PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, April 2018
Conditions in the U.S.
preferred stock marketplace continue to
favor buyers. Falling prices have delivered
higher dividend rates for new issues and
increasing yields for previously introduced
shares.
Another noteworthy milestone was reached during
April for income investors. Often cited as a
predictor of the dividends to be offered on
newly introduced preferred stock, the 10-year
Treasury note blew through the magic three
percent threshold on April 24 for the first time
since July 2011.
While the extent to which new
preferred stock dividend rates and the 10-year
Treasury yield are related is actually
questionable (see “How
Well Do Government Money Rates Predict Preferred
Stock Dividend Trends?” for correlation
values), there is a certain body of historical
research indicating that when the 10-year moves
above three percent, the risk/reward math starts
to turn away from value (common stock) investors
to favor income investors (bonds, preferred
stocks).
April’s
new issues
April’s four new preferred stocks
are offering an average annual dividend (coupon)
of 6.9 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 $24.58 (April 30), offering an average
current yield of 5.62 percent. And 70 of these
high quality issues are selling below their $25
par value offering an average current yield of
6.0 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).
Buying
new shares for wholesale
Note that ETPPP from Energy
Transfer Partners, L.P. (ETP) is still trading
on the wholesale Over-The-Counter exchange (as
of April 30). This a temporary OTC trading
symbols until this security moves to the NYSE
exchange, 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. ETPPP will become ETP-C.
About
the new issues
The April issues have several
things in common, but each is also unique in its
own way.
OFSSL from OFS Capital
Corporation (OFS) is an 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. OFS is a closed-end management investment
company incorporated as a business development
company. OFS provides primarily debt capital to
middle market companies. OFSSL is unrated and
becomes callable in April 2020, a relatively
short two year call protection period compared
to the more common five years.
ECCX is from Eagle Point Credit (ECC),
offering a 6.6875 percent coupon. Like OFSSL,
ECCY is also an ETDS. Being incorporated as a
management investment company, ECC invests in
equity positions and loan instruments that are
“…unrated or rated below investment grade and
are considered speculative with respect to
timely payment of interest and repayment of
principal.” The company is using the proceeds
from the new ECCX to redeem the outstanding
shares of their 7.0 percent ECCZ. While doing so
does not produce much in the way of an interest
expense savings, it does extend to maturity of
this debt to 2028 from 2020.
SJIU is offered by South Jersey
Industries (SJI), a regulated New Jersey gas
utility founded in 1910. The proceeds from SJIU,
and the company’s concurrent common stock
offering, are being used to fund its pending
acquisition of Elizabethtown Gas and Elkton Gas.
SJIU, April’s only convertible preferred stock,
is the company’s first income security since it
issued SJI-T in 1997 (called in 2003). 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. SJIU is a mandatory convertible
preferred stock with a somewhat unusual $50 par
value.
ETPPP/ETP-C from Energy Transfer
Partners, L.P. is a Ba2/BB rated traditional
preferred stock using the fixed-to-floating
dividend rate structure. With this structure,
this security offers a fixed 7.375 percent
coupon until its May 15, 2023 call date. At that
time, the coupon varies based on the three-month
LIBOR rate (currently 2.32084 percent) plus
4.530 percent. Note that ETP is a limited
partnership, meaning that ETPPP/ETP-C
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. After
completing its merger with a subsidiary of
Sonoco last year, ETPPP/ETP-C is the company’s
only income security currently trading.
Sources: Preferred stock data -
CDx3 Notification Service database,
PreferredStockInvesting.com. Prospectuses
OFSSL,
ECCX,
SJIU,
ETPPP/ETP-C
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 April.
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 (April’s OFSSL and ECCX), 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, none of April’s new
issues pay QDI dividends (otherwise, “QDI” would
appear in the Status column). All of April’s new
issues pay dividends that are taxed as regular
income.
In
Context: The U.S. preferred stock marketplace
The Federal Open Market Committee
is meeting again on May 1 and 2. We’ll see if
they continue to raise interest rates, but given
that household income and personal consumption
are finally increasing for the first time in
many years, another quarter point increase of
the federal funds rate would not be too
surprising.
The following chart illustrates
how increasing interest rates over the last
twelve months have delivered a $1.00 per share
cost savings to today’s preferred stock buyers.
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 that the average
current yield realized by preferred stock since
January has increased by 0.3 percent.
U.S.-traded preferred stocks are currently
returning an average current yield of 6.8
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 2.5 percent.
For comparison, I have set the
Yield column in the first table above to show
the current yield of the new April preferreds on
April 30. It is into this marketplace that
April’s new issues were introduced.
|
to the