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PREFERRED
STOCK NEWS
New Preferred Stock
IPO’s, October 2019
In anticipation of a drop in rates, preferred stock buyers
continued to push up the prices of previously issued higher payers. As
the month came to a close, the average market price for all U.S.-traded
preferred stocks was $26.02 per share, up $0.09 per share over the last
month.
Octobers’s new issues
October’s
thirteen new preferred stocks are offering an average annual dividend
(coupon) of 6.1 percent, an average current yield (which does not
consider reinvested dividends or capital gain/loss) of 6.0 percent and
an average Yield-To-Call (which does consider reinvested dividends and
capital gain/loss) of 5.9 percent (using October 31 prices).
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 and “PSA.PA” at Seeking Alpha. 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 125 high quality preferred stocks selling for an average
price of $26.35 (October 31), offering an average current yield of 5.3
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
is now a total of 927 of these securities trading on U.S. stock
exchanges
(including convertible preferred stocks).
About the new issues
As
the Fed once again lowered the federal funds rate on October 30,
feeding at the low-rate preferred stock trough continued throughout
October with 13 new issues to consider. One thing that struck me about
October’s crop was the quality of the issues – four are offering
investment grade ratings from Moody’s, three have double-investment
grade ratings, and three of these new issues are actually
Exchange-Traded Debt Securities. As bonds (recorded on the company’s
books as debt), ETDS’ often offer a lower risk profile than the same
company’s preferred stock (equity).
DLR-L
is a traditional preferred stock offered by Digital Realty (DLR) with
an investment grade rating from Moody’s Investors Service. DLR has six
preferred stocks trading on U.S. stock exchanges, although it may use
the proceeds from the 12 million new shares of DLR-L (5.2 percent) to
redeem all 9 million outstanding shares of DLR-G (5.875 percent). DLR-G
became callable on April 9, 2018. DLR is incorporated as a property
REIT specializing in data centers with properties throughout North
America, Europe, Asia and Australia. With cloud and mobile computing
demand pushing expansion, the company has announced a joint venture
with Mitsubishi, purchasing a five-acre parcel in Tokyo upon which it
will build a new data center hub. DLR-L pays cumulative dividends.
PRIF-E
is an unrated traditional preferred stock issued by the Priority Income
Fund offering 6.375 percent 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-E is the fund’s fourth preferred
stock offering in the last twelve months. While the prior two
securities offered non-cumulative dividends, the new PRIF-E’s dividends
are cumulative. Neither Destra nor Priority Senior Secured Income
Management, LLC are publicly traded (no common stock).
RILYP
from B. Riley Financial (RILY) is an unrated traditional preferred
stock offering a 6.875 percent coupon. RILYP is the company’s eighth
income security offered within the last three years, its third this
year. The company’s other seven currently-trading income securities are
Exchange-Traded Debt Securities (baby bonds) while the new RILYP is the
company’s first preferred stock. B. Riley always strikes me as a
company that has a hard time saying no. Its most recent acquisition was
that of magicJack VocalTec, a company that manufactures a voice over IP
telephone device. The $519 million company is in a multitude of
businesses from financial services, retail store liquidation, internet
domain and email hosting and, now, magicJack. Founded in1973, B.Riley
is headquartered in Woodland Hills, California.
NYMTM
is an unrated traditional preferred stock from New York Mortgage Trust
(NYMT) paying 7.875 percent cumulative annual dividends. NYMT has four
preferred stocks currently trading on U.S. stock exchanges, the most
recent two of which use the fixed-to-float dividend structure. With
this structure, the security’s coupon rate is fixed (7.875 percent in
the case of the new NYMTM) until the security’s call date (January 5,
2025) at which time the rate becomes variable based on the three-month
LIBOR rate (currently at 1.94 percent) plus 6.429 percent. Page S-18 of
the prospectus specifies how the coupon rate will be calculated in the
event the LIBOR rate becomes unavailable. NYMT is a $1.6 billion
residential mortgage REIT based in New York City and established in
2003.
YCBD-A
is an unrated, optionally convertible traditional preferred stock
issued by cbdMD, Inc. (YCBD) offering 8.0 percent cumulative dividends,
paid monthly. Convertible preferred stocks come in two flavors –
optional and mandatory. An optional preferred stock is one that can be
converted to the issuing company’s common stock at the option of the
shareholder (although significant conditions and restrictions on the
timing and conversion ratio typically apply). Mandatory convertibles,
on the other hand, are converted to the issuer’s common stock at a
certain point in time and/or under certain conditions whether you want
them to or not. Convertibles are typically issued by relatively new,
and relatively speculative, companies with the idea being that the
preferred shares provide them cash now which the company will
presumably use to develop that Next Big Thing, making their common
stock skyrocket, providing untold wealth and greatness for all of those
who had purchased the preferred shares in the early days (or not).
cbdMD is a $105 million company founded in 2015 and produces
marijuana-based products. An interesting but risky way to stumble into
the ground floor of what could become a significant opportunity
(dude!). But note that YCBD-A has failed to reach its $10 par value
since its October 11 introduction (indicating overly gleeful, and
perhaps impaired, judgement of what the market would pay $10 for by the
security’s underwriters).
AEFC
is an ETDS from Dutch insurer AEGON (AEG) and is one of three ETDS’
introduced during October. ETDS’ are classified as debt so, by
definition, their dividends are actually cumulative interest (taxed as
regular income). AEFC is one of three income securities from AEGON, the
first since 2005, and offers a 5.1 percent coupon with
double-investment grade ratings (Baa1/BBB). This security is
call-protected until December 15, 2024.
EFC-A
is from Ellington Financial, Inc. (EFC), offering 6.75 percent
‘fixed-to-float’ cumulative dividends. The 6.75 percent coupon rate is
fixed until the security’s October 30, 2024 call date at which time the
rate floats based on a formula equal to the three-month LIBOR rate plus
5.196 percent. Page S-11 of this security’s prospectus describes how
the rate will be calculated in the event that the LIBOR rate becomes
unavailable. EFC-A is Ellington’s first, and only, preferred stock
offering. Ellington is a mortgage REIT, meaning that they raise capital
(such as with a new preferred stock offering) and use that cash to
purchase bundles of mortgages that, hopefully, pay a higher rate than
the cost of the capital used to buy them, the spread becoming gross
profit. Ellington was founded in 2007 and is headquartered in Old
Greenwich, Connecticut.
FDUSG,
like AEFC discussed above, is also an ETDS although FDUSG is unrated.
FDUSG offers 5.375 percent annual interest and is issued by Fidus
Investment Corporation (FDUS). The $53 million in net proceeds from
FDUSG are being used to pay down debt under the company’s Credit
Facility, under which it currently owes $62.5 million. While the 5.375
percent annual interest expense that comes with FDUSG is a higher rate
than the company is incurring on its Credit Facility, using the
proceeds from FDUSG to pay down the Credit Facility has several
benefits, including shifting the risk of default from the company’s
lender to the stock buying general public (that’s us). FDUS has three
ETDS trading, the most recent two of which were both introduced in
2019. FDUS is a business development company investing in U.S.-based
companies.
GLADL
is an ETDS from Gladstone Capital Corporation (GLAD), the company’s
second ETDS introduced within the last 12 months. Both of Gladstone’s
ETDS’ become callable a mere two years after their IPO dates, which is
an extremely quick trigger. Almost certainly, this very short call
protection is likely due to the company anticipating that interest
rates will continue to fall and they want to be in a position to issue
a new ETDS a couple of years from now at a lower rate and use the
proceeds to redeem one or both of their two current issues. According
to the prospectus of GLADL, the company is planning on using the
proceeds from this new issue to pay down a chunk of the $118.6 million
it owes under its Credit Facility. Interestingly, the Credit Facility
costs the company a rate calculated as the 30-day LIBOR (currently at
1.82 percent) plus 2.85 percent. Put another way, Gladstone just issued
an ETDS costing them 5.375 percent in order to pay down debt costing
them 4.67 percent (Seattle School District new math?). While this math
may suggest that Gladstone executives may have enjoyed a research road
trip to cbdMD headquarters, my guess is that the company is faced with
a debt maturity timing issue here and had little choice. Gladstone is a
$295 million private equity venture capital investment company.
CIMXP
is an unrated optionally convertible traditional preferred stock from
Cimarex Energy Company offering 8.125 percent fixed-rate dividends.
This is a very odd security in several ways so I’m not going to spend
much time on it. Issues: It has a $1,000 par value and only one trade
has been recorded since its October 17 introduction – 100 shares at
$1,295; the prospectus does not specify a call date whatsoever; usually
the “Definition of terms” section of a prospectus takes up about two
pages but the prospectus for CIMXP introduces so many terms with
special meanings that it gets it down in seven pages; while CIMXP is an
temporary OTC wholesale symbol, the prospectus does not state what the
symbol will become once retail trading (NYSE) begins; and the
conversion terms span six pages with six different algebraic formulas.
As I read the prospectus (written by lawyers for lawyers), I kept
hoping that it would get better – and I have read thousands of
preferred stock prospectuses over the last 15 years – but it just
doesn’t. I’m sure they were thinking of something very lofty when this
document was crafted, but the wisdom behind this security’s structure
is far from obvious. CIMXP is the company’s first, only and hopefully
last income security.
CFG-E
is from regional bank Citizens Financial Group (CFG) and offers 5.0
percent fixed-rate dividends. This security has a speculative-grade BB+
rating from S&P. As with all traditional preferred stocks issued by
banks since July 2010, this security’s dividends are non-cumulative.
With cumulative dividends, shareholders are still owed any dividends
that are skipped when due; dividends of cumulative preferred stock can
be “deferred” while those of non-cumulative preferred shares can be
“suspended” outright (watch for these key words in prospectuses). The
Dodd-Frank Wall Street Reform Act correctly (but unfortunately for us)
determined that bank reserves aren’t really any good if holders of
cumulative preferred stock shares have a claim to the cash, so all
bank-issued preferreds since July 2010 have been non-cumulative. CFG-E
is the company’s second new preferred stock introduced this year. CFG
is a $16 billion regional bank founded in 1828 and headquartered in
Providence, Rhode Island.
PSPBZ/PSB-Z
is a traditional preferred stock from property REIT PS Business Parks,
Inc. PSB preferred stocks command double-investment grade ratings
(Baa2/BBB), which allows the company to offer new income securities at
miserly coupons, such as this security’s 4.875 percent. PSB is one of
the offshoots of Public Storage’s management genius Ron Havner, now
retired. Havner was an amazing CEO and mentor to his management teams
for many years, growing Public Storage to the global self-storage
standard, primarily using preferred stock issues for capital, and is
now the highest-rated property REIT in the United States. For several
years, Havner also served as CEO of spin-off PS Business Parks,
specializing in office buildings and other commercial real estate.
Another successful Havner-inspired spin-off is American Homes 4 Rent
(AMH), founded and managed to this day by a group of former Havner
Public Storage executives. PSB is using the proceeds from PSPBZ to
redeem all outstanding shares of two older, higher-paying preferred
stocks – PSB-U (5.75 percent) and PSB-V (5.70 percent) – saving the
company about $8.2 million per year in dividend expense.
NTREL/NTRSO
from Northern Trust Corporation is a traditional preferred stock paying
non-cumulative 4.7 percent dividends. NTREL is one of three October
issues that offer double-investment grade ratings (Baa1/BBB+), hence
the paltry 4.7 percent coupon. With downward pressure on interest
rates, how inflation and taxes affect net returns from low-paying
income securities starts to become more important. Annual inflation is
running at about two percent, so that has to come right off the top of
the 4.7 percent paid by this security. And if you buy these shares in a
taxable account, the tax needs to be subtracted from whatever is left.
NTRS is going to use the proceeds from the new NTREL to redeem all
outstanding shares of NTRSP, a 5.85 percent security that became
callable on October 1. Northern Trust is a $21 billion international
financial institution founded in 1889 and headquartered in Chicago.
Sources:
Preferred stock data - CDx3 Notification Service database,
PreferredStockInvesting.com.
Prospectus:
DLR-L, PRIF-E, RILYP, NYMTM, YCBD-A, AEFC, EFC-A, FDUSG, GLADL, CIMXP, CFG-E, PSPBZ/PSB-Z, NTREL/NTRSO
Preferred Stock Tax treatment
The
2017 Tax Relief Act included a provision aimed at small businesses that
also delivers an enormous benefit to those holding shares of preferred
stocks issued by REITs (which is pretty much all of us). Most small
businesses are incorporated as a Limited Liability Corporation (LLC).
Under this structure, the company’s earnings are passed through to the
owners who then pay the tax on their personal returns. The Act allows
those receiving such income to deduct, right off the top, up to twenty
percent of this “pass-through income.”
But remember that REITs do the same thing as LLC’s – at least 90
percent of a REIT’s earnings are passed to the REIT’s shareholders
primarily in the form of preferred stock dividends; the shareholders
then pay the tax on their personal returns. In other words, preferred
stock dividends received from REITs qualify under the Act’s
“pass-through income” provision and are therefore up to twenty percent
deductible. Such income is reported to you on the 1099 for received
from your broker as “Section 199A” income.
The
tax treatment of the taxable 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.
Unless
specified otherwise, traditional preferred stock dividends, including
those paid by partnerships, as pass-through income or are otherwise
paid out of pre-tax profits, are taxable as regular income; you pay the
full tax since the company has not (RILYP, YCBD-A, CIMXP, PRIF-E).
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, taxable dividends received from REITs are taxed as regular
income (DLR-L, NYMTM, EFC-A, PSPBZ/PSB-Z).
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. Since
Exchange-Traded Debt Securities are debt, ETDS shareholders are on the
hook for the taxes. Income received from ETDS’ is taxed as regular
income (AEFC, FDUSG, GLADL).
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 (CFG-E, NTREL/NTRSO).
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
6.4
percent (blue line) while the annual return being offered to income
investors
by the 10-year treasury is 1.8 percent and that of the 2-year bank CD
has turned
the yield curve upside down at 2.3 percent (shorter term money very
rarely
offers a higher return than longer term money).
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 30. It
is
into
this marketplace that October’s new issues were introduced.
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