A 6% Yield From This Large Utility For Current Income

In this article, we'll take a look at a different kind of security that utility investors can hold for a great source of current income that is outside the realm of traditional utility stock investing. That security is a trust preferred issue from NextEra (NEE), a large utilities provider, and we'll examine it now to see if the 5.875% Preferred Trust (NEE-C, may differ depending on your broker) is right for your portfolio.

First, we'll define exactly what NEE-C is. NEE-C is a trust preferred security which means that is has the characteristics of traditional preferred stock with a couple of important differences. First, trust preferreds have stated maturity dates as they are based on underlying debt issues in contrast to traditional preferred stock issues which have no maturity date. In addition to that most preferreds are eligible for the favorable dividend tax treatment but as trust preferreds distribute interest payments, they do not enjoy that taxation status. As a result, trust preferred holders are subject to higher taxation, all else equal, than traditional preferred stock investors.

In the case of NEE-C the underlying debt security is the company's 5.875% Junior Subordinated Deferrable Interest Debentures due 2044. There is a lot of information in the title of this debt issue so we'll take it bit by bit to make sure we have a good understanding of what it is. First, the interest rate is self-explanatory. The next part, Junior Subordinated, means that this debt issue is a lower tranche in the event of bankruptcy by NEE. If NEE were to face a situation where it was being liquidated due to bankruptcy, holders of NEE-C would be very far down the line of creditors to receive payouts. You can judge for yourself if you think bankruptcy is a risk for NEE but it is something to keep in mind if you do.

Next, Deferrable Interest means exactly that; NEE can defer interest payments on the underlying debt of the trust for up to 20 consecutive quarters. This means that NEE could potentially defer interest payments on NEE-C for up to five years at its option. Although you'd be entitled to receive deferred interest payments you'd still be holding a non-paying security if NEE decided to do this. I'm not sure under what circumstance that would occur as deferring interest payments would be a disaster if NEE ever wanted to access the capital markets again, but the clause exists. The final piece is also self-explanatory; this issue matures, if it isn't called, in 2044 when the underlying debt matures, essentially making this a thirty year bond if purchased today.

Speaking of calling the issue, since 2009 NEE has had the option to redeem NEE-C and hasn't done so. However, it does have the option to redeem this security anytime it likes and I suspect that is part of the reason why NEE-C is trading so close to its issue price of $25. At the current price of $24.60 NEE-C is trading for a small discount to its issue and call price. And with the coupon on this issue at $1.46875 annually, paid in quarterly installments, the current yield of 6% is slightly higher than the stated rate of 5.875%.

One benefit of NEE-C trading past its call date is that, in my view, the interest rate risk that most interest-bearing securities are subject to is mitigated. With NEE able to call this issue at any time it likely won't trade far from $25 because if it does, arbitrage investors who are hoping for a call would likely step in to own this issue. No one knows if NEE has any intention of redeeming this issue early but with that prospect hanging over NEE-C I suspect we won't see the price move much up or down.

To sum it up, in NEE-C you've got a trust preferred security with characteristics that will not suit every investor but is still a worthy holding for many. The current yield of 6% is very strong in the interest rate environment we find ourselves in but the taxation treatment of the issue's distributions is an issue for those holding it in a taxable account. The fact that it could be called at any time is likely buoying the price of the issue and while that is keeping capital losses to a minimum, it also could mean that holders get called before they'd like to be. And while I don't think NEE will defer interest payments it certainly has the right to do so, subjecting holders to capital losses as the issue would undoubtedly trade down on such news. If you hold NEE-C in a retirement account and don't mind the potential of being called early, the strong current yield and principal protection could be the addition to your income portfolio you've been searching for.

Source: A 6% Yield From This Large Utility For Current Income

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. (More...)

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