The recent rally in bank stocks has helped raise the investor appeal of banks' convertible preferred stock.
Prices of many convertible stocks, which may be traded in for the common shares of a bank after a future date, have either been flat or drifted lower, in contrast to the upward trend in the underlying common stocks.
As a result, investments in these hybrid securities can be seen as paying off sooner.
"Some of the convertible preferreds are looking more interesting at this point," said Kathryn H. Bissette, banking industry analyst at Sterne, Agee & Leach Inc., Birmingham, Ala.
Convertibles appeal to some investors because they carry less market risk than common stock, but still offer an opportunity to share in the fortunes of the bank for whose stock they can be traded.
Investors pay a premium for convertibles based on the right of exchanging them for common stock. As preferred shareholders, they have greater rights as creditors of a company, but fewer ownership rights.
Two key valuation yardsticks for the issues are the conversion premium and break-even period.
The conversion remium is the percentage that the price of the convertible issue trades above its conversion issue trades above its conversion value.
The break-even period is the amount of time required to earn back the premium, based on the prices and yields of both securities.
Ms. Bissette's analysis shows many banks' convertible preferred stocks to have improved by both measures since last winter, when she urged caution about such investments.
The analyst warned in February that premiums and break-even periods for bank convertible preferreds were historically high and vulnerable to rising interest rates.
When conversion premiums are high, convertible preferred stocks tend to trade more like bonds and fall in value as rates rise.
Ms. Bissette also expressed concern that some less sophisticated investors, enticed by the securities' higher yields, might be unaware of the approaching redemption dates.
She cautioned that capital losses are possible. She warned investors against assuming the convertible feature is "only a plus -- long-term protection against inflation -- on top of an assured long-term fixed yield."
Now the situation has changed. Perhaps the most striking example is Barnett Banks Inc.'s issue of convertible preferred class c shares, which will be exchangeable after Oct. 15, 1995, for $52.40 per common share.
Common shares of Florida's largest banking company closed Monday at $46.25, up 13% from $40.87 on February 10. Growing takeover speculation as the era of full interstate banking approaches, as well as Barnett's own good first quarter earnings, have helped the stock.
In the same period, the price of the $100 million convertible preferred class c has eased slightly to $65.25 on Monday from $66 on Feb. 10.
Thus the premium on the Class c Barnett preferred stock has plummeted to 11.5%, as of Monday, from 28.8% on Feb. 10, shortly after the Federal Reserve Board began raising short-term rates.
The break-even period is now 3.4 years, down strikingly from 9 years in February.
Ms. Bissette noted Tuesday that "investors would obviously have been far better off' back in February getting into Barnett's common stock rather than its convertible preferred.
However, two weeks ago, the analyst cut her investment rating on Barnett's common stock to a strong hold" from a "buy" rating because of its recent price rise.
"The bank stocks have done relatively well recently and they aren't as cheap as they were' in February, Ms. Bissette said Tuesday. "We've pared back our recommendations and are urging more selectivity by investors."
At that midwinter point, the Federal Reserve Board had only begun to push up short-term interest rates and industrial stocks were, bank stocks were firmly out of favor.
The Fed has since raised rates three times and the Dow Jones industrial average had fallen 7.6% from its high on Jan. 31. Banks, having less downside risk than other stocks, have attracted investors in search of shelter in a bear market.
Among bank convertibles, premiums and break-even times have fallen for other issues besides Barnett.
The conversion premium for First Chicago Corp's $200 million preferred issue that is redeemable after April 1, 1997, has dropped to 11.5% from 27.9%. Break-even time is now 4.7 years, down from 12.4 years.
The premium on National City Corp's $175 million issue, exchangeable after May 1, 1996, is down to 4.6% from 10.7$ in February. Breaking even requires 2.7 years, down from 6.9 years.
For First Bank System's $100 million issue, redeemable after Jan. 1, 1996, the premium has moved down to 7.3% from 15.9% in February. The break-even period is down to 2.6 years from 5.5 years.
Attractive Yields Available
Meanwhile, the preferred investors can still get yields as attractive as in February, or even a bit more so.
Barnett's class c convertible preferred this week yields 6.1%, up from 6.0% on Feb. 10.
First Chicago Corp.'s issue, whose price was up slightly to $55.75 on Monday from $55 back on Feb. 10, continues to yield 5.2%.
The National City preferred, at $67 now versus $66.63 on Feb. 10 still yields 6.0%. First Bank System's, up in price to $64.13 from $62.50, the yield is off slightly to 5.6% from 5.7%.