PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, May 2018
The upward pressure on
interest rates that has been building for
some time now continues to deliver benefits
to preferred stock investors. For the first
time since November 2016, there were
multiple investment grade preferred stocks
issued during May paying 6+ percent
dividends.
May’s new issues
May’s five new preferred stocks
are offering an average annual dividend (coupon)
of 6.8 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 120 high
quality preferred stocks selling for an average
price of $24.80 (May 31), offering an average
current yield of 5.57 percent. And 60 of these
high quality issues are selling below their $25
par value offering an average current yield of
5.51 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 895 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
About
the new issues
Bank of America (BAC) started off
the month’s new offerings with its 6.0 percent
non-cumulative Series GG preferred stock, BAC-B,
with an investment grade BBB- rating from S&P.
BAC-B is a massive issue raising $1.2 billion
and allows BAC to redeem all outstanding shares
of BAC-I (6.625%), MER-P (7.375%), CFC-B (7.0%)
and a partial redemption of BAC-D (6.20%). MER-P
and CFC-B were two of the last Big Bank Trust
Preferred Stocks, issued prior to the global
credit crisis when BAC was “required to
volunteer” to acquire Countrywide and Merrill
Lynch. Finally getting clear of the related
litigation, these two securities will stop
trading on June 6 followed by BAC-I on July 2.
DCP-B from DCP Midstream, LP (DCP) is a B1/B
rated traditional preferred stock using the
fixed-to-floating dividend rate structure. With
this structure, this security offers a fixed
7.875 percent coupon until its June 15, 2023
call date. At that time, the coupon varies based
on the three-month LIBOR rate (currently 2.35375
percent) plus 4.919 percent. Dividends from
DCP-B are cumulative meaning that if the company
misses a dividend payment to you, they still owe
you the money (their obligation to pay you
accumulates). Note that DCP is a limited
partnership, meaning that DCP-B shareholders
will receive a K-1 at tax time, rather than a
1099 form. The $6 billion (market cap) company,
based in Denver and founded in 2005, collects,
sells and transports natural gas.
NBR-A is offered by Nabors Industries Ltd.
(NBR), a $2.5 billion onshore and offshore oil
and gas drilling company headquartered in
Bermuda and founded in 1952. The proceeds from
this unrated offering, together with an
accompanying common stock offering, are being
used to repay debt, converting debt into equity
on the company’s balance sheet. NBR-A, May’s
only convertible preferred stock, is the
company’s first income security and pays
cumulative dividends. 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. NBR-A is a
mandatory convertible preferred stock with a
somewhat unusual $50 par value.
OAK-A from Oaktree Capital Group, LLC (OAK)
carries an investment grade BBB S&P rating and
offers 6.625 percent non-cumulative dividends.
OAK is a $6.2 billion investment management firm
founded in 2007 and headquartered in Los
Angeles. OAK-A is the company’s first preferred
stock issue raising gross proceeds of $180
million.
RILYH from B. Riley Financial (RILY) is an
unrated Exchange-Traded Debt Security, also
referred to as a baby bond. 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.
The proceeds from RILYH will go toward RILY’s
acquisition of magicJack VocalTec, a company
that manufactures a voice over IP telephone
device. RILY has four ETDS’ trading with RILYH
being the company’s third ETDS issued within the
last eleven months.
A special note this month: There’s a new ETDS
from Unum Group (UNM) with an IPO date of May 21
that, as of May 31, has yet to start trading (so
is not shown on the above list of May IPO’s).
Its trading symbol has yet to be assigned, but
underwriting closed on May 30 so this new
security should start trading within the next
few days. Unum Group’s new ETDS offers a 6.25
percent coupon and a Baa3 investment grade
rating from Moody’s Investors Service. According
to the prospectus for this security, UNM will
use the $289 million net proceeds from this
offering to “…repay, redeem or repurchase $200
million aggregate principal amount of our 7%
Senior Notes due 2018.” UNM, an $8.2 billion
insurer founded in 1848 and headquartered in
Chattanooga, offers a wide variety of insurance
products throughout the U.S. and the U.K.
Sources: Preferred stock data - CDx3
Notification Service database,
PreferredStockInvesting.com. Prospectuses
BAC-B,
DCP-B,
NBR-A,
OAK-A,
RILYH,
Unum ETDS
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). There
were no REIT-issued preferred stocks during May.
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 (May’s RILYH and Unum), 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, two of May’s new
issues pay QDI dividends (BAC-B and NBR-A).
In
Context: The U.S. preferred stock marketplace
The Federal Open Market Committee
is meeting again on June 12 and 13 and is widely
expected to continue to raise the federal funds
rate. Doing so puts upward pressure on the
dividends paid by newly introduced income
securities (preferred stocks, bonds), treating
today’s preferred stock buyers to a long overdue
income boost.
Further, upward pressure on rates puts downward
pressure on the prices of previously issued
lower-payers, creating additional buying
opportunities for income investors.
The following chart illustrates the effect of
the Fed’s rate increases on 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 2.8 percent and that of the 2-year
bank CD has recovered nicely to 2.6 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.
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