PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, July 2017
Preferred stock investors have
ignored the last three interest rate hikes from
the Federal Reserve. Despite three rate hikes
since December 2016, preferred stock buyers have
pushed the average price of these securities up
by $1.39 per share so far this year, a 9.6
percent annualized value gain for preferred
stock investors.
July’s new issues
New preferred stock introductions
continue to be robust. After June’s eight new
offerings, seven new preferred stocks were
introduced during July for the consideration of
preferred stock investors.
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.
There are currently 97 high quality preferred
stocks selling for an average price of $26.09
(July 31), offering an average coupon of 5.60
percent and a current yield of 5.35 percent. And
12 of these high quality issues are selling
below their $25 par value, providing an average
yield-to-call of 5.42 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.
There are now a total of 953 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
Buying
new shares for wholesale
Note that the two newest issues –
ANNPP from Annaly Capital (NLY) and VLYYP from
Valley National Bancorp (VLY) - are still
trading on the Over-The-Counter exchange (as of
July 31). These are temporary OTC trading
symbols until these securities move to the NYSE,
at which time they will receive their permanent
symbols.
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. ANNPP will become NLY-F and VLYYP will
become VLY-B.
About the new issues
With the exception of VLYYP, none
of July’s new issues are rated. And again with
the exception of VLYPP, all offer cumulative
dividends, meaning that if the company skips a
dividend payment, their obligation to pay you
accumulates; they still owe you the money. In
such a case, short of a bankruptcy, the company
is prohibited from paying dividends to their
common stock shareholders until all accumulated
dividends owed to their preferred stock
shareholders have been paid.
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 (AMH) 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. With the new AMH-G, the company now
has seven income securities trading. These
issues are unique in that their prospectuses
include a provision that allows shareholders to
participate in any appreciation of these rental
homes over time. Called the “Home Price
Appreciation Amount,” these securities’ $25 par
value increases over time as published on the
company’s website (a variety of exceptions,
limitations and conditions may apply). In the
event of a redemption, shareholders can actually
receive more than the stated $25 par (see “American
Homes 4 Rent Preferred Stocks, Opportunities And
Risks”).
$50 million of the proceeds from
the new TPVY from TriplePoint Venture Growth BDC
Corporation (TPVG) are being used to redeem all
outstanding shares of the company’s older TPVZ
security. Doing so saves the company about
$500,000 in annual interest expense with about
$15 million in cash left over. Both the old TPVZ
and the new TPVY are Exchange-Traded Debt
Securities, which are bonds recorded on the
company’s books as debt. As such, these “baby
bonds” pay interest, rather than dividends,
which is therefore taxed as regular income.
TriplePoint is incorporated as a Business
Development Company, investing in “venture
growth stage businesses.”
TWO-B from Two Harbors Investment
Corporation (TWO) is the company’s second
preferred stock offering within the last four
months. While their Series A security was
introduced with an 8.125 percent coupon in March
at 5.75 million shares, the new TWO-B is
composed of a relatively huge 11.5 million
shares for the consideration of preferred stock
investors. Interestingly, the coupon rates of
these two issues, issued a mere four months
apart, illustrates an oddity currently playing
out within the U.S. preferred stock marketplace
– during a period of increasing interest rates,
prices, which normally move opposite the
direction of rates, have continued to rise as
well, putting downward pressure on yields. It is
this current oddity that has allowed TWO to
issue the new Series B at a substantially lower
coupon rate than their Series A just four months
ago. As a mortgage REIT, TWO does not own
physical property; rather, the company 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.
CCI-A from Crown Castle
International (CCI) was introduced to help fund
the company’s pending merger with Lightower
Acquisition for $7.1 billion in cash. Crown
Castle, a $37 billion company (market cap) with
$14 billion in debt, owns an impressive network
of wireless communications infrastructure that
is leased out to wireless carriers. CCI-A, with
a $1,000 par value, is aimed at institutional
and commercial investors. This security, raising
$1.5 billion, represents significant risk to CCI
if the Lightower merger cannot be finalized by
its June 29, 2018 deadline. Note too that this
security is a mandatory convertible preferred
stock, meaning that on the security’s August 1,
2020 call date, these preferred stock shares
will convert to the company’s common shares (see
prospectus for conversion terms and rates).
UMH-C from UMH Properties (UMH)
is one of three preferred stocks currently
trading from this company. 3.6 million of the
new UMH-C’s 5 million shares will be used to
redeem the company’s UMH-A, an 8.25 percent
preferred stock originally offered in May 2011.
Doing so delivers an annual dividend expense
savings of $1.4 million to UMH. After having
gone five years without introducing a new
preferred stock (its Series A to its Series B),
the new UMH-C is the company’s second new
offering in the last fifteen months. UMH is a
property REIT and is somewhat unique within the
U.S. preferred stock marketplace in that it owns
and operates manufactured home communities,
leasing manufactured home sites to private
owners of manufactured homes. UMH is a $500
million company (market cap) founded in 1968.
Of the four preferred stocks that
Annaly Capital currently has trading, the new
ANNPP/NLY-F is the company’s largest by far. At
28 million shares, this security has raised
about $700 million for NLY. About $200 million
of these proceeds will go to redeem their 7.875
percent NLY-A. The company has announced no
plans to redeem any of their other three
preferreds, even though the new NLY-F leaves
them with plenty of cash to do so. According to
Annaly’s press release, the remaining $500
million will go to “…acquire targeted assets
under the Company’s capital allocation policy,
which may include further diversification of its
investments in Agency assets as well as
residential, commercial and corporate credit
assets.” Like TWO-B, this security offers a
fixed-to-float rate, meaning that it pays a
fixed 6.95 percent coupon until its September
30, 2022 call date. At that time, the coupon
rate becomes variable, pegged to the 3-month
LIBOR rate (currently 1.30072 percent) plus
4.993 percent.
VLYYP/VLY-B from Valley National
Bancorp (VLY) is the only rated preferred stock
to be introduced during July, albeit a
lackluster BB+ from S&P. Founded in 1927, the
bank operates 209 branches primarily in New York
and Florida, making it virtually unknown to the
rest of the country. VLYYP is the company’s
second preferred stock offering, with VLY-A
introduced at 6.25 percent in 2015. As with most
recent bank-issued preferreds, VLYYP pays
non-cumulative dividends with a fixed-to-float
rate structure. This security pays a 5.5 percent
dividend until its June 30, 2022 call date. At
that time, the coupon rate will be pegged to the
3-month LIBOR rate plus 3.578 percent.
(Sources: Prospectuses
AMH-G,
TPVY,
TWO-B,
CCI-A,
UMH-C,
ANNPP/NLY-F,
VLYYP/VLY-B. CDx3 Notification Service
database,
PreferredStockInvesting.com)
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 VLYYP 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 July issues
stack up within the context of today’s preferred
stock marketplace?
We’re all taught that during a
period of increasing rates the market prices of
fixed-return securities (bonds, preferred
stocks) will tend to decrease, moving in the
opposite direction of rates.
But 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.
As they have since the Fed started raising rates
in December 2016, preferred stock buyers
continued to totally ignore today’s upward
pressure on rates throughout July.
Demand for U.S.-traded preferred stocks has
remained high, as indicated by the continuation
of increasing prices, despite the rate hikes.
The average market price of U.S.-traded
preferred stocks is now at $26.11 per share, an
annualized value increase of 9.6 percent for
2017.
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
6.4 percent (blue line) while the annual return
being offered to income investors by the 10-year
treasury is 2.3 percent and that of the 2-year
bank CD is a meager 1.8 percent.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new July preferreds on
July 31. It is into this marketplace that July’s
new issues were introduced.
Income versus Value
Investing, Year-To-Date
With an average current yield of
6.4 percent, plus the 9.6 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 16.0 percent (6.4 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 July 31 at 2470, an
unrealized annualized value gain of about 16.6
percent plus about two percent in average
annualized dividend yield – a year-to-date
annualized gain of about 18.6 percent for common
stock investors.
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