PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, June 2017
Preferred stock investors have
ignored the last three interest rate hikes from
the Federal Reserve. Despite three rate hikes
over the last seven months, preferred stock
buyers have pushed the average price of these
securities up by $1.23 per share so far this
year, a 10.0 percent annualized value gain for
preferred stock investors.
June’s new issues
Eight new preferred stocks were
introduced during June for the consideration of
preferred stock investors, the most robust
monthly offerings so far this year.
There are currently 100 high quality preferred
stocks selling for an average price of $25.92
(June 30), offering an average coupon of 5.60
percent and a current yield of 5.40 percent. And
16 of these high quality issues are selling
below their $25 par value, providing an average
yield-to-call of 6.04 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.
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 now a total of 955 of these securities
trading on U.S. stock exchanges (including
convertible preferred stocks).
Buying new
shares for wholesale
Note that the two newest issues –
CMMPP from Compass Diversified Holdings (CODI)
and PNNMP from PennyMac Mortgage (PMT) - are
still trading on the Over-The-Counter exchange
(as of June 30). 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. CMMPP will become CODI-A
and PNNMP will become PMT-B.
About
the new issues
RILYZ from B. Riley Financial (RILY)
is the company’s second income security offering
within the last seven months, their RILYL being
introduced last November. While June’s RILYZ
raised over twice the capital as last November’s
RILYL ($52.5 million versus $25 million,
respectively), the two securities are nearly
identical – both are Exchange-Traded Debt
Securities (baby-bonds, so pay cumulative
interest), offer a 7.5 percent coupon, are
unrated and use the same quarterly interest
payment schedule. Founded in 1973, B. Riley is a
financial services company, offering a wide
variety of services to commercial and high net
worth clients throughout the U.S. and Europe.
OXLCM, an unrated traditional
preferred stock offering cumulative dividends,
was introduced by Oxford Lane (OXLC) with a 6.75
percent coupon in early June. OXLCM’s 2.5
million shares raised just over $60 million but
brings with it a $4.2 million annual dividend
expense obligation. The company is using about
$28 million of the OXLCM proceeds to redeem all
1.12 million outstanding shares of their older
OXLCN. While the new OXLCM delivers a dividend
cost savings per share over the older OXLCN, the
new OXLCM was issued for twice the number of
shares, increasing the company’s annual dividend
expense by about $2 million. From their website
“Oxford Lane Capital Corp. is a publicly-traded
registered closed-end management investment
company. It currently seeks to achieve its
investment objective of maximizing total return
by investing in securitization vehicles which,
in turn, primarily invest in senior secured
loans made to companies whose debt is rated
below investment grade or is unrated.”
NGL-B from NGL Energy Partners LP
(NGL) is probably the most complex security
among June’s new offerings. NGL, a newcomer to
the preferred stock market, is a limited
partnership so owning shares of its equity
securities, such as NGL-B, has tax and reporting
consequences to shareholders (see tax advisor).
Further, this security has the fixed-to-floating
rate structure meaning that its coupon rate
starts out at a fixed 9.0 percent until its July
1, 2022 call date. At that time, NGL-B becomes a
variable rate security with its coupon equal to
the then-current three-month LIBOR rate
(currently at 1.21806 percent) plus 7.213
percent. Buyers should remember that having this
variable rate structure kick in on the day the
security becomes redeemable is not an accident.
Historically, issuers will frequently redeem the
shares if the coupon adjustment is going to
result in a significantly increased dividend
expense.
MH-D, a traditional preferred
stock issued by Maiden Holdings (MHLD) on June 8
at 6.7 percent, is one of three June preferred
stocks that are rated by S&P, offering a BB
rating. MH-D’s 6 million shares raised about
$150 million for the company. With the
introduction of the new MH-D, Maiden Holdings
redeemed all outstanding shares of their 8.0
percent MHNB baby bond on June 27, leaving the
company with five remaining income securities
trading on U.S. stock exchanges. Since MHNB, now
redeemed, was an Exchange-Traded Debt Security,
this maneuver converted $100 million of MHNB
debt into equity on the company’s books,
improving its debt-to-equity ratio. Maiden is a
property and casualty insurance company founded
in 2007 and domiciled in Bermuda.
VR-B from Validus Holdings (VR)
is one of two investment grade preferred stocks
offered during June (Baa3/BBB-). This
non-cumulative traditional preferred stock
offers a 5.8 percent coupon and is almost
identical in its terms to the company’s VR-A
security offered at 5.875 percent a year ago
except that the new VR-B is substantially larger
(raising $250 million versus VR-A’s $150
million). VR is a holding company for an array
of subordinate companies (including Validus
Reinsurance, Ltd., Talbot Holdings Ltd., Western
World Insurance Group, Inc. and AlphaCat
Managers, Ltd.) most of which are in the
reinsurance or direct insurance business.
Validus was founded in 2005 and, like Maiden
Holdings, is domiciled in Bermuda.
SCE-L, a double-investment grade
trust preferred stock paying 5.0 percent
cumulative dividends, is issued by Southern
California Edison, a subsidiary of Edison
International (EIX). The 19 million shares of
SCE-L raises $475 million, all of which will be
used to redeem all outstanding shares of the
older 5.625 percent SCE-F on July 19.
CMMPP/CODI-A, offered by Compass
Diversified Holdings (CODI) at 7.25 percent, is
an unrated traditional preferred stock paying
non-cumulative dividends. Similar to NGL, CODI
is a master limited partnership so owning shares
of its equity securities, such as CMMPP, has tax
and reporting consequences to shareholders (see
tax advisor). The $100 million proceeds from
CMMPP will largely go toward paying down the
company’s debt in the wake of its June 2017
agreement to acquire Crosman Corporation
(sporting equipment). Compass acquires and
manages small to middle market U.S. businesses
with stable and growing cash flows. The company
was founded in 2005 and is headquartered in
Connecticut.
PNNMP/PMT-B issued by PennyMac
Mortgage (PMT), is the company’s second
preferred stock issue this year, raising a net
of $170 million on June 27. As a mortgage REIT,
PennyMac does not own physical property; rather,
PMT 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
(8.0 percent in the case of the new PNNMP) 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. In PennyMac’s case, this mechanism can
be amplified since the company specializes in
distressed mortgage loans for its revenue.
(Sources: Prospectuses
RILYZ,
OXLCM,
NGL-B,
MH-D,
VR-B,
SCE-L,
CMMPP/CODI-A,
PNNMP/PMT-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 MH-D, VR-B and SCE-L 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 June 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.
On June 14, the Fed’s Open Market
Committee raised interest rates for the third
time in seven months. And, for the third time in
seven months, preferred stock buyers reacted
with a collective yawn.
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 $25.95 per share, an
annualized value increase of 10.0 percent for
2017.
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.
Foreign investors continue to be
attracted by U.S. income securities since they
are facing zero-to-negative rates at home. This
foreign demand puts upward pressure on prices
here. And U.S. banks are holding over $2
trillion in excess reserve cash - that's above
and beyond the elevated 2010 Dodd-Frank
requirements. The demand by member banks for
overnight loans from the Fed has been, and
remains, minimal, rendering changes to the
federal funds rate less compelling. Coming out
of their June meeting, however, the Fed
announced that it will launch a new program to
deal with these excess reserves. If successful,
doing so should make federal funds rate
adjustments more effective.
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
6.5 percent (blue line) while the annual return
being offered to income investors by the 10-year
treasury is 2.2 percent and that of the 2-year
bank CD is a meager 1.7 percent.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new June preferreds on
June 30. It is into this marketplace that June’s
new issues were introduced.
Income
versus Value Investing, Year-To-Date
With an average current yield of
6.5 percent, plus the 10.0 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 16.5 percent (6.5 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 June 30 at
2423, an unrealized annualized value gain of
about 15.2 percent plus about two percent in
average annualized dividend yield – a
year-to-date annualized gain of about 17.2
percent for common stock investors.
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