PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, July 2018
Preferred stock prices have
fallen an average of $0.50 per share so far
this year, delivering higher returns to
today’s preferred stock buyers. Continuing
upward pressure on interest rates is likely
to put additional downward pressure on
preferred stock prices. But demand for these
securities remains high, keeping the average
market price at $25.36, $0.36 per share
above par.
July’s
new issues
July’s four new preferred stocks
are offering an average annual dividend (coupon)
of 6.5 percent 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.
A special note regarding preferred stock trading
symbols: Annoyingly, unlike common stock trading
symbols, the format used by exchanges, brokers
and other online quoting services for preferred
stock symbols is not standardized. For example,
the Series A preferred stock from Public Storage
is “PSA-A” at TDAmeritrade, Google Finance and
several others but this same security is
“PSA.PR.A” at E*Trade. For a cross-reference
table of how preferred stock symbols are denoted
by sixteen popular brokers and other online
quoting services, see “Preferred
Stock Trading Symbol Cross-Reference Table.”
There are currently 121 high
quality preferred stocks selling for an average
price of $25.08 (July 31), offering an average
current yield of 5.51 percent. And 52 of these
high quality issues are selling below their $25
par value offering an average current yield of
5.33 percent. By high quality I mean preferreds
offering the characteristics that most
risk-averse preferred stock investors favor such
as investment grade ratings and cumulative
dividends.
There are now a total of 901 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
Buying
new shares for wholesale
Note that KYYCP from KeyCorp
(KEY) is still trading on the wholesale
Over-The-Counter exchange (as of July 31). This
is a temporary OTC trading symbols until this
security moves to the NYSE, at which time it
will receive its permanent symbol.
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
if prices drop (if they choose to sell).
Your broker will automatically
update the trading symbols of any shares you
purchase on the OTC. KYYCP will become KEY-J.
About
the new issues
SRE-B from Sempra Energy (SRE) is
July’s only convertible preferred stock. There
are two types of convertible preferred stock –
mandatory convertibles, where the shares will be
converted to some number of shares of the
issuer’s common stock on a specific date and
optionally convertibles, where shareholders have
the option to convert their shares to the
issuer’s common stock (or not). The various
conversion ratios, limitations, timing and
conditions are spelled out in the security’s
prospectus. Southern California Gas is a
subsidiary of Pacific Enterprises which, in
turn, is a subsidiary of Sempra Energy. Sempra
has four preferred stocks trading, including two
issued by Southern California Gas many years
ago. SRE-B, with a par value of $100 per share,
is the company’s second preferred stock issued
this year and offers cumulative dividends (if
the company misses a dividend payment, they
still owe you the money; their obligation to you
accumulates).
ETP-D from Energy Transfer
Partners, L.P. is a Ba2/BB rated traditional
preferred stock using the fixed-to-floating
dividend rate structure and cumulative
dividends. With this structure, this security
offers a fixed 7.625 percent coupon until its
August 15, 2023 call date. At that time, the
coupon varies based on the three-month LIBOR
rate (currently 2.34250 percent) plus 4.738
percent. Note that ETP is a limited partnership,
meaning that ETP-D shareholders will receive a
K-1 at tax time, rather than a 1099 form. The
$21 billion (market cap) company, based in Texas
and founded in 1995, collects and transports
natural gas. ETP-D is the company’s second
preferred stock issued this year.
Bank of America (BAC) was back in
the preferred stock market during June for the
second month in a row with its 5.875 percent
non-cumulative Series HH preferred stock, BAC-K,
raising net proceeds of about $835 million. This
non-cumulative security offers an investment
grade rating from S&P (BBB-). The proceeds from
last month’s mega preferred, BAC-B, were used to
redeem several older issues and the same is true
of this month’s BAC-K. In a July 26 press
release, BAC announced that it will be redeeming
all outstanding shares of BML-I (6.375 percent,
originally issued by Merrill Lynch) and BAC-D
(6.204 percent).
KYYCP/KEY-J from KeyCorp (KEY)
offers an investment grade rating (Baa3 from
Moody’s) and a somewhat miserly 5.650 percent
fixed dividend. This security is similar to
BAC’s BAC-K in many ways, but its comparatively
low coupon probably explains why buyers have
been discounting the pricing of the new KEY
issue since its introduction on July 24. As with
BAC-K, the dividends for KYYCP/KEY-J are
non-cumulative. KEY has one other preferred
stock trading, issued in 2016 at 6.125 percent.
Most recently, KEY sold its insurance business
to USI Insurance, producing a gain of $78
million on the sale. The bank also noted during
July that its 2016 acquisition of First Niagara
Financial Corp. has finally produced the hoped
for $450 million annualized cost savings.
KeyCorp was founded in 1849 and is headquartered
in Cleveland.
Sources: Preferred stock data -
CDx3 Notification Service database,
PreferredStockInvesting.com. Prospectuses
SRE-B,
ETP-D,
BAC-K,
KYYCP/KEY-J
Tax
treatment
The tax treatment of the income
you receive from income securities can be a bit
confusing, but it really boils down to one
question – Has the company already paid tax on
the cash that is being used to pay you or not?
If not, the IRS is going to collect the full tax
from you; if so, you still have to pay tax, but
at the special 15 percent rate.
Companies incorporated as REITs
are required to distribute at least 90 percent
of their pre-tax profits to shareholders. Doing
so in the form of non-voting preferred stock
dividends is the most common method of complying
and because these dividend payments are made
from pre-tax dollars, dividends received from
REITs are taxed as regular income (i.e. they do
not qualify for the special 15 percent dividend
tax rate). The same is true for dividends
received from partnerships since each partner is
responsible for their own tax obligations
(ETP-D).
Interest that a company pays to
those loaning the company money is a business
expense to the company (tax deductible), so the
company does not pay tax on the interest
payments it makes to its lenders (i.e. interest
payments made to lenders are paid with pre-tax
dollars). Since Exchange-Traded Debt Securities
are debt, ETDS shareholders are on the hook for
the taxes. Income received from ETDS’ is taxed
as regular income.
Lastly, if a company pays your
preferred stock dividends out of its after-tax
profits, the dividend income you receive is
taxed at the special 15 percent tax rate. Such
dividends are referred to as “Qualified Dividend
Income” or QDI. QDI preferred stocks are often
seen as favorable for holding in a
non-retirement account due to the favorable 15
percent tax treatment. Looking at the Status
column in the above table, three of July’s new
issues pay QDI dividends (SRE-B, BAC-K,
KYYCP/KEY-J).
In
Context: The U.S. preferred stock marketplace
After an initial $0.25 spike
upward in early-July, U.S. preferred stock
prices came right back down throughout the rest
of the month, providing some price relief to
today’s buyers by ending slightly lower. Since
most U.S.-traded preferred stocks offer a fixed
dividend, paying less for your shares delivers
an increase in your rate of return in addition
to the cash savings. The price settled at $25.36
per share, down $0.17 from the month’s high.
The following chart illustrates
the average market price of U.S.-traded
preferred stocks over the last twelve months.
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.
Moving down the risk scale, the
next chart compares the average current yield
realized by today’s preferred stock buyers when
compared to the yield earned by those investing
in the 10-year Treasury note or 2-year bank
Certificates of Deposit. Note how the lower
prices seen since January in the above chart
have pushed up the current yield being earned by
today’s preferred stock investors.
U.S.-traded preferred stocks are
currently returning an average current yield of
6.7 percent (blue line) while the annual return
being offered to income investors by the 10-year
treasury is 3.0 percent and that of the 2-year
bank CD has recovered nicely to 2.8 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.
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