PREFERRED
STOCK NEWS
New
Preferred Stock IPO’s, August 2018
Preferred stock prices have
fallen an average of $0.18 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 $25.50, $0.50 per share
above par.
August’s new issues
August’s seven new preferred
stocks are offering an average annual dividend
(coupon) of 6.6 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 123 high quality preferred
stocks selling for an average price of $25.14
(August 31), offering an average current yield
of 5.50 percent. And 52 of these high quality
issues are selling below their $25 par value
offering an average current yield of 5.32
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 900 of
these securities trading on U.S. stock exchanges
(including convertible preferred stocks).
About the new issues
OAK-B from Oaktree Capital Group,
LLC (OAK) carries an investment grade BBB S&P
rating and offers 6.550 percent non-cumulative
dividends. OAK is a $6.2 billion investment
management firm founded in 2007 and
headquartered in Los Angeles. OAK-B is the
company’s second new preferred stock issued
within the last 90 days. Increasing risk
tolerance has pushed up the price of the things
that investment management firms invest in,
sidelining the cash held by the less risk
tolerant. Consequently, OAK’s revenue has shrunk
dramatically over the last year (-33.7 percent),
while it has been a net seller of its investment
assets. Preferred stock investors should also
consider this statement from page S-24 of
OAK-B’s prospectus: “…holders of Series B
Preferred units who are U.S. taxpayers should
anticipate the need to file annually with the
IRS (and certain states) a request for an
extension past the applicable due date of their
income tax return…”
CAI-B, issued by CAI
International (CAI), offers a fixed-to-floating
rate structure, with an 8.5 percent coupon that
is fixed until the security’s August 15, 2023
call date. At that time, the dividend rate will
vary based on the 3-month LIBOR rate (currently
at 2.34825 percent) plus 5.687 percent. CAI-B is
the company’s second preferred stock issued this
year, is unrated, but offers cumulative
dividends. The proceeds from this offering will
go toward paying down 2020 debt. If you find
yourself in need of a couple thousand railcars,
CAI will be happy to either finance your
purchase or sell you some of theirs. CAI is a
$470 million transportation lending and
logistics company (market cap) founded in 1989
and headquartered in San Francisco.
PRS from Prudential Financial,
Inc. (PRU) is the company’s first income
security introduction in over five years. PRU
now has three such securities trading, all of
which are nearly identical Exchange-Traded Debt
Securities. 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. While the
prospectus for PRS does not specifically say so,
it would not be surprising if Prudential uses
the $500 million in PRS proceeds to redeem its
PJH (PJH is also a $500 million issue and became
callable on December 4, 2017). With the new PRS
costing the company 5.625 percent in annual
interest expense, compared to 5.750 percent for
PJH, using the proceeds from PRS to redeem PJH
would not provide much in the way of an expense
savings for the company but would extend the
maturity of this debt by almost six years (to
2058 from 2052).
USB-P from US Bancorp (USB) is
the company’s first preferred stock issue in
five years and offers a 5.5 percent fixed-rate,
non-cumulative dividend. With double investment
grade ratings (A3/BBB), USB-P has been trading
above its $25 par value since its introduction.
Operating in 25 states, USB was a beneficiary of
the credit crisis ten years ago, snapping up
over-leveraged, smaller banks for bargain
prices. Last month the bank announced plans to
aggressively extend its mobile banking platform.
Seventy-five percent of the bank’s service
transactions to check a balance or make a
deposit are done via its mobile app. Extending
mobile banking allows USB to capture new
customers without having to build and staff new
branch offices (of which it currently has over
3,000). US Bancorp is a $90 billion regional
bank founded in 1863.
LTSK is an unrated ETDS offered
by Ladenburg Thalmann Financial Service, Inc. (LTS)
at 7.250 percent. LTS has a total of four income
securities currently trading, one traditional
preferred stock (LTS-A, 8.0 percent) and three
ETDS. LTS-A became callable on May 24 of this
year. While redeeming the 4.6 million shares of
LTS-A would generate a significant savings to
the company, Ladenburg would need a bit over
$100 million in cash to call LTS-A.
Interestingly, the two most recent ETDS, LTSF
(7.0 percent) and the new LTSK (7.25 percent),
were issued less than 90 days apart, with LTSF
raising $40 million last May and the new LTSK
raising $60 million. While neither prospectus
for LTSF nor LTSK says so, issuing the new LTSK
for $60 provides the remaining cash the company
needs to redeem the 8.0 percent LTS-A. Using the
proceeds from LTSF and LTSK to redeem the LTS-A
preferred stock delivers a $2.05 million per
year dividend expense savings to the company.
But this maneuver also converts about $115
million in equity (in the form of LTS-A shares)
into $100 million in debt, weakening the
company’s debt-to-equity ratio. LTS is a highly
diversified financial services firm established
in 1876 and headquartered in Miami.
GAINL from Gladstone Investment
Corporation (GAIN) raises $65 million in gross
proceeds, all of which is being used to redeem
all outstanding shares of GAINO (6.75 percent)
and GAINN (6.50 percent). Offering a 6.25
percent cumulative dividend, GAINL is unrated.
GAINL is a “term preferred stock,” meaning that
it has a specific maturity date. Only about
thirty percent of currently trading preferred
stocks are structured this way. While the
company can redeem GAINL shares on or after the
security’s August 31, 2020 call date, they are
required to do so on the August 31, 2025
maturity date. As a business development
company, GAIN invests in small to mid-cap U.S.
companies with both debt and equity investments.
SAF is an ETDS from Saratoga
Investment Corporation (SAR) with 6.25 percent
annual interest payments, maturing on August 31,
2025. SAF is unrated by either Moody’s or S&P
but has a BBB investment grade rating from
independent rating agency Egan-Jones. Saratoga
is a relatively small business development
company with a market capitalization of only
$185 million. The $35 million raised by the new
SAF represents about twenty percent of the
company’s market value. SAR has two income
securities currently trading both of which are
ETDS with three-year call protection (its other
ETDS, SAB, was issued in December 2016 at 6.75
percent with a call date of December 21, 2019,
maturing in 2023). In general, the company’s
financial stats (profitability, current ratio,
revenue growth, cash flow) look strong, although
the high debt ($200+ million) typically carried
by such companies puts their debt-to-equity
ratio at a whopping 142 (as of May 31, 2018).
Liquidity, as measured by their current ratio
(assets-to-liabilities) is over 4, meaning that
if the company were to liquidate its assets, it
could pay its liabilities four times over.
Sources: Preferred stock data -
CDx3 Notification Service database,
PreferredStockInvesting.com. Prospectuses
OAK-B,
CAI-B,
PRS,
USB-P,
LTSK,
GAINL,
SAF
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
(OAK-B, GAINL). The same is true for dividends
received from partnerships since each partner is
responsible for their own tax obligations.
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 (PRS, LTSK, SAF), 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 August’s new
issues pay QDI dividends (CAI-B and USB-P).
In
Context: The U.S. preferred stock marketplace
With consumer spending up,
household income up, high employment, GDP growth
at an almost unheard of 4.3 percent and consumer
confidence hitting historic highs last week, the
Fed is certain to continue putting upward
pressure on interest rates. Hopefully, their
efforts to do so will soften at least some of
the huge demand that pushed up the prices of
U.S. preferred stocks during August
Despite repeated increases in the
federal funds rate, the average U.S.-traded
preferred stock price has increased by $0.53
from its February 15 low of $24.97. By the end
of August, the average price settled at $25.50
per share.
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.
Even though it is a different
buyer that purchases U.S. treasuries versus
those putting their savings into bank CDs, I
find it very interesting that the 10-year
treasury and the 2-year bank CD reached parity
on August 30. Tying up your money for an
additional eight years now offers the same
return with what many would argue to be the same
risk due to the federal insurance of bank CDs.
U.S.-traded preferred stocks are
currently returning an average current yield of
6.6 percent (blue line) while the annual return
being offered to income investors by the 10-year
treasury is 2.9 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 August preferreds
on August 31. It is into this marketplace that
August’s new issues were introduced.
|
to the