Floating Rate and Fixed-to-Floating Rate Preferred Stocks

Issuers of preferred stock have a number of different options in the terms and conditions of the preferred stock that they issue.

One of those options is in determining what is the correct coupon amount to offer–the coupon that makes the security attractive to the investor yet is most beneficial for the company (the lowest coupon).

In preferred stock most issues are fixed rate, but in recent times companies are issuing more and more issues with floating rate coupons.

Floating rate preferreds are perpetual preferred stocks that are issued and from the time of issuance they are immediately ‘floating rate’ securities that pay dividends to holders, in arrears. This mean that the coupon rate paid for a quarter is determined after the quarter ends.

The floating rate issues outstanding now all have minimum coupons ranging from 3% to 4%. Floating rate preferreds now outstanding have very SMALL ‘spreads’ used to determine the quarterly coupon payment.  This means that with the 3 month libor rate just under 2% many issues will be paying the minimum coupons for the foreseeable future as most spreads are less than 1%. The ‘spread’ is the amount added to 3 month libor to determine the quarterly coupon rate.

Fixed-to-Floating rate preferred stocks start with a much higher initial coupon and after a period of 5 to 10 years they convert into a floating rate preferred. Unlike the pure floating rate preferreds the spreads on fixed-to-floating rate preferreds are much higher.  The fixed-to-floating rate preferreds all use 3 month Libor as their base rate and to this the original prospectus specifies a “spread” to be added to 3    month Libor to determine the distribution rate for the quarter.

As you can see below almost all of the pure floating rate issues are currently redeemable, but given the skimpy coupons we wouldn’t expect them to be called for years and years–no one is going to redeem an issue that is perpetual and on which they are paying only a coupon of 3% to 4%.

Below we list the current coupon as well as the ‘spread’ and a ‘potential coupon’. The potential coupon is simply what the coupon would be today if it was floating. Issues begin to float on the earliest redemption date shown below.

NOTE–all issues below use 3 month Libor to determine the quarterly coupon with the exception of 1 issue which uses 1 month Libor (this is the Targa Resources issue).