PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, October 2018
The U.S. Labor Department
reported on October 31 that the
long-awaited increase in household income is
finally underway with third quarter wages
and salaries jumping by 3.1 percent, the
largest increase in ten years. On that news,
the Fed is more likely than ever to continue
increasing interest rates in an effort to
keep inflation in check. As rates go up,
market prices of fixed-income securities
(preferreds, bonds) come down, creating a
buyer-friendly market for preferred stock
investors.
For preferred stock buyers, the
wage and salary news delivers a triple benefit:
upward pressure on interest rates boosts the
dividends paid by new issues, increasing your
income and lower prices bring not only cash
savings on your share purchases but higher
yields since you earn the same dividend income
without having to invest as much of your cash;
your income, cash balance and yield benefit as
prices return to normal.
Over the last couple of months,
the average market price of U.S.-traded
preferred stocks fell by $0.95 per share, now
sitting at $24.49, creating the best opportunity
for preferred stock buyers that we have seen
since 2016.
Importantly, note that $24.49 is
below these securities’ $25 par value. Remember
that the par value is what shareholders will
receive in cash should the issuing company
decide to redeem your shares so buying shares
below par sets you up for a downstream capital
gain on top of the regular dividend income
provided by these securities.
October’s new issues
October’s seven new preferred
stocks are offering an average annual dividend
(coupon) of 7.0 percent compared to 6.4 percent
from September’s new issues.
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 126 high
quality preferred stocks selling for an average
price of $23.95 (October 31), offering an
average current yield of 5.79 percent. And 89 of
these high quality issues are selling below
their $25 par value offering an average current
yield of 5.74 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 907 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
About
the new issues
BC-A from Brunswick Corporation
(BC) is a double-investment grade
Exchange-Traded Debt Security offering a 6.5
percent coupon (green font in the above table).
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 next time you’re hauling
in a bass from a Boston Whaler or jumping a
double wake behind a Bayliner with a big Mercury
outboard, thank Brunswick. Or while you are
telling exaggerated stories of your greatness
over a game of pool, don’t forget to notice that
the table is almost certainly made by this
company. BC is the Procter and Gamble of
recreational products; there’s very little
outdoor or indoor fun you can have without
coming into contact with something they make.
Established in 1824, this $5.1 billion company
is headquartered in Mettawa, Illinois.
DCP-C from DCP Midstream, LP
(DCP) is a B1/B rated traditional preferred
stock using the fixed-to-floating dividend rate
structure. This is DCP’s second new income
security issued within the last five months.
With this structure, this security offers a
fixed 7.95 percent coupon until its October 15,
2023 call date. At that time, the coupon varies
based on the three-month LIBOR rate (currently
2.39813 percent) plus 4.882 percent. Dividends
from DCP-C 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-C 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.
On October 4, THL Credit, Inc. (TCRD)
introduced TCRW, an unrated ETDS offering a
6.125 percent coupon. $45 million of the $50
million raised by the new security is going to
redeem all outstanding shares of the company’s
TCRX. TCRX, paying 6.75 percent, became callable
last November. While this refinance maneuver
does not deliver a huge interest expense savings
to TCRD, it does push the maturity of $45
million in debt by two years from 2021 to 2023.
TCRD is a business development company providing
debt and equity financing to middle market
companies.
AQNA from Algonquin Power &
Utilities Corp. (AQN) is an ETDS with a BB+
speculative grade rating from S&P. This security
uses the fixed-to-float rate structure, offering
a fixed 6.875 percent coupon until its October
17, 2023 call date. The coupon will then float,
being equal to the then-current three-month
LIBOR rate plus 3.927 percent. Because utilities
have an enormous amount of infrastructural
equipment (and debt on that equipment), I always
find it a bit more challenging to assess their
financials; AQN is no exception. AQN has a
market cap of $4.8 billion, so that’s what
investors are saying the company is worth even
though their balance sheet claims that their
property plant and equipment is worth $6.3
billion with $3.5 billion in long-term debt. And
they only report about $38 million in cash
(explaining their massive negative $211 million
in free cash flow). Throw in the huge seasonal
gyrations in revenue that most utilities
experience and AQN’s recent 25 percent
acquisition of Atlantica, and assessing the risk
of AQNA becomes more of a science project than
most preferred stock investors will be
interested in pursuing. AQN is headquartered
just upstream of Niagara Falls in Oakville,
Ontario.
OFSSZ from OFS Capital
Corporation (OFS) is another Exchange-Traded
Debt Security. OFS is a relatively small
closed-end management investment company
incorporated as a business development company
with a $150 million market cap. OFS provides
primarily debt capital to middle market
companies. OFSSZ is unrated and becomes callable
in October 2020, a relatively short two year
call protection period compared to the more
common five years. OFSSZ is the company’s second
ETDS issued within the last six months. The
company is headquartered in Chicago.
DLNG-B is an unrated, traditional
preferred stock from Dynagas LNG Partners LP
(DLNG) offering 8.75 percent fixed-to-floating
cumulative dividends. This is the company’s
second income security, with DLNG-A introduced
in 2015. The company’s assets are held primarily
in the form of six LNG tankers. The $300 million
company posted declining revenue and negative
profit for the quarter ending June 2018 with
significantly negative cash flow (hence the new
preferred stock). DLNG was founded in 2013 and
is headquartered in Monaco.
PRIF-B is a traditional preferred
stock issued by the Priority Income Fund
offering 6.25 percent cumulative dividends. The
fund is managed by Priority Senior Secured
Income Management, LLC which, in turn, is part
of the Destra Capital Investment, LLC stable. On
their website, the fund’s objectives are stated
in the most non-specific terms possible as
“Priority Income Fund seeks to generate current
income and long-term capital appreciation by
strategically investing in broad pools of senior
secured, floating rate loans made primarily to
U.S. companies. The Fund's goals are to increase
income and portfolio diversification and reduce
correlation to traditional fixed-income assets.”
(make some investments and make some money).
PRIF-B is the fund’s second preferred stock
offering in the last four months with the nearly
identical PRIF-A being issued last June. Neither
Destra nor Priority Senior Secured Income
Management, LLC are publicly traded.
Sources: Preferred stock data -
CDx3 Notification Service database,
PreferredStockInvesting.com. Prospectuses:
BC-A,
DCP-C,
TCRW,
AQNA,
OFSSZ,
DLNG-B,
PRIF-B
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.
Traditional preferred stock
dividends are typically paid out of pre-tax
profits so are taxable as regular income; you
pay the full tax since the company has not
(PRIF-B). The same is true for dividends
received from companies taxed as partnerships
where each partner is responsible for their own
tax obligations (DCP-C).
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).
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 (BC-A, TCRW, AQNA, OFSSZ), 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, only one of October’s
new issues pays QDI dividends (DLNG-B since
Dynagas has elected to be taxed as a corporation
even though it is a partnership).
In
Context: The U.S. preferred stock marketplace
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.
U.S.-traded preferred stocks are
currently returning an average current yield of
6.9 percent (blue line) while the annual return
being offered to income investors by the 10-year
treasury is 3.1 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 October preferreds
on October 31. It is into this marketplace that
October’s new issues were introduced.
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