as defined by the Prospectus, right?

“Yes, the issue is cumulative and you will get paid if Ford survives and this issue makes it too. But that is not a sure thing by any means.”

I’m not sure what you mean by “if this issue makes it too”. If Ford survives, this debt survives, right? Or do you mean that Ford could be absolved of the debt (especially since it’s subordinate) in a chapter 11 filing? I can understand this, I guess...

“Defaults are not so common, but when they happen with large companies they make big news. That is what is happening with the US auto industry right now. They are likely to fail unless a bailout is arranged. Usually a trust preferred in a major company reporting profits is a great investment. But once you know they are in trouble, investing in a losing company is very risky. “

Agreed. But wouldn’t these shares represent a less risky proposition than common? The income they generate, while it can be suspended, mitigates losses. Furthermore, since they’re convertible, even without a dividend, they can’t fall below their conversion to common value. So, even without a dividend, they really can’t fall below common. Someone would arbitrage them, wouldn’t they?

For that matter, these issues shouldn’t default in the first place, since they don’t need to—they can be suspended with accrual. Obviously, bankruptcy changes everything. (For that matter, waiting 5 years to get your money, while their value deflates is not really going to be any consolation... )

I don’t see it as likely that that the auto industry can be allowed to collapse. There are too many jobs linked to it, and it spreads this virus directly onto Main St. Those who bet on the Chrysler bailout did pretty well. I don’t think that the pols will allow GM or Ford to fail. The backlash would be substantial.

Given that thesis, are preferred shares a safer option given the income, or am I just full of manure? If I am, go ahead and tell me so, LOL. I’m a big boy, and I’d rather learn by being wrong on a message board, than in my brokerage account. I’ll readily agree that there are safer investments by far. But, is the central premise that the preferreds offer a greater measure of safety than common reasonable? Or would you just buy the common, if you were already ready to accept the risk in the first place.

Thanks again for “listening” to my ramblings.
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<<<<<<<<But, is the central premise that the preferreds offer a greater measure of safety than common reasonable? >>>>>>> The answer is "yes" if you are talking about the distribution. Also, some pfds. have been sold down to a level where they probably offer a greater capital gain potential than the common for the foreseeable future.
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I don't want to belabor the issue, JustMee. I think you are aware of the risks and have a reasonable understanding of how these things work. In buying this issue, you are indeed betting that some form of assistance will come up that will make bond holders whole. The risks are there, but you might be right.

By comparison, recent events in the news tell us--

Bear Stearns: common shareholders got abt $0.10/$ compared to stock price before the crisis. Bondholders came out OK as far as I know. I have not heard of any preferred issues involved.

Lehmans: common shareholders will probably get nothing. Some bond and pfd holders are not getting paid and are in bankruptcy court. But other pfds in the Lehman name got sold and seem to be OK so far (I think).

So Ford can be OK, but the risks are there. You have to decide if its worth the risk.

You are buying a ticket on the Titanic. Is it a berth on a lifeboat or is it merely a cabin higher above the water line? Time will tell.
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Thanks for your insights. I'm not sure that I'll actually buy these-- I'm more interested in making sure that I understand how these things work.

I will watch them, though.

Your cautionary note is also appreciated, by the way. I certainly don't mean to be argueing with you. I just want to make sure that what I "think" I understand is accurate. I don't dispute the risk in any way...

Thanks again.
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No problem on my side, justmee. I don't mean to sound argumentative either.

Technical questions do make for longer postings. Usually not light reading. But hopefully the points get explained well enough.

If you have more questions, feel free to post them.
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