PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, June 2016
Preferred stock issuers
continue to take advantage of our low rate
environment and high demand for income
securities. June was a big month for new
preferred stocks, with thirteen new issues
being introduced with an average current
yield of 6.5 percent for the consideration
of preferred stock investors. There are now
901 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 two most
recently introduced issues – GDVVP and NTTNP
- are still trading on the Over-The-Counter
exchange (as of June 30). These are
temporary OTC trading symbols until these
securities move to a big board exchange, at
which time they will receive their permanent
symbols. But there is no need to wait;
during a period of 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).
Your broker will
automatically update the trading symbols of
any shares you purchase on the OTC. GDVVP
will become GDV-G and NTTNP will become
NGHCN.
Diversification
June’s preferred stock
offerings are unique in several ways. First,
eleven of the thirteen new issues are
traditional preferred stocks with RZB from
Reinsurance Group (RGA) and WALA from
Western Alliance Bancorporation (WAL) being
Exchange-Traded Debt Securities. ETDs are
bonds and are recorded on the company’s
books as debt rather than as equity, as in
the case of preferred stocks. As debt, ETDs
pay interest and, unless specified otherwise
in the prospectus (which I have only seen
once several years ago), are cumulative
(meaning that in the event of a skipped
dividend payment, the company still owes you
the money; their obligation accumulates).
Beyond Western Alliance’s new
ETD, WFC-X from Wells Fargo (WFC) was the
only other bank-issued preferred during
June. WFC-X is a large issue, its 40 million
shares raising just under $1 billion.
WFC-X’s dividends are non-cumulative,
allowing the value of this security to be
counted toward WFC’s Tier 1 regulatory
reserves.
June’s offerings also
included three new issues from property
REITS –AMH-E from American Homes 4 Rent
(AMH), their second new issue in as many
months; INN-D from Summit Hotel Properties
(INN); and PEB-D from Pebblebrook Hotel
Trust (PEB). These latter two continue a
trend that we have seen this year with new
preferred offerings from hotel REITs.
Rounding out June’s new
preferreds are KKR-B from KK&R (KKR) and
ARES-A from Ares Management (ARES), both
highly diversified limited partnerships
investing in a variety of businesses; SSW-G
from Seaspan (SSW), a shipping company
headquartered in the Marshall Islands; MINDP
from newcomer Micham Industries (MIND),
which leases scientific equipment to
geo-based industries; VR-A and RZB are from
reinsurers Validus Holdings (VR) and
Reinsurance Group, respectively; NTTNP (soon
to be NGHCN) is from insurer National
General Holding Company (NGHC). GDVVP (soon
to be GDV-G) is a new closed-end fund
offering from Gabelli.
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
qualified 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 the six new preferred stocks
in the above table that have “QDI” in the
Status column are a distribution of the
company’s after-tax earnings and are
therefore designated as being Qualified
Dividend Income, although there are
exceptions and conditions (see prospectus).
About the New Issues
Shortly after the housing
collapse that began in 2008, a group of
senior executives spun away from Public
Storage and formed American Homes 4 Rent
and, using the same capital raising strategy
that they had become accustom to, issued
three new preferred stocks – AMH-A, AMH-B
and AMN-C. With the proceeds, AMH bought
tens of thousands of distressed homes
throughout the U.S. at bargain basement
prices and turned them into rental
properties. These three issues are unique in
that their prospectuses include a provision
that increases these securities’ $25 par
value over time (the amount of the increases
being published on the company’s website).
In the event of a redemption, shareholders
will actually receive more than the stated
$25 par (see “American Homes 4 Rent
Preferred Stocks, Opportunities And Risks”).
Sadly, as with the May introduction of
AMD-D, that par-inflating provision has been
removed from the new AMD-E. Upon redemption,
AMD-E shareholders will receive the stated
par value of $25.
Reinsurance Group’s RZB
offers fixed-to-floating dividends, meaning
that this ETD pays interest at the indicated
coupon rate (5.75 percent) until its call
date (June 15, 2026) then, at that time, the
interest rate becomes variable, resetting
each quarter based on a formula as presented
within this security’s prospectus. The
current 5.75 percent coupon rate will be
reset to the three-month LIBOR rate at the
time (currently 0.63 percent) plus 4.04
percent. Variable rate preferreds usually
also include a minimum rate provision,
should the LIBOR fall through the floor
(usually around 3 or 4 percent). Looking
ahead to the possibility of a negative
LIBOR, the prospectus of RZB sets that
minimum rate at zero percent: “…will bear
interest at an annual rate equal to the sum
of three-month LIBOR, reset quarterly, plus
4.04%; provided that any such sum shall not
be less than zero.”
Preferred stock investors
should be aware that variable rate preferred
stocks have rarely, if ever, benefited
shareholders. While the notion that your
dividend rate will go up with interest rates
sounds great, the fact that the presumably
upward adjustment in the rate is tied to the
call date is no accident. Historically, if
the dividend rate is going to adjust upward,
the issuing company will usually redeem the
shares in order to avoid the increase in
dividend expense. Consequently, those
purchasing fixed-rate preferred stock shares
have earned about 180 percent more than
those purchasing variable-rate preferreds
during the same period (for historical data
see “Variable-Rate Preferred Stocks
Underperform Their Fixed-Rate Cousins”).
(Sources: Prospectuses
ARES-A,
RZB,
MINDP,
PEB-D,
VR-A,
WFC-X,
SSW-G,
WALA,
KKR-B,
INN-D,
AMH-E,
GDVVP,
NTTNP. CDx3 Notification Service
database,
PreferredStockInvesting.com)
In
Context: The U.S. Preferred Stock
Marketplace
So how do the new June issues
stack up within the context of today’s
preferred stock marketplace?
The Brexit vote provided
another example where the forces that move
common stocks are different from those that
move preferred stocks. U.S. common stocks
got clobbered for a couple of days following
the vote due to uncertainty; but with a
known return, preferred stocks offer far
less uncertainty so U.S. preferred stock
prices only fell by an average of $0.14 per
share in response to the Brexit vote (since
recovered and then some).
Demand for these securities
remains very high.
Coupled with the limited
success of the Fed’s efforts to increase the
cost of money, the average market price of
U.S.-traded preferred stocks has increased
by $1.26 per share this year (an annualized
value gain of 10.2 percent), including a
$0.23 increase during June.
The data being charted here
is limited to call-protected issues in order
to limit the price distorting effect of an
anticipated redemption.
Beyond ratings, 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.
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 7.1 percent (blue line) while the annual
return being offered to income investors by
the 10-year treasury is 1.5 percent and that
of the 2-year bank CD is a meager 1.4
percent.
It is into this marketplace
that June’s thirteen new issues were
introduced.
Income versus Value
Investing, Year-To-Date
For comparison, I have set
the Yield column in the first table above to
show the current yield of the thirteen new
June preferreds on June 30. With an average
current yield of 7.1 percent, plus the 10.2
percent annualized YTD 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 17.3
percent (7.1 percent of which is realized in
dividend cash).
Those investing in common stocks, as
measured by the S&P500, have not done as
well this year. Starting at 2012.66, this
common stock value index closed on June 30
at 2098.86, an unrealized annualized value
gain of about 10.3 percent plus about two
percent in average annualized dividend
yield.
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