Banco Popular: Trading Under Par, The Preferred Stock Of This…
Summary
Banco Popular, a regional bank serving Puerto Rico and portions of the mainland United States, is in the process of repositioning itself.
An outstanding issue of the company’s Trust Preferred Securities offers nearly an 8% yield with cumulative protection and currently trades below par value.
Other regional banks have proactively redeemed similar types of high interest securities in order to take advantage of historically low interest rates.
Should Popular call back its Trust Preferred Securities at par, investors will receive nearly a 19% capital gain in addition to an almost 8% annual yield at current prices.
As Popular sheds assets, redeploys capital and repays TARP money, its preferred stock will also appreciate closer to par value to reflect this improving financial position.
A Matter of Preference
Preferred stocks are often some of the most unloved securities on the market, usually for good reason. While preferred securities are primarily attractive to investors because of their high yields and special tax status, these advantages are tempered by the fact that preferreds rank junior to bonds and they can have their dividends suspended at the will of company management. Unlike common stock, shareholders of preferred securities also do not have the chance to participate in the appreciation of a company’s equity (unless preferreds are convertible to shares of common stock). Preferreds can also be called back early at par value, exposing investors to reinvestment risks and, should the issue be traded over par, potentially a loss of principal.
Despite the fact that there are several disadvantages when it comes to owning preferred stocks, the universe of preferreds is both large and occasionally appealing offerings can be found due to the fact that the universe is neglected by many investors. Whenever there are less eyes on a sector, there is a chance for value to be had.
When I look for preferred stocks, I often look for ones that carry the “cumulative” designation – meaning that the issuer of the preferred is obligated to make up any dividend payments should they be suspended (for whatever reason). I also look for preferred securities which are trading below par, which is typically $25 or $50 dollars per share. Purchased at a low enough price, investors have the opportunity to receive healthy annual income through dividends in addition to a significant capital gain if preferred shares are redeemed early by the issuing company.
In this article, I will discuss a preferred issue (BPOPN) of Banco Popular (BPOP), a large regional bank headquartered in Puerto Rico with a presence in the continental United States. I believe that an issue of Popular’s preferred stock, or more correctly stated, Trust Preferred Securities, provides investors seeking income with an attractive yield in addition to the potential for a substantial capital gain should the stock be called back.
What Popular Does
With a market capitalization of slightly over $3 billion, Popular is a mid sized regional bank operating in both the Commonwealth of Puerto Rico and the several areas in the United States of America. Like many regional banks, Popular experienced significant difficulty during the financial crisis, accepted TARP money and suspended its dividend on common shares.
After weathering the financial crisis, Popular has been making important strides in turning itself around over the past several years. Some measures that the company has taken include divesting assets, exiting certain markets and applying to repay TARP money.
From a valuation perspective, common shares of Popular now appear cheap. The stock currently trades with a P/E ratio of 5.38 and is priced well below its book value of $44 per share. The bank is also in the process of divesting a payment services subsidiary, Evertec (EVTC), in order to solidify its financial position. I believe that these measures will enable common shareholders to realize significant value through share price appreciation, the resumption of dividends and potential repurchases in the near to medium term.
A fellow contributor has also recently published a thoughtful discussion regarding the merits of Popular’s common stock as an investment and I would urge interested readers to explore his work. I will not discuss issues related to the common stock of Popular at further length in this article due to the fact that the preferred issuance ranks senior to the common, and holders of the Preferred securities (like bondholders) are much more concerned with the fact that the company’s common equity will not be wiped out (thus beginning to endanger higher levels of the capital structure).
I will say that I believe that the management of Popular has righted the course of the company after a period of significant tumult and I believe that due to this fact, other parts of Popular’s capital structure are now attractive and deserve attention.
The Terms of the TruPS (Trust Preferred Securities)
Popular has two issues of preferred securities outstanding currently. Of the two TruPS issuances that Popular has outstanding (Capital Trusts I & II), I am concerned with Popular Capital Trust I, which has the symbol of (BPOPN). These preferred securities have several interesting features which make them attractive (in my mind) at current price levels. Though issued with a face yield of 6.7%, these securities have fallen in price below par and now currently yield almost 8%. This yield is also paid monthly, making this issue very attractive for individuals seeking stream of regular monthly income.
The second attractive feature of these securities is the fact that this issue of preferreds bears the “cumulative” designation, which means that if any preferred dividends are suspended by the management of the company, they must be repaid at a later date which in this case the terms of the company’s indenture stipulates as being no more than 60 months from the date of a missed payment. Though these securities do have a very consistent payment record, it is important to note that two payments were missed during the depths of the financial crisis in 2009 (almost 60 months ago).
Currently priced at approximately $21, these securities trade well below par value of $25 per share, something I believe makes these them attractive to investors who have the willingness to tolerate potential volatility in the short term in favor of significant gains in the medium to long term.
Investors have the chance to reap a substantial gain (in the universe of fixed income) of approximately 19% should these securities be redeemed, plus an annual yield of close to 8% paid monthly. From an annualized perspective, if an investor holding these securities for one year has his or her preferreds called back, they stand to realize a pretax gain of approximately 27% when factoring redemption at par in addition to twelve monthly payments. Should these securities be called within two years, investors will realize an annualized gain of around 17%. For fixed income investors, this combination of both a high regular yield of close to 8% and the possibility of a redemption occurring at par is extremely attractive in my mind.
The Case For Early Redemption? Not Without Precedent
By this point, I am sure the reader is wondering why I am so concerned with the possibility early redemption occurring. The reason I am so concerned with this event occurring is because since 2008, Popular has been able to call back this outstanding issue of preferreds at any time at the redemption preference of $25 plus all unpaid but accrued dividends.
Given the low interest rate environment and the recent steps taken by Popular to firm up its balance sheet through asset divestitures and sales, I believe that there is a very real possibility that Popular will attempt to refinance some of its debt in the near to medium term to achieve further savings.
I believe that the Capital Trust I issue a very likely candidate for refinancing in Popular’s capital structure, given its relative high interest rate of 6.7% at face value (in contrast to Capital Trust II’s 6.125%). I am also not wantonly speculating about the possibility of this event occurring, because other banks are doing it to
Among regional banks with outstanding Trust Preferred Securities, this type of behavior is not without precedent. In an earlier article, I discussed Valley National Bancorp (VLY) being well served in the near term after repositioning it’s capital structure through redeeming similar high interest Trust Preferred obligations. In September of 2013, Valley National retired its 7.75% Trust Preferred securities in favor of newly issued 5.125% subordinated debentures, resulting in 2.625% worth of interest savings.
Like Valley National, I believe that it is within the realm of possibility for Popular to engage in a similar type of behavior in order to achieve interest savings in the near to medium term, particularly if interest rates further decline. Capital Trust I, with its higher yield, than Capital Trust II, is the logical target for refinancing.
Should Popular redeem this issue in the short term, investors stand to gain approximately 19% excluding regular monthly distributions paid at a high yield.
Why The Cheap Valuation in the First Place?: Investors Can’t See The Forest
The economy of Puerto Rico has been in the news over the past several months due widespread concerns about the municipal debt incurred by the principality. While these issues are significant, I believe that this concern has significantly impacted the price of Popular’s common and preferred shares unfairly, particularly since the company has made significant strides in the past decade to solidify its financial position and return to profitable operations.
After struggling through the financial crisis, Popular emerged a stronger entity as a result of more stringent regulations and capital requirements. While Popular does business in Puerto Rico, I believe that the market is ignoring the fact that the common equity of the bank was able to endure the financial crisis and management is now continuing to shore up its position through asset sales, unit divestitures and repaying TARP obligations, providing adequate protection to higher levels of the company’s capital structure.
Risks
Despite the fact that this issue carries the Cumulative designation (meaning that missed payments are tacked onto the principal), it is important to understand that preferred securities are a form of debt that is junior to bonds and should the company go bankrupt, holders of preferreds are lower on the food chain and could face a significant loss of principal. Though I believe that this possibility is remote, investors must be aware.
Investors must also understand that these securities are subject to considerable volatility (for a Preferred), and despite a relatively consistent payment record (and cumulative protection) could fluctuate considerably. However, I believe that this volatility will be significantly reduced as the business fundamentals for Popular continue to improve. Despite being cumulative, there is also the risk that management could briefly suspend it’s payment of dividends as it has in previous periods of extreme financial crisis and uncertainty.
Due to the fact that Popular is located in Puerto Rico, investors must also be aware of the fact that the tax treatment of these securities is somewhat unique and should consult with a tax professional. However, per the company’s prospectus, Popular already withholds Puerto Rican taxes on behalf of investors. In addition, Popular’s location in Puerto Rico makes it vulnerable to any further serious declines in economic activity on the island.
Final Thoughts
With a yield hovering near 8% at current price levels, I believe that Popular’s Capital Trust I Preferred Securities are worth a spot in an investors fixed income portfolio as the terms of the issue are advantageous to investors seeking a relatively high yield that is protected due to the presence of the cumulative feature.
In addition to a steady source of income, investors also retain a call option on significant appreciation through early redemption should this issue be called as the company seeks to further reduce costs, something that I believe is likely given the low interest rate environment and the fact that this pattern of early redemption has been recently observed in the sector.
I am also of the opinion that investors will enjoy a higher degree of protection going forward as Popular continues to reposition its business through asset sales, strategic divestitures and the repayment of TARP funds over the near to medium term. As Popular’s common stock begins to appreciate upward and the company benefits from the efforts of management, I believe that the company’s preferred securities will also appreciate closer to the par value of $25 in a more gradual fashion.
Source:
Banco Popular: Trading Under Par, The Preferred Stock Of This Regional Bank Is Attractive
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More…)
Additional disclosure: I am long shares of Popular Capital Trust I – 6.70% Cumulative Monthly Income Trust Preferred Securities, listed on the Nasdaq as BPOPN
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Banco Popular: Trading Under Par, The Preferred Stock Of This…
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