Financial Tips

Published 12:00 am Wednesday, January 24, 2001

ALAN S. MOORE

The operative word is Preferred’ when it comes to securities

One 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 that are seeking to enhance their income stream without sacrificing credit quality. Preferred securities can offer these benefits because they possess the features of both corporate bonds and preferred stockā€¦ 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 these securities are purchased by individual investors who seek to maximize income from their investments. Generally, all preferred securities can be redeemed prior to maturity. As with 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 the shares are issued. The call feature tends to limit the appreciation potential 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. In addition, 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 $14 billion in 94 deals, and the majority of new issues, 88 percent, were investment grade. To attract investors during this period of heavy supply, issuers have increased the yields and have made these securities the “preferred” investment. Alan S. Moore is a Financial Advisor in the Mandeville office of Legg Mason Wood Walker, Inc., a diversified investment brokerage and financial services firm in (branch city).