A Safe 7.1% Yield And 20% Upside Potential From This Financial Issue

SunTrust Banks (STI) is a strong, profitable regional bank based in the Southeast US. The company had a rough go in the financial crisis but has since returned to strong profitability like many US banks. However, the company's common stock dividend has never recovered from pre-crisis levels, leaving income investors out in the cold. But there is hope for income investors looking to capitalize on STI's continued success and in this article, we'll take a look at the company's Series E Perpetual Preferred Stock Depositary Shares (STI-E, may differ depending on your broker) to see if it is a fit for your income portfolio.

The Series E is a traditional preferred stock meaning there is no stated maturity date and the issue pays regular quarterly dividend payments. Also, as the distributions from STI-E are dividends and not interest payments, they are eligible for the favorable dividend tax treatment. This can give holders of STI-E in a taxable account a significant boost in after-tax yield over a comparable interest-bearing security such as exchange-traded debt, for instance.

The Series E depositary shares represent 1/4,000th of a share of Series E preferred stock. In other words, by purchasing STI-E shares you are really purchasing a fractional interest in the company's Series E preferred stock. That doesn't really change anything as far as the way STI-E functions for holders of the security so it is nothing to get hung up on. STI-E was issued at $25 per depositary share, indicating each Series E share was issued at $100,000. As that kind of price doesn't lend itself to liquidity, SunTrust decided to offer the depositary shares for increased trading volume and access for smaller investors.

STI-E pays an annualized dividend of $1.46875 paid out in $0.3671875 quarterly installments. At the issue price this is good for a 5.875% yield but at the current trading price of $20.68, the current yield of STI-E is actually much higher at 7.1%. Consider that yield from a very strong regional financial in an environment of 3% 10 Year Treasuries and you'll see why I like STI-E so much.

STI-E is also callable starting in 2018 which means that if SunTrust decides to redeem STI-E holders will be entitled to $25 per depositary share. As STI-E is trading for under $21 at present such an event would provide a substantial capital gain of more than 20%. Whether or not SunTrust will redeem STI-E at such time is anyone's guess but it is something to keep in mind and with the possibility of 20% capital gains on top of a 7%+ current yield, STI-E is even more attractive.

Of course, there are some risks to owning STI-E. First and foremost is interest rate risk. As we've seen over the past year when interest rates move up income securities often move down in price in order to accommodate higher interest rates. This is great if you are in cash and looking to buy because you can get a higher current yield but holders are subjected to capital losses when such an event occurs. As we are in an environment where interest rates spike and plummet on every word from the Fed it is something to keep in mind; you may be subjected to capital losses if interest rates spike.

In addition, STI-E's dividend payments are non-cumulative, meaning that if SunTrust misses dividend payments on STI-E it is under no obligation to make them up. This means that if SunTrust were to run into financial trouble and miss dividend payments STI-E would likely plummet in price to reflect the expectation that dividend payments would be missed and not made up. I don't find this to be a credible risk given SunTrust's profitability and strong balance sheet but it is something to keep in mind.

Overall STI-E offers investors a great yield north of 7% from a very strong regional financial institution that I would consider to be quite safe. Of course, there are risks such as the non-cumulative nature of the dividend payments and the interest rate risk inherent in owning virtually any income-producing security but coupling the safety of the payer, the great yield and the large discount to the issue price, I think you can do much worse than STI-E.

Source: A Safe 7.1% Yield And 20% Upside Potential From This Financial Issue

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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