Preferred stock suggestion from an experienced bond fund manager

25 Jun 2013 by Jim Fickett.

Sallie Mae preferred pays libor plus 1.7 percentage points and sells well below par.

Earlier this month Bloomberg had an interesting article about the Eaton Vance Bond fund (EVBAX), managed by Kathleen Gaffney, who previously co-managed the well known Loomis Sayles Bond Fund with Dan Fuss, for 15 years. The article summarizes one of Gaffney's ideas, which sounds, superficially at least, quite attractive:

Gaffney is also investing in floating-rate preferred stocks issued by student loan company SLM Corp. (SLM) – formerly known as Sallie Mae – as a substitute for floating-rate bank loans and junk bonds, which she says have become too popular. “It’s become more of an issuer’s market than an opportunity for investors to find great value,” she says.

Sallie Mae’s preferred stock trades at $69.50 a share, a deep discount to its $100 par value. The stock has a coupon payout of 1.7 percentage points above the London Interbank Offered Rate, or LIBOR, which is currently .7 percent. Gaffney suspects if interest rates rise, companies like Sallie Mae will redeem floating-rate preferreds to avoid the expense of increasing debt payments. Then the price of Sallie Mae’s preferred shares would rise from $69.50 to its par value of $100 – a gain of 45 percent. That would be on top of any interest payments.

And even if Sallie Mae does not redeem the preferreds, in an era of rising rates, which is where we are likely to be, a variable-rate instrument might be attractive. If you are interested in researching further, the symbol for the variable rate preferred is SLMBP.