Preferred securities are attractive investmentsAlan S. Moore / L’Observateur / July 29, 1998One of the most attractive fixed-income investments introduced over the past two years is the preferred security. Developed in the early 1990s,preferred securities offer the investor the opportunity to maintain good liquidity in portfolios and earn a higher income than they would if they invested in comparable corporate bonds and preferred stocks.
The securities, often known as TOPRs, MIPs, QUIPS and Trust Preferreds, are commonly purchased by individual investors who seek an affordable fixed-income investment who are seeking to enhance their income stream without sacrificing credit quality. Preferred securities can offer thesebenefits because they possess the features of both corporate bonds and preferred stock.
Like corporate bonds, preferred securities offer the following benefits: * The regular income of preferred securities is based on a fixed interest rate and stated monthly or quarterly payment dates.
* Preferred securities have senior ranking to common and preferred stock in the issuer’s capital structure.
* Many preferred securities have a stated maturity date.
Like preferred stock, preferred securities generally have the following characteristics: * Liquidity-shares trade on the New York Stock Exchange (NYSE) or the American Stock Exchange (ASE).
* Par or liquidation value of $25 per share.
Preferred securities also have various features that provide the investor higher income than other fixed-income products. That’s why thesesecurities are purchased by individual investors who seek to maximize income from their investments.
Generally, all preferred securities can be redeemed prior to maturity. Aswith all fixed-income securities, the value will depend on market interest rates, the issuer’s current credit quality and the market balance between supply and demand. These bonds are also callable, five years after theshares are issued. The call feature tends to limit the appreciationpotential of preferred securities; however, the issuer compensates the investor by offering a higher yield on the security when purchased.
Investors also receive higher yields on preferred securities-as opposed to comparable corporate bonds-because they permit the deferral of payments and because the securities rank lower than senior debt in the issuer’s capital structure and, therefore, represent a higher degree of risk. Inaddition, unlike preferred stock, preferred securities have special tax considerations and do not offer tax benefits to corporate investors but typically do offer a higher yield.
Issuance of preferred securities has skyrocketed this year as interest rates have fallen and corporations have enjoyed the ability to lock in low cost financing. For the first half of 1998, total issuance exceeded $14billion in 94 deals, and the majority of new issues, 88%, were investment grade. To attract investors during this period of heavy supply, issuershave increased the yields and have made these securities the “preferred” investment.
(Alan S. Moore is a financial advisor in the New Orleans office of LeggMason Wood Walker, Inc., a diversified investment brokerage and financialservices firm.)
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