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APRIL 2017

Issue 121


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by Doug K. Le Du


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See page 1 of this month's issue of the subscriber's newsletter, CDx3 Research Notes, for symbols.








Top 10 Investment Grade, Cumulative Preferreds Available Under $25



The highest quality preferred stocks that are selling for a sub-$25 market price are offering income investors an average 7.2 percent Yield-To-Call in today's preferred stock marketplace and there are now 41 of these gems to pick from.

As rates move up and down over time, prices tend to move in the opposite direction, moving down and up, respectively. This is why preferred stock investing is long-term investing, taking advantage of the known inverse relationship between rates and prices over time.

The search engine parameters seen in Figure 1 look for preferred stocks and exchange-traded debt securities (ETDs) that are currently trading below their $25 par value, have cumulative dividends (meaning that if the issuing company skips a dividend payment to you, they still owe you the money) and offer investment grade ratings from Moody's Investors Service.


Currently priced below par

Purchasing shares below $25 is an important consideration for many preferred stock investors. In the event that your shares are redeemed (bought back from you) by the issuing company, shareholders will receive the security's par value in cash in exchange for their shares. By purchasing shares below their par value ($25 in most cases and in all of the cases shown here), preferred stock investors are able to add a layer of principal protection to their investment while also positioning themselves for a downstream capital gain in the event of a future call.


Figure 1 shows the complete filter used to find the highest quality preferred stocks available for less than $25. Of the twenty-five parameters that can be set, the four arrows highlight the keys for this search. Setting the "Currently priced below par" parameter to "Yes" does the magic here.



In addition to finding the highest quality issues that offer cumulative dividends and are currently trading below their $25 par value, this filter also limits the list to issues that have not suspended their dividend payments. And by setting "Today's price, at least" to $0.01 and "Today's volume, at least" to 1 share the filter will exclude less liquid issues (securities that have not traded today).

This is just one example. Click on the filter image to see another one along with a more detailed explanation.


Figure 2 shows the results when this search is applied to our Preferred Stock List
TM database, with ETDs shown in green font (please note that to protect the values of subscriptions to our CDx3 Notification Service, trading symbols are obscured here). Already a CDx3 Notification Service subscriber? See page 1 of this month's issue of the subscriber's newsletter, CDx3 Research Notes, for symbols.



There were a total of 958 preferred stocks and ETDs trading on U.S. stock exchanges as the month came to a close (including convertible preferred stocks). Of these 958, these are the top ten highest quality issues that are trading below their $25 par value. This list is sorted by dividend rate (coupon) with the highest payers listed first.


All of these high quality securities have a current market price (seen in the Last Price column) that is below their $25 par value (as shown in the Liquid Price column) and enjoy an investment grade rating from Moody's.

Keep an eye out for sub-$25 buying opportunities such as those listed here. The lower your purchase price, the more principal protection you'll have. The preferred stocks and ETDs listed in Figure 2 are offering some of the best choices available to you as an income investor.

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New Preferred Stock IPO’s, March 2017


The March 15 hike in the federal funds rate had little-to-no effect on the average market price of preferred stocks. Where the last two hikes (December 2015 and December 2016) were characterized by falling preferred stock prices for several months in advance, prices did not start dropping in advance of the March 15 increase until March 1, only to regain that ground by the end of the month.

March’s new issues

While this was going on, four new preferred stocks were introduced during the month for the consideration of preferred stock investors, with three of the four coming from new comers to the U.S. preferred stock marketplace. March’s four new issues follow three new issues last January and only two new preferreds last month. Maybe with the rate hike now behind us, issuers are starting to offer a more robust collection of new preferred stocks.

There are currently 105 high quality preferred stocks selling for an average price of $25.24 (March 31). And 41 of these high quality issues are selling below their $25 par value, offering an average yield-to-call of 7.22 percent. 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.

But with 41 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.



There are now a total of 958 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

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.

About the new issues

Three of the four new March issues offer the fixed-to-float rate structure, where the security pays a fixed dividend rate until its call date then becomes a variable-rate security based on a formula specified in the prospectus. While a variable-rate structure sounds appealing during a period of increasing rates, buyers should consider the historical tendency of issuers to redeem variable-rate securities on or near the call date if the rate is going to adjust upward (see ”Variable-Rate Preferred Stocks Underperform Their Fixed-Rate Cousins”).

PMT-A, issued by PennyMac Mortgage (PMT), is the company’s only preferred stock issue, raising a net of $111 million on March 2. As a mortgage REIT, PennyMac does not own physical property; rather, PMT raises capital (such as through a preferred stock offering) that it uses to buy bundles of residential mortgages from financial institutions. If the cost of the raised capital is less than the bundled mortgage rate, mortgage REITs make money on the spread. The cost of investment capital that mortgage REITs are able to raise is determined by today’s prevailing interest rates while the revenue coming from the mortgages, at least to some degree, remains fixed until the mortgages mature. So during a period of increasing interest rates, the profitability of mortgage REITs tends to get squeezed. In PennyMac’s case, this mechanism can be amplified since the company specializes in distressed mortgage loans for its revenue. At 8.125 percent, PMT-A was the only fixed-rate preferred stock offered during March.

TWO-A from Two Harbors (TWO) shares a number of similarities with PennyMac’s PMT-A. Like PennyMac, Two Harbors is also a mortgage REIT, although with a somewhat more diverse business. Introduced within five days of each other, both of these traditional preferred stocks offer the same 8.125 percent coupon and cumulative dividends (if they miss a payment, they still owe you the money; their obligation accumulates). And both of these securities raised about the same amount of capital, with TWO-A generating $121 million for Two Harbors. But there are differences, too. While PMT-A offers a fixed 8.125 percent coupon, TWO-A’s 8.125 percent dividend is fixed until its April 2027 call date. At that time, the coupon rate for TWO-A shareholders will be equal to the three-month LIBOR (currently 1.09278 percent) plus 5.660 percent.

SPKEP, issued by Spark Energy (SPKE) on March 8, is a small traditional preferred stock, its 1.4 million shares raising about $34 million. Spark, based in Houston and founded in 1999, is in the energy business, distributing natural gas and electricity to its residential and other customers located in 18 states. Like PMT-A and TWO-A, SPKEP also offers cumulative dividends, but at a more generous 8.750 percent coupon rate. This rate is fixed until SPKEP’s April 15, 2022 call date, and then becomes equal to the three-monthly LIBOR rate plus 6.578 percent.

NYCB-A from New York Community Bancorp (NYCB) is the only rated preferred stock among March’s offerings, commanding speculative grade ratings from Moody’s (Ba1) and S&P (BB-). NYCB-A’s 6.375 percent dividend is non-cumulative, allowing NYCB to count the $490 million value of this security toward its Tier 1 Capital regulatory reserves (as of 2010, cumulative securities issued by banks cannot be counted toward Tier 1 Capital reserves since, with cumulative securities, shareholders have a claim to the cash, defeating the purpose of reserves). New York Community Bancorp is a retail bank founded in 1859.

(Sources: Prospectuses PMT-A, TWO-A, SPKEP, NYCB-A. CDx3 Notification Service database,

Tax treatment

When purchasing preferred stock in a non-retirement account, many preferred stock investors will favor shares that are designated as paying Qualified Dividend Income (“QDI” in the Status column of the above table) since QDI dividends are taxed at the more favorable 15 percent tax rate.
If a company pays your dividend out of their after-tax cash (i.e. the company has already paid tax on the cash), you are obligated to pay additional tax on this same money, but at the lower 15 percent rate (this taxing of the same money twice is the “double taxation” of dividends that often serves as a favorite political football).

On the other hand, if the company pays your dividend out of pre-tax earnings, such as the case with REIT preferred stocks (both property REITs and mortgage REITs), the government collects the full tax from you, taxing such dividends as regular income (no tax break).

Looking at the Status column, dividends received from Spark Energy’s SPKEP and New York Community Bancorp’s NYCB-A are a distribution of the company’s after-tax earnings and are therefore designated as being Qualified Dividend Income (see prospectus for exceptions and conditions).

In Context: The U.S. preferred stock marketplace

So how do the new March issues stack up within the context of today’s preferred stock marketplace?

After the Fed’s December 2015 rate hike, market prices of income securities predictably fell, at least for about eight weeks. But throughout 2016, skeptical income investors came to doubt that the rate hike of the previous December was anything more than a one-shot deal; prices shot up shortly thereafter by an average $3.05 per share.

Similarly, anticipating a Q4 2016 hike, sellers started selling their shares in August 2016 with the expected rate hike becoming a reality in December 2016. But notice in the next chart how income investors pushed prices right back up immediately following the December 2016 hike. Income investors were still skeptical of the idea that rate hikes were likely to continue.

That multi-year skepticism ended in March.


On March 15, 2017 the Fed made believers out of income investors. By raising the federal funds rate for the second time within four months, the price increase then underway was cut off at $1.15.  Reminiscent of the Greenspan Fed, back-to-back rate hikes are, in fact, possible once again.

The notion that additional rate hikes are more likely has more credibility with income investors now than it has in several years. If that continues to be the case, seeing another $3 increase in the average market price of U.S.-traded preferred stocks, as we did after the December 2015 rate hike, seems unlikely. With the idea of additional rate hikes now having more creditability, 2017 could bring more favorable pricing to preferred stock buyers.

The average market price of U.S.-traded preferred stocks is now at $25.57 per share, an annualized value increase of 13.8 percent for 2017.

For many months now, two of the most significant contributors to upward price pressure have been (1) continued zero-to-negative rates implemented by foreign central banks and (2) insensitivity by member banks toward changes in the federal funds rate.

Foreign investors continue to be attracted by U.S. income securities since they are facing zero-to-negative rates at home. This foreign demand puts upward pressure on prices here. And U.S. banks are holding over $2 trillion in excess reserve cash - that's above and beyond the elevated 2010 Dodd-Frank requirements. The demand by member banks for overnight loans from the Fed has been, and remains, minimal, rendering changes to the federal funds rate less compelling.

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, 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.

While the continuing strong demand for U.S. preferred stocks can be attributed to several factors, the next chart makes it pretty clear that the lack of attractive alternatives is certainly among them.

U.S.-traded preferred stocks are currently returning an average current yield of 6.5 percent (blue line) while the annual return being offered to income investors by the 10-year treasury is 2.4 percent and that of the 2-year bank CD is a meager 1.6 percent.



For comparison, I have set the Yield column in the first table above to show the current yield of the new March preferreds on March 31.

It is into this marketplace that March’s new issues were introduced.

Income versus Value Investing, Year-To-Date

With an average current yield of 6.5 percent, plus the 13.8 percent annualized value gain, those investing in U.S.-traded preferred stocks since the beginning of 2017 are currently on pace for a total annualized return of 20.3 percent (6.6 percent of which is realized in dividend cash).

Starting at 2252 at the beginning of the year (January 3, 2017 open), the S&P500 common stock value index closed on March 31 at 2363, an unrealized annualized value gain of about 19.7 percent plus about two percent in average annualized dividend yield – a year-to-date annualized gain of about 21.7 percent for common stock investors.










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Preferred Stock Investing, Fifth Edition

Learn how to screen, buy and sell the highest quality preferred stocks


Preferred Stock Investing is one of the highest reader-rated books in the United States with 94 reviews posted at Amazon.

The Fifth Edition addresses selecting, buying and selling the highest quality preferred stocks during the market conditions that we are currently facing.

See: Reviews | Table of Contents | Free Excerpt | Paperback | eBook

The Fifth Edition has 21 chapters organized into six Parts over 334 pages. Here are some highlights:

- Part I, "The Preferred Stock Market," introduces a new suite of charts and metrics specifically designed to measure and track the preferred stock marketplace.

- Part III, "Buying the Highest Quality Preferred Stocks," includes several new chapters such as "Buying 'Fed-Free' Preferred Stocks," "Keeping Up with Increasing Interest Rates" and "Buying Less-Than-Perfect Preferred Stocks."

- And chapter 8, "Managing the Risks," has been completely rewritten and expanded to include risks that are unique to preferred stocks during the increasing rate environment that awaits us.

You can pick up a copy of the new Fifth Edition of Preferred Stock Investing at your favorite online retailer such as Amazon (paperback) or directly from BookLocker, the book's publisher (BookLocker provides paperback and PDF eBook formats).













Recent Preferred Stock Articles by Doug K. Le Du


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The content of this newsletter, and the materials that it links to that are owned by Del Mar Research, LLC, are to be regarded as educational, rather than advisory. There can always be exceptions to trends and/or generalizations that may be presented herein. Consider your financial resources and goals before investing. You, and not Del Mar Research, LLC, are solely responsible for your own investing decisions.