PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, May 2017
Preferred stock investors have
ignored the last two interest rate hikes from
the Federal Reserve. Despite two rate hikes over
the last six months, preferred stock buyers have
pushed the average price of these securities up
by $1.10 per share so far this year, a 10.7
percent annualized value gain for preferred
stock investors. The Federal Reserve’s Open
Market Committee will hold their next two-day
meeting on June 13-14.
May’s new issues
Five new preferred stocks were introduced during
May for the consideration of preferred stock
investors.
There are currently 102 high quality preferred
stocks selling for an average price of $25.73
(May 31), offering an average coupon of 5.60
percent and a yield-to-call of 3.87 percent
(although calls of these relatively low coupon
issues is becoming less likely). And 25 of these
high quality issues are selling below their $25
par value, providing an average yield-to-call of
6.81 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.
But with 25 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.
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 959 of these securities
trading on U.S. stock exchanges (including
convertible preferred stocks).
Buying new shares for
wholesale
Note that the two newest issues –
PBSPP from Public Storage (PSA) and CLNYP from
Colony NorthStar (CLNS) - are still trading on
the Over-The-Counter exchange (as of May 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. PSBPP will become PSA-F (see cautionary
note below) and CLNYP will become CLNS-I.
About the new issues
All five of May’s new issues
offer cumulative dividends, meaning that if the
issuing company skips a dividend payment to you,
they still owe you the money; their obligation
to pay you accumulates.
AI-B from Arlington Asset Investment Corporation
(AI) is the company’s first preferred stock,
although they also have two Exchange Traded Debt
Securities currently trading. AI is a small cap
company ($341 million), making its money by
leveraging their portfolio of primarily
residential mortgage backed securities. Somewhat
uniquely, the company has chosen to not
incorporate as a mortgage REIT. AI-B is a very
small issue of 135,000 shares raising just over
$3 million.
GLOP-A, issued by GasLog Partners LP (GLOP), is
May’s only fixed-to-float security, meaning that
it pays a fixed 8.625 percent dividend until its
June 15, 2027 call date. The rate becomes
variable at that time, calculated by adding 6.31
percent to the then-current three-month LIBOR
rate (currently at 1.17372 percent). GasLog,
founded in 2014 and headquartered in Monaco,
charters its fleet of nine LNG tankers. GLOP-A
is the company’s first and only income security.
With total 2016 gross revenue reported at $229
million, the $125 million raised by GLOP-A
represents about half of this company’s annual
sales volume. Note that GasLog is structured as
a foreign limited partnership. Those considering
buying GLOP-A shares should consult a tax
specialist regarding the taxation and reporting
requirements of income from such securities.
BDXA from Becton Dickson and Company (BDX) is
easily the most complex preferred stock issued
during May. BDXA is a “term, mandatory
convertible preferred stock,” meaning that it
will only trade for a specific term (until its
May 1, 2020 call date) and on that date, the
shares will convert from preferred stock shares
to the company’s common stock shares, the
conversion ratio formula being specified within
the security’s prospectus. Note that this
conversion is mandatory, meaning that the
preferred shares will convert to common shares
whether or not the conversion is beneficial to
shareholders. This security also includes a
provision stating that prior to its May 1, 2020
call date, shareholders may convert their BDXA
shares to BDX common shares at the option of the
shareholder. BDX is a $43 billion (market cap)
medical supply company founded in 1897. BDXA is
the company’s only income security.
The new “Series F” PBSPP is the newest of 14
preferred stocks from Public Storage currently
trading. PSA offers the highest rated preferred
stocks of any U.S. REIT (A3/BBB+), which
explains the miserly 5.15 percent coupon of this
new issue. Typically, PSA uses the proceeds from
a new, lower paying preferred to redeem the
shares of an older, higher payer. But while
three of PSA’s 14 currently-trading preferreds
are redeemable (PSA-S, -T and –U), the new PBSPP
only generates enough cash to redeem the lowest
payer of the group, PSA-U at 5.625 percent. PSA
favors preferred stock issuance over debt to
raise capital. Consequently, over any five-year
call period, the company issues so many
preferred stocks that the NYSE frequently finds
itself having to issue the same trading symbol
for the new security as one that has been
recently redeemed by the company (e.g. PSA-A,
PSA-F). As discussed earlier, PBSPP is a
temporary OTC trading symbol with this Series F
security being destined to become PSA-F in
early-June. But since PSA-F was the symbol used
by a PSA preferred stock introduced in 2005 and
redeemed in 2012, those researching this new
issue should be certain that you are looking at
information for the new security.
CLNYP from Colony NorthStar is an unrated
traditional preferred stock offering a 7.15
percent cumulative dividend. The proceeds from
CLNYP (a 12 million share issue) will be used by
CLNS to redeem two of the company’s older
preferreds – CLNS-A (2.2 million shares
initially issued by NorthStar Realty at 8.75
percent) and CLNS-F (5.2 million shares at 8.5
percent issued by Colony Financial). This move
will leave the company with about $115 million
in left over CLNYP cash plus an annual dividend
expense savings of about $5.6 million. Colony
NorthStar is an $8.3 billion (market cap)
diversified REIT founded in 2009 and invests in
a wide range of commercial and residential real
estate throughout North America and Europe.
(Sources: Prospectuses
AI-B,
GLOP-A,
BDXA,
PBSPP/PSA-F,
CLNYP/CLNS-I. 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 Arlington Asset’s AI-B, GasLog’s GLOP-A and
Becton’s BDXA 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 May issues
stack up within the context of today’s preferred
stock marketplace?
After the Fed’s December 2015 rate hike, market
prices of income securities predictably fell, at
least for about eight weeks. But throughout
2016, skeptical income investors came to doubt
that the rate hike of the previous December was
anything more than a one-shot deal; prices shot
up shortly thereafter by an average $3.05 per
share, all the way to $26.40 per share.
Similarly, anticipating a Q4 2016
hike, sellers started selling their shares in
August 2016 with the expected rate hike becoming
a reality in December 2016. But notice in the
next chart how income investors starting pushing
prices back up immediately following the
December 2016 hike.
On March 15, 2017 the Fed raised the federal
funds rate for the second time within four
months, but income investors remain undeterred.
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 $25.82 per share, an
annualized value increase of 10.7 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.
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 1.6 percent.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new May preferreds on
May 31. It is into this marketplace that May’s
new issues were introduced.
Income versus Value
Investing, Year-To-Date
With an average current yield of
6.5 percent, plus the 10.7 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 17.2 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 May 31 at 2411, an
unrealized annualized value gain of about 16.9
percent plus about two percent in average
annualized dividend yield – a year-to-date
annualized gain of about 18.9 percent for common
stock investors.
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