Citigroup’s Series J preferred shares: C.PR.J, 9.4% Yield From The Bank (NYSE:C.PR.J)

Thesis

Citi (C) reported earnings on January 12, 2024, that beat EPS estimates, but trailed revenue expectations. Citi is a mammoth organization spanning the globe, and while it took some impairment charges around its Russia and Argentina businesses, its Tier 1 capital ratio stands at a very healthy 13.3%:

It seems that Armageddon is priced in the common shares, with the bank’s tangible book value per share at $86.19 while its common shares are trading at $52/share.

In this article we are going to explore an interesting development within the bank’s funding structure, namely the very high yield exhibited by the bank’s Series J (C.PR.J) preferred shares. The securities are now yielding in excess of 9.4% on a current yield basis.

The high yield is not an expression of any systemic issue with Citi, with the bank in a very healthy capital position, but have more to do with the institution’s internal funding management. Savvy retail investors can take advantage of any presented arbitrage opportunities on the back of the current pricing.

The J Series are not cumulative and have a perpetual maturity date, having had their first call date in September 2023, after their initial 10-year fixed rate period.

The preferred shares are yielding in excess of 9%

Just like typical preferred shares, C.PR.J were issued with a fixed to floating structure, with the floating rate kicking in after the first call date on September 30th, 2023. After this date the shares would pay 3M Libor plus 4.04% as per the original prospectus. The last quarterly dividend amounted to $0.606/share after the SOFR conversion:

This level translates into a current yield of over 9.4% for the preferred shares. As long as SOFR remains at current levels and the bank does not redeem the shares, an investor is set to realize this dividend yield. As of the latest fixing, the shares will pay $.609/share on their March payment date.

The first call date has just passed

The first call date for the preferred stock series was September 30th, 2023:

Please note the series is callable at $25/share on every quarter going forward, coinciding with its payment dates. It is also interesting to see a feature dealing with a Federal Reserve approval of the redemption. Citigroup is famous for having been under an enforcement action by the Fed, which was terminated in October 2023:

The Federal Reserve Board on Thursday announced the termination of the enforcement action listed below: Citigroup Inc., New York, New York Cease and Desist Order dated May 20, 2015, Terminated October 19, 2023

We believe that the enforcement action being still live played a role in the bank’s decision not to call the preferred shares on their first call date in September.

The Series-K preferred shares were called

A similar preferred shares series from Citi, namely the Series-K was called in November 2023, on its first call date:

NEW YORK – Citigroup Inc. is redeeming, in whole, all $1.495 billion aggregate liquidation preference of Series K Depositary Shares representing interests in its 6.875% Fixed Rate / Floating Rate Noncumulative Preferred Stock, Series K (ticker “C Pr K”) (the “Preferred Stock”).

The redemption date for the Preferred Stock and related Depositary Shares is November 15, 2023 (the “Redemption Date”). The cash redemption price, payable on the Redemption Date for each Depositary Share, will equal $25. Any quarterly dividend declared but not paid prior to the Redemption Date will be paid on the Redemption Date to holders of record on a date prior to the Redemption Date set by Citigroup’s Board of Directors. The redemption announced today is consistent with Citigroup’s liability management strategy and reflects its ongoing efforts to enhance the efficiency of its funding and capital structure.

The respective series was switching to a floating rate formula, initially penned as Libor + 4.13% in the prospectus.

Via its redemption on the first call date Citi showed it follows standard market practice for preferred shares. What is interesting to note is that the call date fell after the Fed stay was lifted.

Partial redemption for Series J happened in December 2023

The Series J experienced a partial redemption in December 2023, following the lifting of the Fed stay:

November 29, 2023 NEW YORK – Citigroup Inc. is redeeming 16,000 shares out of 38,000 shares outstanding of its 7.125% Fixed Rate / Floating Rate Noncumulative Preferred Stock, Series J (ticker “C Pr J”) (the “Preferred Stock”), equivalent to $400 million out of an outstanding total of $950 million aggregate liquidation preference of Series J Depositary Shares representing interests in its Preferred Stock. The redemption date for the Preferred Stock and related Depositary Shares is December 29, 2023 (the “Redemption Date”).

The bank qualified the redemption as being consistent with Citigroup’s liability management strategy, and reflective of its ongoing efforts to enhance the efficiency of its funding and capital structure.

When looking at the bank’s preferred share structure, we can notice that Series J is the only publicly traded tranche that has not been fully called yet:

What is next for the Series-J preferred shares

We feel the bank will ultimately call the preferred shares this year, with only internal asset/liabilities reshufflings standing in the way. That will translate into a mathematical ceiling for a potential investor equal to the call price of $25/share plus the estimated quarterly dividend of $0.6/share at current SOFR levels. The all-in level therefore is roughly $25.6/share.

A retail investor should not buy the security at a price above the potential next payment date repayment level, since they can incur a loss if they are called. On the flip side any dip in price towards $25/share should be bought. The shares will have a very low volatility due to their continuous call, high dividend yield and robustness of underlying issuer.

Given the current structure of the preferred shares, any risk-off event that will see the price of C.PR.J move towards $25/share should represent an appealing short term buying opportunity.

Conclusion

Citi announced on January 12 another set of robust results, exposing a healthy capital ratio exceeding regulatory requirements. While its common shares are trading significantly below book value, signaling the market’s take on the bank’s balance sheet, the 9% plus yield exhibited by the Series J preferred shares does not represent a sign of distress.

The preferred shares became callable in September 2023, with the bank redeeming roughly half of the outstanding shares in December. After its first call date the securities switched to a floating rate which has resulted in the current yield on the shares to exceed 9.4%. An investor should not pay more than $25.6/share for C.PR.J risking a capital loss in case they are called on the next payment date, but any dip towards $25 should be bought.