How to make 26% annualized:
- Find a small bank which suspended its preferred stock’s dividend during the credit crisis.
- Make sure the dividend was cumulative and will pay interest on the dividends in arrears while you wait for it to resume payments.
- Make sure the bank will have the resources to payback the dividends it missed.
Here is our candidate:
Old Second Capital Trust I, 7.80% Cumulative Trust Preferred Securities (Nasdaq: OSBCP)
Old Second Bank is a small bank holding company serving the western Chicago suburbs. Like many banks it was unprepared for the financial crisis of 2008/9, needed TARP money, and got overextended. At its nadir, it suspended payment of its preferred stock effective June 2010 and became subject to Federal Reserve supervision.
The preferred is redeemable by the bank at $10 plus all outstanding dividends at anytime prior to 2033. At $10/share, OSBCP yields 7.8% or 19.5 cents per quarter. Since last paying its dividend in June of 2010, the preferred will have missed 16 payments by June 30, 2014 for a total of $3.62 ($3.12 in dividends and $.50 in interest on the missed dividends).
So why buy the preferred now? Well for starters, the bank is doing better now and is no longer under a Federal Reserve consent decree, so it can pay dividends again. Second, the bank recently issued new common stock with the stated goal of “We plan to use the proceeds of this offering to pay the accrued and unpaid interest on the Trust Preferred Securities”. While no date has been announced for the dividend payments to resume, my calculations use the next available payment window of June 30, 2014.
Purchase price 4/23/2014: $12.98
Dividends to be received on June 30th, 2014: $3.62
Absolute Return on investment = $.64/$12.98 = 4.93%
Annualized return on a 67 day investment = 4.93% * (365/67) = 26.8%
Assumptions: I am assuming the preferred will trade at $10/share once the back dividend is paid and the regular dividend schedule resumes. Most likely, it will actually trade a little below $10 once the dividend is first paid out and then start to trade a little above $10 once yield investors see a bank preferred paying 7.8% interest and bid up the price.
Taxes: You will want to do this in your IRA our else as the $3.62 dividend is fully taxable as ordinary income.
Risk: The largest risk is that the bank delays paying off the suspended dividends for another quarter. While we would continue to earn the 7.8% rate while waiting; our annualized return will suffer. Also, this issue is thinly traded. Use a limit order and be patient else you could get a really bad price when buying or selling.
The prospectus: http://www.sec.gov/Archives/edgar/data/357173/000104746903022390/a2113714z424b1.htm
Disclaimer: I own OSBCP and may sell it at anytime.
4/25/14 Update: Since posting, I’ve received some valuable feedback from readers that leads me to be concerned that this issue may not be very liquid after it resumes its dividend. As a result, this security is unlikely to trade near par anytime soon after its dividends resumes and would therefore be unlikely to achieve a high annualized rate.
Its probably best to take a pass unless you have room for an illiquid holding.