PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, November 2016
Last month’s update gave
preferred stock buyers a heads-up, saying
that “…it is time for preferred stock buyers
to start paying attention.” On cue, November
delivered the best market for preferred
stock buyers that we have seen since
mid-February. If you haven’t checked prices
lately, now’s the time to do so.
Since last February, high quality sub-$25
candidates have been hard to come by. By
high quality I mean preferreds offering the
characteristics that most risk-averse
preferred stock investors favor such as
investment grade ratings, cumulative
dividends and call-protection.
There are currently 81 of these high quality
preferred stocks selling for an average
price of $23.73 (November 30), offering an
average yield-to-call of 8.78 percent.
November’s new
issues
With upward pressure on
rates, we typically see fewer new preferred
stock issues and November was no exception.
Only four new preferred stocks were
introduced for the consideration of
preferred stock investors during November.
But with 81 high quality issues currently
available for less than their $25 par value
to pick from, the number of new preferred
stock IPOs becomes much less relevant to
today’s buyers.
Issuers have brought 86 new
preferred stocks to market this year. There are
now 882 of these securities trading on U.S.
stock exchanges.
Note that I am using IPO date here, rather than
the date on which retail trading started. The
IPO date is the date that the security’s
underwriters purchased the new shares from the
issuing company. Anxious to sell the new shares,
underwriters will generally sell to
broker/dealers using a temporary trading symbol
on the wholesale Over-The-Counter exchange (who,
in turn, sell them to us at retail within a few
days of the IPO date).
Buying New Shares for
Wholesale
Note that the most recently
introduced issue – CFFFP from Capital One (COF)
- is still trading on the Over-The-Counter
exchange (as of November 30). This is a
temporary OTC trading symbol until this security
moves to the NYSE, at which time it will receive
its permanent symbol.
But there is no need to wait; during a period of
relatively high prices, individual investors,
armed with a web browser and an online trading
account, can often purchase newly introduced
preferred stock shares at wholesale prices just
like the big guys (see "Preferred
Stock Buyers Change Tactics For Double-Digit
Returns" for an explanation of how the
OTC can be used to purchase shares for
discounted prices during a period of high
preferred stock prices).
Those who have been following this strategy of
using the wholesale OTC exchange to buy newly
introduced shares for less than $25 are more
able to avoid a capital loss as prices start to
drop (if they choose to sell).
Your broker will automatically update the
trading symbols of any shares you purchase on
the OTC. CFFFP will become COF-H.
Diversification
While relatively few in number,
November’s four new issues are from surprisingly
diversified issuers - one property REIT, two
financial institutions and one energy limited
partnership.
Hotel REITs have been very active
throughout 2016 with new preferred stock
offerings coming from this sector just about
every month. Hersha Hospitality Trust (HT)
issued its Series E traditional preferred stock
during November, raising about $100 million at
6.5 percent. HT-E is Hersha’s second preferred
stock offering within the last six months, its
Series D issue being introduced last May, also
at 6.5 percent.
B. Riley Financial (RILY) is a small financial
services firm founded in 1973 as Great American
Group. The company provides financial and
trading services to businesses and high net
worth clients. RILY executed the acquisition of
United Online, Inc. in July of this year. RILYL
is actually an Exchange-Traded Debt Security
(indicated by green font in the above table).
ETDS are very similar to preferred stocks and
are frequently labeled as such on brokerage
statements, but are actually bonds recorded on
the company’s books as debt rather than equity.
BILYL is the company’s only offering, raising
about $25 million and offering a 7.5 percent
coupon that matures in 2021.
NuStar Energy (NS) is a petroleum pipeline,
storage and fuel marketing limited partnership
founded in 1999. Those purchasing shares of the
company’s new NS-A preferred stock should expect
to receive a K-1, rather than a 1099, at
tax-time. NS-A offers buyers an 8.5 percent
coupon until the security’s December 15, 2021
call date. At the time, the dividend rate
offered by this security becomes a floating rate
pegged to the 3-month LIBOR rate (currently at
0.92 percent), plus 6.766 percent. Buyers should
be cautious of this structure since, while
sounding especially attractive during a period
of increasing rates, issuers will frequently
call the shares on the call date if not doing so
means increasing their dividend expense to
shareholders (see “Variable-Rate
Preferred Stocks Underperform Their Fixed-Rate
Cousins”).
Capital One (COF) has issued two new traditional
preferred stocks within the last four months,
both of which are nearly identical in their
terms and size. Interestingly, this is the same
four month period over which preferred stock
prices have declined in anticipation of a Q4
rate increase by the Fed. You can see the magic
of decreasing prices by comparing the coupon
rates offered by these two COF preferreds: COF-G
was issued on July 26 with a coupon of 5.2
percent while the company had to pony up 6.0
percent on the new CFFFP (soon to be COF-H) just
four months later.
Sources: Prospectuses
HT-E,
RILYL,
NS-A,
CFFFP/COF-H. CDx3 Notification Service
database,
PreferredStockInvesting.com
Tax
Treatment
Dividends paid by REIT preferred
stocks are a pre-tax distribution of the
company’s earnings to shareholders. As a pre-tax
distribution, it is the shareholder who pays the
full tax so dividends received from REITS do not
qualify for any type of favorable tax treatment
(although portions of REIT dividends are
frequently re-classified at tax-time as capital
gains, hence lowering your tax burden in that
manner).
On the other hand, dividends received from
Capital One’s CFFFP are a distribution of the
bank’s after-tax earnings and are therefore
designated as being Qualified Dividend Income (“QDI”
in the Status column of the above table),
although there are exceptions and conditions
(see prospectus).
In Context: The U.S.
Preferred Stock Marketplace
So how do the new November issues
stack up within the context of today’s preferred
stock marketplace?
Market prices for preferred stocks are finally
returning to more normal levels. By “normal” I
mean returning to a price that is closer to par
and determined by market participants rather
than being artificially propped up by the Fed’s
monetary policies.
Just like 2015 at this time, preferred stock
market prices have been falling since
early-August in anticipation of a Q4 rate
increase by the Federal Reserve. Remember that
interest rates and the market prices of
fixed-return securities (bonds, preferreds) move
in opposite directions (rates up, prices down).
As prices fall, and yields rise, preferred stock
buyers realize higher returns for lower prices.
As the following chart illustrates, we saw the
same price drop in late-2015 in anticipation of
a December 2015 rate increase, which the Fed did
at their December 2015 meeting. Prices dropped
before and after the December 2015 rate
increase, but only for about six weeks as it
became apparent that the Fed was unlikely to
raise rates again in early-2016, as had been
expected. After reaching a low of $23.35 per
share on February 11, 2016, prices started going
back up and peaked at $26.40 in early-August
again.
The data being charted here
is limited to call-protected issues in order
to limit the price distorting effect of an
anticipated redemption.
At their November 1-2 meeting, the Fed
deferred raising rates as to not influence
the U.S. election, but odds makers and Fed
followers now put the likelihood of a
December rate increase at a near certainty.
The price drop that we have been seeing
since early-August is typical when the
market expects a rate increase.
The average market price of U.S.-traded
preferred stocks is now at $24.68 per share,
up an annualized 0.4 percent for the year.
As prices trend back toward normal, there
will be many more high quality preferreds
available, for less than their $25 par
value, for preferred stock buyers to pick
from.
Will it last?
What is less clear is how
long this return toward more normal pricing
will last. Foreign investors have been
moving record amounts of cash into U.S.
income securities for many months (see “Here’s
why 10-year Treasury may still drop below 1%“),
putting upward pressure on prices here,
because of the zero-to-negative domestic
rates set by their central banks. If
anything, the U.S. income security market
has become even more attractive to such
foreign investors.
Further, remember that the federal funds
rate is the rate that member banks are
charged when they need to borrow some cash
overnight to pump up their reserves in order
to meet regulatory requirements. U.S. banks
have over $2 trillion in excess reserve cash
- that's above and beyond the elevated 2010
Dodd-Frank requirements (see “Fed
Worries About Deflation But Pays Banks
Billions Not To Lend QE Proceeds”).
The demand by member banks for overnight
loans from the Fed has been, and remains,
minimal, so fiddling with the federal funds
rate does not have anything like the lasting
impact it used to.
With increasing foreign demand and a banking
system awash with cash, it would not be
surprising if the current fall in the market
prices for U.S. income securities is
short-lived (as it was after the December
2015 rate increase).
But many things affect the market prices of
these securities such as the proximity to
their call or maturity date, proximity to
their next ex-dividend date, industry and/or
overall health of the issuer (think upstream
oil producers), perceived direction of
interest rates, pending government
regulatory or policy changes, cumulative
versus non-cumulative dividends and tax
treatment of dividend payments. So what we
really need to look at is current yield,
which calculates the average annual dividend
yield per dollar invested (without
considering re-invested dividend return or
any future capital gain or loss). Current
yield is a “bang-for-your-buck” measure of
value that normalizes differences in coupon
rate and price to give us a single,
comparable metric.
U.S.-traded preferred stocks are currently
returning an average current yield of 6.8
percent, up from 6.4 percent in early-August.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the four new November
preferreds on November 30. It is into this
marketplace that November’s new issues were
introduced.
Income versus Value
Investing, Year-To-Date
With an average current yield of
6.8 percent, plus the 0.4 percent annualized
value gain, those investing in U.S.-traded
preferred stocks since the beginning of 2016 are
currently on pace for a total annualized return
of 7.2 percent (6.8 percent of which is realized
in dividend cash).
Benefiting from the November
election results, those investing in common
stocks, as measured by the S&P500, saw an uptick
after declining returns throughout the summer
months. Starting at 2013 at the beginning of the
year, this common stock value index closed on
November 30 at 2199, an unrealized annualized
value gain of about 10.1 percent plus about two
percent in average annualized dividend yield – a
year-to-date annualized gain of about 12.1
percent for common stock investors.
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