PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, February 2017
While the Fed’s December 2016
rate hike brought great prices to preferred
stock buyers, preferred stock prices have
been edging back up, increasing an average
of $0.35 per share during February. So far
this year, the average market price of
U.S.-traded preferred stocks is up $0.80, an
annualized increase of 19.4 percent.
There are currently 111 high quality preferred
stocks selling for an average price of $25.12
(February 28), offering an average yield-to-call
of 5.59 percent. And 49 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.
February’s new issues
Uncertainty with respect to the
future direction of the cost of money will often
cause preferred stock issuers to take a
wait-and-see approach to introducing new issues.
While we frequently saw 10 or more new issues
per month a year ago, only two new preferred
stock issues were introduced during February
(following January’s three IPOs). Both of
February’s new preferred stocks are unrated.
But with 49 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 959 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
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 new issues –
PKRDP from Parker Drilling (PKD) and CIMEP from
Chimera Investment Corp. (CIM) - are still
trading on the Over-The-Counter exchange (as of
February 28). 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. PKRDP will become PKDP and
CIMEP will become CIM-B.
About
the new issues
PKRDP (soon to be PKDP) is the
first preferred stock issued by Parker Drilling,
its 500,000 shares raising about $50 million
(gross) for the company. This issue has a
somewhat rare $100 par value and offers 7.25
percent cumulative dividends (if they miss a
payment, they still owe you the money; their
obligation accumulates). This is a mandatory
convertible preferred stock, meaning that these
preferred stock shares will convert to the
company’s common shares on the preferred share’s
maturity date of March 31, 2020 (subject to
several conditions specified in the prospectus).
Parker was established in 1934 and provides
drilling equipment and services to the oil and
gas industry, both domestically and
internationally. The drop in oil prices over the
last couple of years, along with the dilutive
introduction of additional common shares, has
seen Parker’s common stock lose about two-thirds
of its value since January 2014.
CIMEP (soon to be CIM-B) is Chimera’s second
preferred stock issue in less than five months,
its CIM-A security issued last October 6. CIM is
a mortgage REIT, meaning that rather than owning
physical properties as a property REIT would,
Chimera seeks to generate earnings from the
spread between yields on its investments and its
cost of borrowing. Its investments are bundles
of mortgages (residential and commercial), many
of which can be long-term in nature.
Consequently, during periods of increasing
interest rates, the shorter-term cost of
borrowing tends to increase while revenues tend
to be locked in at lower rates for longer
periods of time. This math often squeezes the
earnings of mortgage REITs, requiring nimble
management of their investment portfolio (often
moving toward bundles of variable rate and/or
shorter-term mortgages). CIMEP offers a fixed
8.0 percent cumulative dividend until its March
30, 2024 call date, at which time its dividend
rate will float to equal the three-month LIBOR
rate (currently at 1.034 percent) plus 5.791
percent.
(Sources: Prospectuses
PKRDP/PKDP,
CIMEP/CIM-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 Parker Drilling’s PKRDP 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 February issues
stack up within the context of today’s preferred
stock marketplace?
As illustrated by this chart, preferred stock
investors have been reacting to the December
2016 rate increase in very much the same way
that 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 $25.52 per share, an
annualized increase of 16.7 percent for
February.
Will it last?
The upward pressure on rates that
began last August has clearly started to weaken,
putting upward pressure on preferred stock
prices.
For many months now, 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.
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.
U.S.-traded preferred stocks are
currently returning an average current yield of
6.57 percent, falling 0.07 percent since the end
of January.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new February preferreds
on February 28.
It is into this marketplace that February’s new
issues were introduced.
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