PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, December 2017
The surge of new preferred stock
issues that we have seen over the last several
months cooled off a bit during December, with
seven new preferred stocks being issued during
the last month of the 2017. December’s seven new
preferred stocks are offering an average
dividend (coupon) of 6.2 percent.
December’s new issues
Here are the seven new issues
introduced during December 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 92 high
quality preferred stocks selling for an average
price of $25.73 (December 29), offering an
average coupon of 5.54 percent and a current
yield of 5.38 percent. And 14 of these high
quality issues are selling below their $25 par
value, providing an average yield-to-call of
7.29 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.
There are now a total of 898 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks), 118 of
which were issued during 2017.
About
the new issues
Three of December’s seven new
preferreds were issued by property REITs, all of
which specialize in retail stores. Three of the
new issues come from investment banks with the
remaining new issue being issued by a Business
Development Corporation.
Property
Real Estate Investment Trusts (pREITs)
VNO-M, SRG-A, KIM-M
REITs come in two flavors –
property REITs and mortgage REITs. While
property REITs make money by owning physical
property and leasing it out, mortgage REITs make
money by investing in residential and/or
commercial mortgages (the idea being to borrow
cash at a low rate and use that cash to buy
mortgages that pay a higher rate).
VNO-M from Vornado Realty (VNO), SRG-A from
Seritage Growth Properties (SRG) and KIM-M from
Kimco Realty (KIM) are all cumulative, perpetual
preferred stocks offering fixed-rate dividends.
“Cumulative” means that if the issuer misses a
dividend payment to you, they still owe you the
money (short of a bankruptcy); their obligation
to you accumulates. “Perpetual” means that the
issuer is not required to ever redeem your
shares (i.e. the shares have no maturity date).
Notice that while the preferreds
from Vornado and Kimco enjoy double-investment
grade ratings from Moody’s and S&P, SRG-A from
Seritage is unrated. SRG-A is Seritage’s first
preferred stock issue.
Eighty percent of Seritage’s
retail properties are occupied by Sears and
Kmart stores. As Sears and Kmart have been
vacating leases, Seritage has been subdividing
these large retail spaces into multiple, smaller
units, hence the need for cash. Sears is
obligated to pay Seritage a lease termination
fee in these cases and as long as Sears has the
cash to meet this obligation, Seritage’s chance
of survival improves. But Seritage has an awful
lot of eggs in one basket.
Banks
WBS-F, COWNZ, RILYG
WBS-F is a traditional, perpetual,
non-cumulative preferred stock from Webster
Financial Corporation (WBS). Like VNO-M and
KIM-M, discussed above, WBS-F offers an
investment grade rating from Moody’s Investors
Service. Webster is a holding company for
Webster Bank. According to its web page, the
company operates 175 banking locations and 350
ATMs throughout the United States. Webster, a
$5.5 billion company (market cap), was founded
in 1935.
COWNZ from Cowen, Inc. (COWN) and
RILYG from B. Riley Financial (RILY), issued one
day apart, are nearly identical Exchange-Traded
Debt Securities, also known as baby bonds. ETDS’
are bonds recorded on the company’s books as
debt (rather than as equity, as in the case of
preferred stock). As debt, the obligation to pay
the interest on these bonds is cumulative. As
bonds, ETDS’ are often seen as having lower risk
than the same company’s preferred stock shares.
ETDS are very similar to preferred stocks and
are often listed on brokerage statements as
such.
Business
Development Corporation
CSWCL from Capital Southwest
Corporation (CSWC) is also an ETDS but differs
from COWNZ and RILYG in some important ways.
Where COWNZ and RILYG become callable in three
years (December 2020), Capital Southwest
re-gains the right to redeem CSWCL shares in
just two years (December 2019). More
significantly, CSWCL matures in five years
(December 2022) while COWNZ and RILYG offer ten
year maturities (December 2027).
Sources: Preferred stock data - CDx3
Notification Service database,
PreferredStockInvesting.com. Prospectuses
VNO-M,
WBS-F,
COWNZ,
RILYG,
SRG-A,
KIM-M,
CSWCL
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.
With that rule in mind, here is
how the tax treatment of December’s seven new
issues plays out.
Companies incorporated as REITs (Vornado,
Seritage, Kimco) 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).
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 (COWNZ, RILYG, CSWCL), 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, dividends received
from Webster’s WBS-F 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 December issues
stack up within the context of today’s preferred
stock marketplace?
For many months now, two of the
most significant contributors to upward price
pressure have been (1) continued very low rates
implemented by foreign central banks and (2)
insensitivity by member banks toward changes in
the federal funds rate. Through July of this
year, preferred stock buyers totally ignored the
Fed’s federal funds rate increases.
But that started to change during early-August
with prices gradually dropping since then.
With the surge of new issues that we have seen
over the last six months (78 of the year’s 118
new issues, 66 percent, were introduced since
July 1), it also appears that issuers are
anticipating upward pressure on rates (which
pushes prices down) over the coming months.
With prices gradually decreasing since
early-August and companies rushing to introduce
new issues, perhaps 2018 will be the year that
we finally see preferred stock prices return to
something closer to their $25 par value.
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 2.4 percent and that of the 2-year
bank CD is a meager 2.0 percent.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new December preferreds
on December 29. It is into this marketplace that
December’s new issues were introduced.
Income versus Value
Investing, Year-To-Date
With an average current yield of
6.5 percent, plus the 4.6 percent annualized
value gain, those investing in U.S.-traded
preferred stocks since the beginning of 2017
have seen a total annualized return of 11.1
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 December 29
at 2674, an unrealized value gain of about 18.7
percent plus about two percent in average
dividend yield – a 2017 gain of about 20.7
percent for common stock investors. The
sustainability of this performance has become
the focus of many common stock investors.
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