What is WFC-L

Details and statistics of WFC-LFigure 1. Details and statistics of WFC-L.

We have written an article about WFC-L (NYSE:WFC.PL) and its potential for price growth in the past. Here we are shortly describing what’s WFC-L and why it’s different from other preferred stocks on the market. We also argue that WFC-L is still one of the great arbitrage opportunities.

WFC-L is a preferred stock listed by Wells Fargo & Co.(WFC) at a 7.5% coupon rate. The original stock was listed by Wachovia Corp. under the symbol WBPrL on the New York Stock Exchange as a series L preferred stock. WBPrL prospectus stated that the stock is perpetual and each share could be converted to 32.0513 shares of the corporation’s common stock at a conversion price of $31.20. The preferred stock was not redeemable at any time, but the company could convert all of its series L preferred stocks to common stock if the common stock’s closing price exceeds 130% of the conversion price for 20 trading days during any consecutive 30 trading day period. After the price of the common stock of Wachovia Corp. plunged in 2008 and the bank was bought by Wells Fargo & Co. the preferred stock turned into a busted convertible, (practically making it perpetual preferred stock forever).

The details of WFC-L are shown in Figure 1. It’s worth noticing its last price of $1,369 per share and a current yield of 5.48%.

The fixed-rate banking preferred stocks

There are 91 fixed-rate preferred stocks in our database. 22 of these preferred stocks have a negative yield to call (Figure 2).

Figure 2. Fixed-rate preferred stocks with negative yield to call.

All of these stocks are investable only if one has the special inside knowledge of when and why these stocks will be redeemed. If you are one of those persons you will not be reading Seeking Alpha articles.

WFC is one of the biggest banks in the world so we are excluding any unrated preferred stocks. If they are not big enough for being rated, they are not comparable to WFC. Figure 3-5 shows all the fixed-rate preferred stocks that trade above par. Figure 4 and 5 show a subset of those stocks that are rated BB+ and higher and investment grade, respectively.

Figure 3. Yield to call curve of rated fixed-rate preferred stocks that trade above par.

Figure 4. Yield to worst curve of fixed-rate preferred stocks rated BB+ or higher.

Figure 5. Yield to worst curve of investment-grade, fixed-rate preferred stocks.

I would really like to stress that on these curves you are seeing yield to worst, which is the financial way to call this yield. In fact, it’s the yield to best for these securities. If at their call dates these securities are not redeemed, they are supposed to be pinned to par or trade lower than par. This way their yield to call is the best that can actually happen. 3.5% from stocks like FRC-J which has a 4.5% current yield. Same metrics for JPM-J. To make things even worse for the stocks on the charts above one has to understand that their duration does not bring equal reward to the risk taken. All of these securities are callable which limits their price appreciation. On the raising yield environment there’s nothing to protect you from duration risk. WFC-L compared to these securities has a higher current yield (lower duration) and no price cap to the upside. If WFC can issue a 1% preferred stock WFC-L will trade at $7500 with all the logic in the world. For FRC-J to go to 1% YTC the price will rise to only $29, for example. One could say: What about bank preferred stocks that trade bellow par and are treated like perpetuities from the market? At the moment of writing there’s only one BB+ or higher fixed rate banking preferred stock that trades below par. It’s ironically WFC-L’s brother WFC-Z. It’s our best comparison to prove how mistreated WFC-L is from the market and the comparison is to follow in the next section. Enjoy!

Is WFC still an Investment-grade preferred stock issuer?

In fact, WFC common stock performance is among the worst in the sector (Figure 6).

Figure 6. WFC price movement. Adapted from yahoo.finance.com

WFC has been in the headlines, its reputation suffered and it’s not anymore the bank that was rock solid even in the crisis of 2008-2009. Anyway, there are recent updates from Moody’s Corporation and Fitch Ratings as demonstrated in Table 1 and Table 2

Table 1. Creditworthness of Wells Fargo & Company according to Fitch Ratings. Adapted from Fitch Ratings Rating Action Commentary.

Table 2. Creditworthness of Wells Fargo & Company according to Moody’s Corporation. Adapted from Moody’s Corporation Investors Service

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Of course, there are many people that think rating agencies always are wrong. I’m one of these people sometimes (very rarely). Basically, the people who think rating agencies always are wrong are the same people that believe they can eat all they want as much as they want and have 5% body fat. Rating agencies are right most of the time and they specialize and spend a lot of money to find the best possible ways to measure credit risk. No individual solely has the same capacity as an organized entity doing this professionally. A person doing credit analysis in his spare time for fun cannot be better than Fitch. If one thinks he can I suggest trying to outrun a professional sprinter because you were jogging for the last month. As far as rating agencies are concerned WFC-L and all WFC preferreds are still investment grade.

1. Comparison with WFC fixed-rate preferred

Figure 7. Statistics of the preferred stoks issued by Wells & Fargo Co.

When we look at other preferred stocks from the same issuer, as shown on Figure 7, it’s apparent that all potentially-callable stocks have very low or even negative yield-to-call. As a retail investor, you would not consider investing in any of those except possibly WFC-Z. Regarding the risk, WFC-L and WFC-Z should have the same current yield. WFC-Z has a current yield of 4.77% as seen in Figure 7 as opposed to the 5.48% current yield of WFC-L. If we assume that WFC-Z and in fact WFC-O, WFC-N, WFC-P, WFC-Y, WFC-X are all overvalued then WFC-Z should increase its current yield to reach the current yield of its counterpart – WFC-L. On the other hand, if we assume that WFC-L is undervalued then its current yield should decrease to reach the current yield of WFC-Z. Moreover, the increase of the price of WFC-Z is caped because it’s a callable, preferred stock, while the WFC-L price increase is not, as explained at the beginning of this article.

There’s not a single reason that can explain why WFC-L would trade at a higher current yield than WFC-Z. Based on normal mathematical logic WFC-Z is the one that should trade with higher yield because it’s somewhat handicapped by having a redemption clause. As a matter of fact, there’s not much to explain here. If WFC-Z trades at 4.8% current yield WFC-L has to trade at most at 4.8% current yield. This puts the price of WFC-L at $1562. This is 14% capital appreciation potential. This logic is not dependent on anything related to the WFC credit rating. This is not dependent on the global economy or any other factor you may think of. It’s pure arbitrage. The only pitfall to this arbitrage is that we don’t actually know which stock is mispriced but based on the previous paragraph we are almost certain it is WFC-L being mispriced. One also can assume that 100 of the other fixed-rate preferred stocks are mispriced and WFC-L is fairly priced. It actually does not matter because none of us knows how this arbitrage will narrow and when. What we can conclude is that based on the pricing of WFC-Z at the moment WFC-L has 14% upside potential. If the forces of arbitrage theory notice this one today they will have to adjust the pricing.

2. Comparison with WFC-Q

The comparison with WFC-Z may seem good enough for us but things get even scarier when we compare WFC-L to its fixed to floating brother WFC-Q. When I look at this extreme arbitrage I really want to go to my finance professor at my university and tell him to leave his job and burn all finance literature there is. WFC-Q has a 4.5% yield to call at the moment and becomes a floating preferred stock in three years at a LIBOR +3.09%. As explained above its yield to call being yield to worst actually is the best an investor can hope for with this security. I understand that 4.5% in three years sounds very appealing at the moment but we have to realize that for WFC to redeem WFC-Q in 2023 it will have to be able to finance lower than LIBOR + 3.09%. The three-month LIBOR expectation at the time is around 0.3%. Let’s assume that WFC indeed is able to finance at 3%. In this case, you will lock 4.5% from WFC-Q. What a good deal you may say, but if WFC is able to finance at 3%, what will happen to WFC-L? As we explained in the beginning WFC-L is a busted convertible and is virtually not callable. Its price appreciation is not limited due to a decrease in its yield to call and at 3% current yield its price would have to rise to $2,500. Here is the question for you: What do you prefer – a 4.5% maximum possible yield to call from WFC-Q or 5.5% current yield +100% capital appreciation in three years from WFC-L? Now you may say but what if they don’t redeem WFC-Q and the 5.5% current yield proves to be correct? In this case, WFC-Q would have to trade at $15. I’m not making these numbers up. Calculating current yields is very simple math. So on the downside, you would still earn 5.5% from WFC-L until the call date of its brother while in WFC-Q you will be way in the red, stuck with one of the worst fixed-income investments you have made. As I’m writing this I cannot believe the numbers. This is financial madness and all of us who are somehow involved in fixed income ETFs, CEFs, etc. – yes we all participate in this madness. Any time you go and buy PFF it just buys a little of WFC-Q instead of selling it and buying WFC-L. Why is this happening? I have no clue. Is this a pure arbitrage in one of the biggest bank preferreds? I’m betting my house on this. But wait. we are still not done with the comparisons. I just want to end this paragraph with a price target of WFC-L based on the price of WFC-Q. I will be somewhat not pushing too much and will say WFC-L has to have a 4% current yield to match WFC-Q at the moment. $1,875 is the price. To me personally, WFC-Q is extremely overvalued, and if it can be so much overvalued why wouldn’t WFC-L be so much overvalued? Let it be $1,875.

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3. Comparison with SNV-D

We were just thinking that the market is crazy valuing WFC-L and WFC-Q in such a way but guess what crazy can always surprise you. It always gets somewhat crazier. SNV-D is very similar to WFC-Q with the only difference that SNV is a much riskier institution compared to WFC. SNV-D has a call date very close to WFC-Q and a LIBOR spread of 3.35% when becoming floating. WFC-Q is still considered investment grade while SNV-D is more of a BB- preferred and the 0.26% yield premium to WFC-Q probably makes it overvalued to WFC-Q (how can a stock be overvalued to WFC-Q? The financial part of my brain wants to explode!). I’m not going to continue with the analysis because it is exactly the same as with WFC-Q just SNV-D is worse. Up to anyone to decide whether they will buy SNV-D or WFC-L and shame on passive strategy ETFs. They do a perfect job “managing” public savings.

4. Comparison with BAC-L

Figure 8. Statistics of BAC-L.

Figure 9. Statistical analysis of WFC-L with BAC-L.

From Figure 9 we can see that Bank of America, 7.25% Non-Cumulative Convertible Preferred Stock, Series L (BAC-L) behaved identically with WFC-L until recently. At the moment they are two standard deviations apart. When we look into the reasons behind this deviation we find that S&P Global Ratings rates these stocks differently, giving WFC-L a grade lower than BAC-L. However, there are two other rating agencies that can confirm if this is the reason for the valuation of the two stocks. Surprisingly Moody’s Investors Service and Fitch Ratings have rated these two stock identically. Moreover, the yield curves of the yield-to-worst of Bank of America’s and Wells Fargo & Co bonds look strikingly similar as shown on Figure 10.

Figure 10. Bond yield to worst curve of WFC (top) and BAC (bottom).

Some of the rating agencies, like S&P, rate WFC-L higher than BAC-L. Even if S&P is correct there’s not a single BB+ rated fixed-rate preferred stock that compares to WFC-L (Figure 11).

Figure 11. Details of BB+ rated fixed-rate preferred stocks.

MS-L and FITBO have 4.7% current yields and 3.7% YTC approximately and the closest to par CFG-E has a current yield of 4.93%. Let’s assume WFC-L is a regular BB+ preferred stock perpetuity. Its current yield should in no way be higher than 5% because as we mentioned several times its price appreciation is unlimited in comparison to any of the stocks above. When we give WFC-L a 5% current yield we are not as demanding as we should be but even in this case its price has to rise to $1,500. This is in fact the price of BAC-L and is in line with their statistical performance. BAC-L itself may very well be slightly undervalued on a relative basis. I would not be surprised at all to see WFC-L and BAC-L at the same price in the future. To me, this makes perfect sense.

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5. Comparison with newly issued bank preferred stock IPOs

The two last recent IPOs of financial companies can be seen on Figure 12.

Figure 12. Newly issued bank preferred stocks.

The BB-rated COF just issued a 4.625% perpetual preferred while the investment-grade FRC issued a 4.125% preferred. Last time we were in school 5.5% was higher than 4.625%. To be fair we have to acknowledge that the bonds of COF and WFC are not priced giving any advantage to WFC. Even though COF prefs are rated BB we have absolutely no problem of WFC-L trading in line with COF preferreds:

Figure 13. Preferred stocks of COF.

COF-I trades at a 4.96% current yield. Even if we assume that WFC is equal in credit quality with COF and all rating agencies are wrong in evaluating credit risk this still puts the target of WFC-L to at least 5% current yield or $1,500. FRC is of course a different success story. Just one look at the price charts of FRC vs. WFC is enough to conclude that FRC is in fact one of the safest financial institutions in the world at the moment. It seems they had a coronavirus immunity way before it happened. Just don’t forget both are investment-grade issuers at the moment and FRC is bold enough to price a 4.125% fixed rate preferred at the moment. Currently, this is almost 1.4% lower than the current yield of WFC-L.

The price target for WFC-L

Based on all the comparisons above It’s fair to say that WFC-L should trade somewhere between 4.70% and 5% current yield. This is absolutely irrelevant of what any one of us thinks about the financial industry or the safety of WFC or the state of US debt or presidential elections or even the price of oil, US dollar, gold, etc… This is a simple apples-to-apples comparison. If 100 other preferred stocks are priced the way they are priced WFC-L has to join this bellow 5% current yield club even with a wild card. Otherwise, it may file a complaint about being mistreated. In the year 2020, you can not judge a stock by its high nominal value. We all understand that you want preferred stocks that come in handy with a $25 par but we all have to be way more tolerant. A reverse stock split is not supposed to change the value of any single instrument so don’t expect WFC-L to do a reverse stock split so that the small investor can trade it. With all jokes and irony left behind WFC-L should trade somewhere in the range $1,500-$1,600 which is the range before the coronavirus. The yields have shifted even lower for bank preferred stocks so WFC-L has any reason in the world to make a new high in price and a new low in current yield

Hedging reaction

It’s a situation in which one can hedge WFC-L with almost any bank preferred stock in the market. In fact, I don’t think one will be able to find a real competition to WFC-L and defend a thesis some of the bank preferreds are better value or have more Alpha than WFC-L. This gives a lot of room for being wrong in the overall direction of the fixed income market. One can short any of the stocks in the article to hedge if needed.

Conclusion

It’s strange to find such a bargain in the current situation in fixed income. WFC-L has been PFF’s most beloved holding for quite sometime. It’s clearly mistreated at the moment and unless there’s some hidden-from-everyone clause that allows WFC to redeem WFC-L, it has at least 10% price appreciation potential to fair value

Author’s note:

To get an idea of our logic, feel free to read our last actionable articles:

  • ZIONL Price at publication on May 30, 2020 – $26.30. Return at 9/12/2020 including interest is 8.55%/ 30% annualized
  • SYF-A Price at publication on May 28, 2020 – $19.35. Return at 9/12/2020 including dividend is 27%/ 94% annualized

Trade With Beta

At Trade With Beta

We closed our official fixed income portfolio just before the crisis because everything was extremely overvalued. In June we started our new fixed income portfolio

The results so far :

June 20 – July 20 – 1.7% / 20% annualized

July20 – September 2 – 3.7% /30% annualized

 

Disclosure: I am/we are long WFC.PL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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