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PREFERRED
STOCK NEWS
New Preferred Stock
IPO’s, August 2020
August’s
nine new preferred stocks are offering an average annual dividend
(coupon) of 6.7 percent, an average current yield (which does not
consider reinvested dividends or capital gain/loss) of 6.5 percent and
an average Yield-To-Call (which does consider reinvested dividends and
capital gain/loss) of 4.9 percent (using August 31 prices).
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.
A
special note regarding preferred stock trading symbols:
Annoyingly, unlike common stock trading symbols, the format used by
exchanges, brokers
and other online quoting services for preferred stock symbols is not
standardized.
For example, the Series A preferred stock from Public Storage is
“PSA-A” at
TDAmeritrade, Google Finance and several others but this same security
is
“PSA.PR.A” at E*Trade and “PSA.PA” at Seeking Alpha. For a
cross-reference
table of how preferred stock symbols are denoted by sixteen popular
brokers and
other online quoting services, see “Preferred
Stock Trading Symbol Cross-Reference Table.”
There
are currently 125 high quality preferred stocks selling for an average
price of
$26.58 (August 31), offering an average current yield of 5.2
percent.
By high quality I mean preferreds
offering the characteristics that most risk-averse preferred stock
investors
favor such as investment grade ratings and cumulative dividends.
There
is now a total of 940 of these securities trading on U.S. stock
exchanges
(including convertible preferred stocks).
About the new issues
WSBCP
is an unrated traditional preferred stock from WesBanco, Inc. (WSBC)
paying an annual non-cumulative 6.75 percent dividend. This coupon
resets every five years, beginning November 15, 2025, based on the
then-current five-year U.S. treasury rate plus 6.557 percent. November
15, 2025 is also the call date for this security, meaning that the
company re-gains the right to redeem your shares rather than pay a
higher coupon at that time. Like many banks, WesBanco is struggling to
meet the challenges of the pandemic and the effect it has had on its
business. Low interest rates, reduced consumer spending, ballooning
cash on deposit, PPP loans, and uncertain economic trends produced
Q2/2020 Net Income of $4.5 million compared to $44.8 million for
Q2/2019. WesBanco, founded in 1870, is a $1.5 billion (market cap)
regional bank primarily serving the mid-Atlantic states.
UZD
is a speculative grade Exchange-Traded Debt Security from United States
Cellular Corporation (USM) offering 6.25 percent annual interest. UZC
is the only ETDS introduced during August and is the fourth such
security from USM currently trading. ETDS’ are also referred to as baby
bonds and are recorded on the company’s books as debt (rather than as
equity, as in the case of preferred stock). As bonds, ETDS’ are often
seen as having lower risk than the same company’s preferred stock
shares. ETDS’ are very similar to preferred stocks and are often listed
on brokerage statements as such. Unless the prospectus says otherwise,
the interest paid by ETDS’ is cumulative, meaning that in the event the
issuer skips a payment to you they still owe you the money (their
obligation to pay you accumulates). It’s too bad you can’t spend the
same money twice, because that’s the situation USM finds itself it. UZD
raises a net of $484 million with which USM would dearly love to pay
down some of its outsized long-term debt ($2.2 billion as of June 30,
2020, including UZD) and fund the implementation of its 5G network. If
USM does decide to use some of the proceeds from the new UZD to redeem
one of its older, more expensive ETDS, it would probably be UZB which
costs the company 7.25 percent in interest expense and became callable
in December of last year. USM is a $3 billion telecommunications
company founded in 1983 and headquartered in Chicago.
KKR-C
is one of two investment grade (BBB+) preferred stocks among August’s
new issues. KKR-C is offered by KKR and Company, Inc. (KKR), the
company’s third preferred stock currently trading, but its first
convertible. Convertible preferred stocks come in two flavors –
mandatory convertibles where the issuing company determines when your
preferred stock shares will convert to the company’s common stock and
optionally convertibles where the power to convert, or not, is in the
hands of shareholders. KKR-C is a mandatory convertible preferred
stock. The $1.5 billion raised by KKR-C will be used to fund the
company’s acquisition of Global Atlantic Financial Group Limited, a
privately held financial services company. KKR is a $30 billion
financial services company founded in 1976 and headquartered in New
York City.
PSA-M
is a double-investment grade traditional preferred stock from Public
Storage, Inc. (PSA) paying cumulative 4.125 percent dividends. As the
highest rated property REIT in the U.S., earning an A3 rating from
Moody’s and BBB+ from Standard and Poor’s, PSA has adeptly leveraged
those rating to reduce the coupon rates offered by their preferred
stock issues from 5.6 percent (PSA-H issued in February 2019) down to
today’s PSA-M at 4.125 percent. Even at a miserly 4.125 percent, market
participants almost immediately pushed the price of the new PSA-M up
well above its $25 par value. PSA has fourteen preferred stocks
currently trading although two of their older issues were called during
August (PSA-X, 5.2 percent; PSA-W, 5.2 percent). On September 30, 2020
holders of PSA-X and PSA-W shares will receive $25 in cash, plus any
accrued dividends, in exchange for their shares and the shares will
stop trading on that date. PSA is a $36 billion self-storage company
operating throughout the U.S. and Europe.
AGM-F
is an unrated, non-cumulative traditional preferred stock from the
Federal Agricultural Mortgage Corporation (AGM), also known as Farmer
Mac, paying 5.25 percent in annual dividends. Note that because of
government-sponsored enterprise registration exemptions, this security
does not have a prospectus; rather, it is issued via an offering
circular available from Morgan Stanley. This security, AGM’s fifth
currently-trading preferred stock, raised $120 million for the company,
$60 million of which is being used to redeem all outstanding shares of
AGM-A (5.875 percent). AGM was founded in 1987 and serves as a
guarantor of a wide variety of loans to agricultural interests and
rural utilities.
CCNEL/CCNEP
is an unrated, non-cumulative traditional preferred stock from CNB
Financial Corporation (CCNE) offering a 7.125 percent annual coupon.
This is the bank’s first preferred stock issue. The only thing that
strikes me about the prospectus terms of this security is how
un-striking they are. This security is about as ‘vanilla’ as a
bank-issued preferred stock can get. The 7.125 coupon is a bit generous
as reflected by its above-par price. This security began OTC trading
late in the day on Friday, August 21 at $25.75 and, with a brief
exception, has traded above $25 ever since. The dividends paid by this
security are non-cumulative (meaning that if the issuer skips a
dividend payment to you they no longer owe you the money, just like the
case with common stock dividends), but all bank-issued preferred stocks
since the Wall Street Reform Act was signed into law in July 2010 have
been non-cumulative. CNB is a $278 million regional bank with branches
in Pennsylvania, Ohio, and New York and just completed its acquisition
of Bank of Akron in July. The bank was founded in 1865 and is
headquartered in Clearview, Pennsylvania.
OTRKP
is an unrated, traditional preferred stock from medical care provider
Ontrak, Inc. (OTRK). Formed in 2003 as Catasys, Inc. the company
changed its name to Ontrak, Inc. in July 2020. Ontrak is a newcomer to
the preferred stock marketplace with OTRKP being its first preferred
stock introduction. As inducement to investors, beyond this security’s
9.5 percent cumulative annual dividends, the prospectus includes an odd
provision – OTRK has created a segregated account into which they have
deposited the first two years’ worth of dividend cash with the covenant
that the company cannot use that cash for any other purpose other than
to pay those dividends. That pencils out to $8,075,000 of the $40
million in net proceeds raised by the new OTRKP. But Ontrak is in a
high risk business, providing medical treatment to patients using its
artificial intelligence-based PRE (Predict-Recommend-Engage) system
which “…predicts people whose chronic disease will improve with
behavior change, recommends care pathways that people are willing to
follow, and engages people who aren't getting the care they need.” The
company’s common stock has boomed from $9.69 in March, now closing in
on $70.
SABRP
is an unrated preferred stock offered by Sabre Corporation (SABR)
paying 6.5 percent cumulative dividends. SABRP, like KKR-C described
above, is a mandatory convertible preferred stock, with the mandatory
conversion into common shares occurring on September 1, 2023. However,
the prospectus for this security includes a provision allowing
shareholders to convert their shares to SABR’s common shares prior to
the mandatory conversion date, although such a conversion would be
subject to the minimum conversion rate (as defined within the
prospectus). The folks at SABR had a very busy August, simultaneously
issuing this new 3 million share preferred stock (at a $100 per share
par value), 35.7 million new common stock shares with an underwriter
option to purchase another 5.3 million shares and announced their
intent to conduct a private offering of an additional $300 million of
senior secured notes. No specific use for the preferred stock or common
stock cash is provided beyond “…general corporate purposes” (that’s a
lot of purposes). SABR, founded in 2006, is a $2 billion company
providing a variety of software and other technology products to the
travel industry.
DRHPP/DRH-A
is an unrated, traditional preferred stock from DiamondRock Hospitality
Company (DRH) offering 8.25 percent cumulative dividends. DiamondRock
is a hotel REIT, a tough business during the COVID shutdown to be sure.
If you are looking for an excellent indicator of how the COVID economic
recovery is coming along, watch hotel occupancy rates. The hotel
business is starting to show some encouraging signs (green shoots),
starting with “drive-to” properties, then luxury or destination hotels,
following by those catering to business travelers and, lastly, those
appointed for group conventions. In April, 20 of DiamondRock’s 30
hotels were closed but, working with health officials, the company was
able to open 12 more properties by the end of Q2. Starting with their
drive-to properties, weekly occupancy rates went from 6.8 percent at
the end of March to over 42 percent by the end of June. And the average
room rate at many properties is starting to increase as well. DRH’s
drive-to resort at Lake Tahoe boasted 80 percent occupancy during July
with the average rate up about $100 per night over last year to just
over $519 per night. While occupancy has a long way to go until
DiamondRock and many other hotel REITs return to profitability, there
is some reason for optimism. DRH is a $1.1 billion company
headquartered in Bethesda, Maryland.
Sources:
Preferred stock data - CDx3 Notification Service database,
PreferredStockInvesting.com.
Prospectuses:
WSBCP, UZD, KKR-C, PSA-M, AGM-F, CCNEL/CCNEP, OTRKP, SABRP, DRHPP/DRH-A
Preferred Stock Tax treatment
The
2017 Tax Relief Act included a provision aimed at small businesses that
also delivers an enormous benefit to those holding shares of preferred
stocks issued by REITs (which is pretty much all of us). Most small
businesses are incorporated as a Limited Liability Corporation (LLC).
Under this structure, the company’s earnings are passed through to the
owners who then pay the tax on their personal returns. The Act allows
those receiving such income to deduct, right off the top, up to twenty
percent of this “pass-through income.”
But remember that REITs do the same thing as LLC’s – at least 90
percent of a REIT’s earnings are passed to the REIT’s shareholders
primarily in the form of preferred stock dividends; the shareholders
then pay the tax on their personal returns. In other words, preferred
stock dividends received from REITs qualify under the Act’s
“pass-through income” provision and are therefore up to twenty percent
deductible. Such income is reported to you on the 1099 for received
from your broker as “Section 199A” income.
The
tax treatment of the taxable income you receive from income securities
can be a
bit confusing, but it really boils down to one question – Has the
company already
paid tax on the cash that is being used to pay you or not? If not, the
IRS is
going to collect the full tax from you; if so, you still have to pay
tax, but
at the special 15 percent rate.
Unless specified otherwise, traditional preferred stock
dividends, including those paid by partnerships, as pass-through income
or are otherwise paid out of pre-tax profits, are taxable as regular
income; you pay the full tax since the company has not (SABRP).
Companies incorporated as REITs are required to distribute at
least 90 percent of their pre-tax profits to shareholders. Doing so in
the form of non-voting preferred stock dividends is the most common
method of complying and because these dividend payments are made from
pre-tax dollars, taxable dividends received from REITs are taxed as
regular income (PSA-M, DRHPP/DRH-A).
Interest that a company pays to those loaning the company
money is a business expense to the company (tax deductible), so the
company does not pay tax on the interest payments it makes to its
lenders. Since Exchange-Traded Debt Securities are debt, ETDS
shareholders are on the hook for the taxes. Income received from ETDS’
is taxed as regular income (UZD).
Lastly, if a company pays your preferred stock dividends out
of its after-tax profits, the dividend income you receive is taxed at
the special 15 percent tax rate. Such dividends are referred to as
“Qualified Dividend Income” or QDI. QDI preferred stocks are often seen
as favorable for holding in a non-retirement account due to the
favorable 15 percent tax treatment (WSBCP, KKR-C, AGM-F, CCNEL/CCNEP,
OTRKP).
In Context: The U.S.
preferred stock marketplace
The
following chart illustrates the average
market price of U.S.-traded preferred stocks over the last twelve
months.
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.
Moving
down the risk scale, the next chart compares the average current yield
realized by today’s preferred stock buyers when compared to the yield
earned by those investing in a 2-year bank Certificates of Deposit or
the 10-year treasury note.
U.S.-traded
preferred stocks are currently returning an average current yield of
6.8 percent (blue line) while that of the 2-year bank CD is at 0.85
percent and the annual return being offered to income investors by the
10-year treasury is 0.74 percent.
For
comparison, I have set the Yield column in the first table above to
show the current yield of the new preferreds on August 31. It is into
this marketplace that August’s new issues were introduced.
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