PREFERRED
STOCK NEWS
Preferred
Stock Market Q3/2015: Investment Grade
Preferred Stocks Available Below $25
Income investors
are focused like a laser on the Fed and its
interest rate deliberations with those holding
unrated shares (i.e. those that offer no Moody’s
rating) being much quicker to bail out as the
threat of a rate hike approached on September
17.
Preferred stock buyers view a period of falling
prices as a time to buy more dividend-paying
shares while price speculators applying value
investing strategies to an income investment
generally view such a period as a time to sell.
Call-Protected
U.S.-traded Preferred Stocks
As we approached
the Fed’s September 17 FOMC rate announcement,
the average market price of call-protected
U.S.-traded preferred stocks (rated and unrated)
started to fall, bottoming out at $24.73 per
share on September 15.
Buyers jumped back
in throughout the third week of the month once
it became known that there would be no increase
in the federal funds rate just yet.
Not to be deterred, those fearing a September
rate hike turned their gaze toward the next Fed
meeting, coming up on October 27-28 and started
selling again at month-end. The average market
price of rated plus unrated, call-protected
preferred stocks ended Q3 at $24.56 per share,
down $0.18 for September and down $0.43
throughout the quarter.
The Preferred Stock
Market, Q3/2015
As controversial
as creditworthiness ratings have been, preferred
stock investors who hold rated shares tend to
hold them with a tighter grip than those who
hold unrated shares.
This Preferred Stock Market Snapshot™ chart
depicts the preferred stock marketplace at the
end of Q3/2015 using two characteristics that
are usually high on the list of considerations
for risk-averse preferred stock investors -
current market price (above and below these
securities' $25 par value) and investment risk
(as reflected by investment grade versus
speculative grade Moody's ratings).
Each diamond
represents a Moody's-rated preferred stock. The
sweet spot of the preferred stock marketplace is
depicted in the green lower-left quadrant -
investment grade preferreds selling for a market
price below their $25 par value.
While there are currently 896 preferred stocks
trading on U.S. stock exchanges, 304 meet the
criteria listed under the chart. The arrow in
the table below the chart points to the
migration that we have seen over the last three
months. As prices of Moody’s-rated preferreds,
as a group, have increased since the end of Q2,
the percentage of the market occupied by
investment grade securities that are priced
below $25 has fallen to 18 percent, down from 25
percent.
Holding all of the
other criteria listed under the chart constant,
the average ending-Q3 market price of securities
without a Moody’s rating ended the quarter at
$23.56 (not shown) compared to $25.35 for the
Moody’s-rated shares depicted in the chart.
Those holding unrated shares were willing to
accept $1.79 per share less in order to exit
their positions at the end of Q3.
(Source: CDx3 Notification Service database,
PreferredStockInvesting.com)
What Does $25 Buy?
The purple
diamonds on the above chart identify one
preferred stock from each quadrant that is
selling for about $25 (not to be taken as
recommendations): JPM-G, THGA, VNO-I and NSS.
These four securities provide a sense for what
$25 buys in today’s preferred stock marketplace.
Note that for
comparison purposes, I have selected Current
Yield (CY) for the Yield column rather than
Yield-To-Call (YTC) or Effective Annual Return
(EAR) since VNO-I has exceeded its call date (YTC
and EAR are not able to be calculated in such
cases). Securities shown in green font (THGA and
NSS) are exchange-traded debt securities.
JPM-G is a traditional preferred stock and was
introduced by JP Morgan (JPM) in May of this
year at 6.1 percent. It pays non-cumulative
dividends, rather than interest, so those
dividends are designated as Qualified Dividend
Income, taxed more favorably (see “Are
Lower Tax Preferred Stock Dividends Really A
Better Deal?”, December 2, 2014). Not
callable until September 2020, at $24.96 JPM-G
offers a Yield-To-Call (now shown) of 6.2
percent.
THGA is an
exchange-traded debt security from Hanover
Insurance Group (THG). ETDs are actually bonds
that trade on the stock exchange and are very
similar to preferred stocks (and may actually be
listed as such on your brokerage statement). As
a bond, your quarterly proceeds are interest,
rather than dividends, and therefore are taxed
as regular income. At $25.20, THGA offers a YTC
of 6.02 percent (not shown).
VNO-I is a
traditional preferred stock from Vornado Realty
(VNO), a retail and office property REIT. Issued
in August 2005 with a five-year call period,
this security became callable on August 31,
2010. VNO-I pays cumulative dividends that are
not QDI designated. Market participants have
started pricing VNO-I as if the likelihood of a
call is very high; the
saw tooth price pattern typical of such
cases kicked in last spring for this security.
VNO-I now trades close to its Positive Return
Line throughout each quarter (see “Another
Principal Protection Strategy For Today's
Preferred Stock Investors”, February 19,
2014).
NSS is an ETDs
introduced by NuStar Logistics LP (a master
limited partnership in the oil pipeline
business) in January 2013, becoming callable on
January 15, 2018. As a bond, NSS pays interest
that is taxed as regular income. At $24.79 per
share, NSS provides a YTC of 8.03 percent. The
coupon structure of NSS is “fixed-to-floating”,
meaning that it has a fixed coupon of 7.625
percent until its January 15, 2018 call date. At
that point, the coupon rate changes each quarter
to the sum of the three-month LIBOR rate plus
673.4 basis points (see “Variable-Rate
Preferred Stocks Underperform Their Fixed-Rate
Cousins”, November 12, 2013).
These four
securities, one from each of the four key
quadrants depicted by the Preferred Stock Market
Snapshot™ chart, are from four vastly different
companies but are being very similarly priced by
today’s preferred stock investors.
(Sources: VNO-I
price chart, MarketWatch.com. SEC prospectus
filings for
JPM-G |
THGA |
VNO-I |
NSS)
What’s next?
Falling prices is
great news for preferred stock buyers, but not
so much for those who have treated an income
investment using value investing strategies. For
the last several years, as prices have been
artificially propped up by the Fed’s monetary
policy, I have issued frequent reminders to use
the wholesale Over-The-Counter stock exchange
for new purchases (see “Preferred
Stock Buyers: Time To Change Tactics For Sub-$25
Purchases”, July 14, 2014). Doing so has
allowed preferred stock buyers to purchase newly
introduced preferred stock shares for sub-$25
wholesale prices; these are the same shares that
those who waited to use the retail NYSE paid a
much higher price for.
But the advantage
of using the OTC will erode as retail prices
continue to fall and sub-$25 shares become more
widely available; the difference between
wholesale OTC prices and retail NYSE prices will
continue to diminish just as they did during the
third quarter of 2015.
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