April 13, 2014 Comments

I have added a Wells Fargo preferred share to the list above. These are the shares that have been in my personal portfolio since December.

I noted on December 19, 2013 (see below) that I had bought these shares at $19.81 to yield 6.5% and I described them in pretty good detail, and my reasons for buying, but noted that I had not done any real analysis.

They rose fairly quickly and have traded mostly fro $21.50 to $22.00.

These perpetual shares move (inversely) with the 30-year U.S. treasury yield, but also move for other reasons.

When the price changes for other reasons such as the outlook for Wells Fargo or the supply and demand for these shares then the “spread” of the yield minus the 30-year treasury changes. When issued the spread was 2.0%. When I purchased these shares they were at a spread of 2.6% (over the treasury then at 3.9%) indicating a possible bargain.

Most of the price gain on these shares since I purchased them has been due to the U.S. 30-year treasury yield falling from 3.9% to 3.5%, Also the shares rose as the spread reduced from 2.6% to 2.4% at this time.

In looking at the attractiveness of these perpetual preferred shares yielding 5.9% several thoughts come to mind.

Long-term interest rates are likely to rise. I have explained why that makes long-term treasury bonds unattractive. If long-term interest rates rise materially then these perpetual shares will definitely sink in value. And there is really no floor to that if interest rates were to rise to very high levels. On that basis perhaps these perpetual shares are a bad idea.

On the other hand, conventional portfolio management practice would suggest that we always hold some assets in many asset classes. And both long-term bonds and perpetual shares are conventional asset classes. If we wish to hold a conventionally balanced portfolio then we should probably hold some perpetual preferred shares and the Wells Fargo shares are a reasonable choice for U.S. investors and for Canadian RRSPs / RIF – and to a lesser extent RESP and TFSA accounts – where a 15% withholding tax on the dividend will apply. (Canadians should choose Canadian companies for preferred shares in taxable accounts).

There could be some up-side on the shares if the spread returns back to the 2.0% above the 30-year treasury that applied when they were issued.

Even if interest rates rise, and the shares fall in price, the 5.9% yield is not likely to be such a bad yield, on the current value, over the longer term given current tame inflation outlooks. But in that event it would be hard not to be distressed by the share price decline.

For myself, I have made a decent gain on these shares and can sell without worrying about a capital gains tax as they are in an RRSP account. I am tempted to sell these and put the funds perhaps partly into additional Wells Fargo Common shares. Basically I have thought of selling these shares ever since they rose to $22 but took no action. I had some thought that they might eventually return to $25, but after further though and analysis, that is unlikely unless long-term interest rates move back to about 3.0% on the 30-year treasury, and the spread on these would also have to narrow.

Rate re-set preferred shares.

Over the past few months I also indicated had bought some rate-reset preferred shares (Canadian Western Bank, National Bank and Enbridge). (CWB.PR.B, NA.PR.S, and ENB.PF.A) These all had to be bought on a moment’s notice, with no time for analysis, as they were bought at the IPOs. These are now trading at $25.50, 25.45 and $25.40 respectively. They were bought as $25.00 yielding 4.4%, 4.1% and 4.4% as an alternative to holding cash. The 5-year government bond rate is a bit higher since these were issued which should have pushed the price of these down. Apparently the spreads on these have narrowed. I believe that these shares, if they should drop in price, will return to about $25 on their rate reset date in five years. And given the probable return to $25 in five years I don’t think they would ever plunge much below $25 unless interest rates really go high or the companies run into financial trouble. (I consider these to be vastly different than perpetual preferred shares). I think they are a good alternative to holding cash or near-cash for several years. I also never expected them to trade much above $25 and if they get much higher and certainly at $26 I might sell.

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