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2 Convertible Preferred Stocks for Income and Upside

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Preferred stocks have become a way for income investors to secure a less risky position in a company, collect a higher yield, and still trade the securities on a relatively liquid market.

But in collecting this higher yield, preferred stockholders typically give up much of the upside to a company in the event its fortunes turn for the better. Here, I'll look at some convertible preferred stocks that offer investors the features of traditional preferred stock while also giving them the potential for upside in the form of capital appreciation.

Regional banks
As the housing market recovers, the demand for mortgages is expected to increase boosting the bottom lines of various banks. Although Bank of America and Wells Fargo also offer convertible preferred stocks, the conversion prices on these preferreds is at least three times the current trading price of the common stock. For those still interested in the Bank of America convertible preferred shares, I have written another article about this series of preferreds.

While I could see the potential for these big bank preferreds to eventually reach their conversion prices, it will likely be decades before they do so. Instead, I will look at the convertible preferred shares of two regional banks that also stand to benefit from a mortgage recovery.

For more near-term upside potential, the convertible preferred shares of KeyCorp (NYSE: KEY  ) and Huntington Bancshares (NASDAQ: HBAN  ) are worth a closer look. KeyCorp Series A Preferred Shares (NYSE: KEY-G  ) have a coupon rate of 7.75% but, because of the preferred trading above liquidation value, currently yield around 6%. The yield on this preferred handily beats out the common stock yield of 1.65% and may be a better pick for an income investor's portfolio.

For upside potential, these preferreds are convertible into 7.0922 shares of KeyCorp common stock. The conversion price is $14.10, about 6% above the current stock price. However, with the preferreds trading above liquidation, the common stock would have to top $18.18, 37% above the current stock price, before preferred shareholders buying today would make money in a conversion. Although it could be a while before the common stock reaches this level, investors in the convertible preferred can collect a sizable dividend while they wait for the common to appreciate.

Huntington Bancshares Series A Preferred Stock (NASDAQ: HBANP  ) has an investment basis similar to that of KeyCorp while offering a slightly higher yield. The preferred has a coupon rate of 8.5% but, like the KeyCorp convertible preferreds, the Huntington preferreds trade above liquidation resulting in a current yield of 6.75%. And, like at KeyCorp, the convertible preferred has a higher yield compared to the common stock, yielding 2.1%.

Huntington convertible preferreds are convertible into 83.668 shares of Huntington Bancshares common stock with a conversion price of $11.95, about 24% above the current share price. Because of the current price of the preferred shares, investors today would need to see the common rise to 57% to $15.06 before realizing any conversion upside potential. But, like with KeyCorp, investors in Huntington convertible preferreds can collect a solid yield while they wait for the common stock to make a conversion profitable.

Income and upside
Both preferreds are perpetual and can only be eliminated through a conversion by the holder or a conversion by the bank if the common stock trades 30% above the conversion price for 20 of the past 30 trading days. While this limits some of the upside if you are only interested in holding the preferred, if the common stock rises to 130% of the conversion price, the common stock will quite likely be paying a higher dividend. At this point income investors can choose to sell for a small gain on the conversion or hold the common stock as an income investment.

Most preferred stocks don't offer investors the opportunity to benefit from a rise in the common stock, but the convertible preferreds from KeyCorp and Huntington Bancshares can give income investors the income they're looking for with some added upside potential as the mortgage market continues to recover. For investors bullish on the mortgage market but also looking to add income generating securities to their portfolio, these convertible preferreds are definetly worth a further look.

More income and upside
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Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 17, 2014, at 7:50 AM, MotleyMiniMe wrote:

    You are correct about 83.668 shares at $11.95 conversion is under water. But Huntington Bank cannot begin conversion of HBANP into HBAN unless HBAN closes above $15.535 for 20 of 30 trading days. This puts the value at $1,300 (83.668 x $15.335 = $1,300). Of course, you might have to buy a few puts to lock in the value of the common if conversion is imminent.

  • Report this Comment On April 17, 2014, at 7:54 AM, MotleyMiniMe wrote:

    The same is true for KEY-PG:

    KeyCorp may, at its option, cause some or all of the Series A Preferred Stock to convert into common shares at the conversion rate if, for 20 trading days during any period of 30 consecutive trading days, the closing price of the common shares exceeds 130% of the conversion price of the Series A Preferred Stock.

    [$14.10 x 130% = $18.33]

    7.0922 x $18.33 = $130./shr

  • Report this Comment On April 17, 2014, at 7:58 AM, MotleyMiniMe wrote:

    Of course, you have to hold until the banks convert. But presumably thet will want to convert as soon as they can to reduce costs (unless rates are sky high or they are short of cash).

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Alexander MacLennan

Alexander MacLennan is a Fool contributor covering Industrials, Airlines, and Financial companies. He is always ready for a good growth or turnaround story and tries to find them before the market does.

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