PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, January 2017
Since the Fed started raising the
federal funds rate in December, the U.S.
preferred stock market has been offering today’s
buyers the best prices (and therefore yields)
that we have seen since last spring.
There are currently 114 high quality preferred
stocks selling for an average price of $24.77
(January 31), offering an average yield-to-call
of 5.70 percent. And 57 of these high quality
issues are selling below their $25 par value. 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 prices have been edging back up since the
beginning of the year as the impact of the Fed’s
December rate increase has started to wear off.
I’ll compare market reaction of the December
2016 rate increase to that of December 2015 in a
moment, but U.S. preferred stock prices
increased an average of $0.59 per share during
January.
January’s new issues
With upward pressure on rates, we
typically see fewer new preferred stock issues
and January was no exception. Only three new
preferred stocks were introduced for the
consideration of preferred stock investors
during January. But with 57 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 879 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 most recently
introduced issues – PNYLP from Pennsylvania REIT
(PEI) and MSDDP from Morgan Stanley (MS) - are
still trading on the Over-The-Counter exchange
(as of January 31). These are temporary OTC
trading symbol 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. PNYLP will become PEI-C and MSDDP will
become MS-K.
Diversification
While few in number, January’s
three new issues are from diversified issuers.
Medley LLC is an operating company held by
Medley Management, Inc. (MDLY). Medley is
primarily in the commercial lending business,
raising capital from investors that it then
loans to commercial borrowers. MDLQ, at 7.250
percent maturing on January 30, 2024, is
actually an Exchange-Traded Debt Security
(indicated by green font in the above table).
ETDS are very similar to preferred stocks and
are frequently labeled as such on brokerage
statements, but are actually bonds recorded on
the company’s books as debt rather than equity.
MDLQ is the second new income security
introduced by Medley LLC since last August, when
it issued MDLX at 6.875 percent. Both are
unrated.
PNYLP (soon to be PEI-C) offers a
7.200 percent coupon and is Pennsylvania REIT’s
first income security since 2012. Founded in
1960, PEI owns and operates a variety of
shopping malls throughout the Eastern United
States. PNYLP is the company’s largest new
issuance to-date, raising about $150 million,
about 50 percent more than its prior two issues.
As with PEI’s prior issues, PNYLP offers
cumulative dividends (if they miss a payment,
they still owe you the money; their obligation
accumulates). With Sears on the brink, and
Macy’s not far behind, shopping mall property
REITs are having to be increasingly creative as
online shopping continues to weigh heavily on
foot traffic. For their part, PEI sold two
non-core malls in January, generating $49
million.
MSDDP (soon to be MS-K) is Morgan
Stanley’s first income security since 2014,
offering a 5.850 percent non-cumulative
dividend. MSDDP continues a trend we have seen
with income securities offered by banks over the
last three years where the dividend rate is
fixed until the call date (5.850 percent until
April 15, 2027 in this case), but becomes
variable after that, pegged to the three-month
LIBOR plus 3.491 percent (currently 1.039
percent). Buyers should be cautious of this
structure since, while sounding especially
attractive during a period of increasing rates,
issuers will frequently call the shares on the
call date if not doing so means increasing their
dividend expense to shareholders (see “Variable-Rate
Preferred Stocks Underperform Their Fixed-Rate
Cousins”).
(Sources: Prospectuses
MDLQ,
PNYLP/PEI-C,
MIDI/MS-K. CDx3 Notification Service
database,
PreferredStockInvesting.com)
Tax
Treatment
Dividends paid by REIT preferred
stocks, such as January’s PNYLP from
Pennsylvania REIT, 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 qualify 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
Morgan Stanley’s MSDDP are a distribution of the
bank’s after-tax earnings and are therefore
designated as being Qualified Dividend Income (“QDI”
in the Status column of the above table),
although there are exceptions and conditions
(see prospectus).
In Context: The U.S.
Preferred Stock Marketplace
So how do the new January issues
stack up within the context of today’s preferred
stock marketplace?
As illustrated in this chart, preferred stock
investors have been reacting to the December
2016 rate increase in very much the same way as
they did to the December 2015 hike. Anticipating
a Q4 hike, sellers started selling their shares
in August of both years. But as multiple,
ongoing increases became less likely, prices
started bouncing back up.
The data being charted here
is limited to call-protected issues in order
to limit the price distorting effect of an
anticipated redemption.
The average market price of U.S.-traded
preferred stocks is now at $25.17 per share,
an annualized increase of 28.8 percent for
January. But even with January’s price hike,
U.S. preferred stock prices are still at
their lowest level since last spring,
presenting a strong market for today’s
income investors.
Will
it last?
The upward pressure on rates
that began last August has clearly started
to weaken, putting upward pressure on
preferred stock prices.
Two of the most significant headwinds that
are keeping rates from rising, and
contributing to increasing preferred stock
prices, are (1) continued zero-to-negative
rates implemented by foreign central banks
and (2) insensitivity by member banks toward
changes in the federal funds rate.
Because of the
zero-to-negative rates set by their central
banks, foreign investors have been moving
record amounts of cash into U.S. income
securities for many months (see “Here’s why
10-year Treasury may still drop below 1%“),
putting upward pressure on prices here. If
anything, the U.S. income security market
has become even more attractive to such
foreign investors.
Secondly, remember that the
federal funds rate is the rate that member
banks are charged when they need to borrow
some cash overnight to pump up their
reserves in order to meet regulatory
requirements. U.S. banks have over $2
trillion in excess reserve cash - that's
above and beyond the elevated 2010
Dodd-Frank requirements (see “Fed Worries
About Deflation But Pays Banks Billions Not
To Lend QE Proceeds”). The demand by member
banks for overnight loans from the Fed has
been, and remains, minimal, so fiddling with
the federal funds rate does not have
anything like the lasting impact it used to.
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.
U.S.-traded preferred stocks
are currently returning an average current
yield of 6.6 percent, down from 6.8 percent
at the end of December.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the three new January
preferreds on January 31.
It is into this marketplace that January’s new
issues were introduced.
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