The first rule when buying preferred shares, in my opinion, is to choose companies where you’d have no problem owning the common shares. Although yield is important, ultimately it comes down to the strength of the business behind the quasi-debt instrument.
State Street, for those unaware, is the second-largest ETF company in the U.S. with 25% market share compared to 42.2% for BlackRock’s (NYSE:BLK) iShares unit. The SPDR brand is part of State Street’s investment management business, operated under State Street Global Advisors, while the investment servicing business provides custodian-type assistance for financial services companies around the globe. Although it’s a much bigger piece of the pie at this point, the ETF business is clearly coming on. In the fourth quarter, its management fees increased 29% year-over-year to $260 million. For all of 2012, they grew 9% year-over-year to $993 million.
State Street’s Series C Preferred Stock pays an annual dividend equivalent to 5.25% interest. The company issued these shares last August, raising $488 million in net proceeds, which it used to redeem all of its outstanding Series A Preferred Stock, which in turn redeemed what are called “Fixed-to-Floating Rate Normal Automatic Preferred Enhanced Capital Securities” (or Normal APEX for short). The most important thing here is that State Street took preferred shares paying 8.25% and replaced them with those paying 300 basis points less.
Buying one common and one preferred share will yield 2.8% at the present moment. It’s not 9%, but it’s better than the 1.7% for the common alone.