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Wednesday August 25, 2010
JPMorgan Fixed-to-Floating: Variable gains
by Amy Calistri, editor The Daily Paycheck  As an income investor, it's difficult to find solid investments that can protect you from interest rate risk. But JPMorgan Chase Fixed-to-Floating Rate Securities (JPM-PZ) -- with a 7.6% variable yield -- looks like a good candidate. Interest rates are at their lowest levels in history. And for the foreseeable future, the U.S. Federal Reserve is going to keep it that way. Until an economic recovery is well in hand, the Fed is going to err on the side of caution and low interest rates. And that's good for existing fixed income securities. When interest rates rise, investors tend to gravitate toward new bonds and preferred stocks that offer higher rates. That puts pressure on the prices of older issues. While we don't have to worry about that now, that will be a bridge we'll eventually have to cross. 
That's what makes this unique investment-grade preferred stock a compelling choice. Initially JPMorgan Chase Fixed-to-Floating rate preferred pays a quarterly dividend of $0.50 per share. At current prices, that equates to a 7.6% yield ($2.00/$26.50). But starting in May 2013, this preferred security converts from a fixed dividend payment to a floating dividend payment. The dividend yield will automatically adjust to a floating rate based on the value of 4.12% plus the prevailing three-month LIBOR interest rate. Right now, the three-month LIBOR rate is about 0.5% -- near its historic low. But in the last twenty years, the average three-month LIBOR rate was just above 4.1%. And it has been as high as 8.5%. On the one hand, it's a bit of a risk. It is possible that interest rates could stay near their historic lows after 2013. In that case, this security would pay between a 4.5% and 5% yield. If you believe that interest rates will return to their long-term historical average, than this security could deliver a future yield of more than 8%. And of course if interest rates go higher than average, so does your yield. And the best news of all is that if rates do rise, the price of this security should remain firm. JPM-PZ can be called any time after May 15, 2015, and it matures on May 15, 2048. If it is called or when it matures, investors will receive the face value of $25.00 per share. This is important to note as JPM-PZ currently trades above its face value. There is little risk associated with the issuer these days, reflected by the investment-grade status of its preferred shares. JPMorgan Chase (NYSE: JPM) emerged from the banking crisis stronger than ever. The bank released its second quarter financial report on July 15th, announcing a +76% increase in net earnings to $4.8 billion. Learn more about this financial newsletter at Amy Calistri's The Daily Paycheck. |
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