New Preferred Stock
IPO’s, March 2020
delivered the best buying opportunity to preferred stock investors that
we have seen since 2008. Where value investors (common stock) make
their money from an increase in the market price of their shares (buy
low, sell high), income investors (preferred stocks, bonds) make their
money from the regular dividends that these securities pay. For income
investors, accumulating dividend-paying shares for the best available
price (and lowest risk) is the objective.
Preferred stock prices fell an average of
share during March, delivering higher returns to today’s preferred
stock buyers. The average share price of U.S.-traded preferred stocks
is now $20.37 (March 31), well below these securities’ $25 par value, now delivering an average current yield of 9.1 percent
to today's buyers.
March’s new issue
rates jumping all over every day throughout March, underwriters have
been unable to accurately set the dividend rate to be offered by a new
preferred stock so issuers are holding off for now. Consequently, there
was only one new preferred stock issued during March - FCNCP from First
Citizens Bancshares (FCNCA).
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
underwriters purchased the new shares from the issuing company.
special note regarding preferred stock trading symbols:
Annoyingly, unlike common stock trading symbols, the format used by
and other online quoting services for preferred stock symbols is not
For example, the Series K preferred stock from Public Storage is
TDAmeritrade, Google Finance and several others but this same security
“PSA.PR.K” at E*Trade and “PSA.PK” at Seeking Alpha. For a
table of how preferred stock symbols are denoted by sixteen popular
other online quoting services, see “Preferred
Stock Trading Symbol Cross-Reference Table.”
are currently 123 high quality preferred stocks selling for an average
price of $24.15 (March 31), offering an average current yield of 5.8
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.
is now a total of 910 of these securities trading on U.S. stock
(including convertible preferred stocks).
About the new issue
(FCNCP) is a 12 million share traditional preferred stock offering
non-cumulative 5.375 percent dividends and a Moody’s investment grade
rating of Baa3.
difference between ‘cumulative’ and ‘non-cumulative’ dividends deserves
a bit of amplification during these volatile times. The prospectus of a
preferred stock will generally state, right on page 1, if the dividends
paid to shareholders are cumulative or non-cumulative. Cumulative
dividends must be paid; that is, if the company misses a dividend
payment to you, their obligation to pay you accumulates (they still owe
you the money). Alternatively, with non-cumulative dividends the
company has no such obligation; if they skip a dividend payment to you,
you lose (such as the case with common stock dividends).
the prospectus of a preferred stock will use different, but critically
important, terminology. Rather than use the term “cumulative,” the
prospectus may state that dividends “…may be deferred” (paid later).
Similarly, rather than use the term “non-cumulative,” the document may
state that dividends “…may be suspended” (never paid). The difference
between the word “deferred” and “suspended” can make a huge difference
to preferred stock investors, especially during volatile times.
keep in mind that the “non-cumulative” designation may or may not
indicate additional risk. Preferred stocks issued by banks, such as
FCNCP, provide an example. Prior to the Dodd-Frank Wall Street Reform
Act being signed into law in July 2010, banks were allowed to issue
cumulative preferred stock and count the value of these securities
toward their regulatory reserve requirement (“Tier 1 Capital”). These
are bank reserves that are intended to be used in the case of some type
of emergency. But what good are reserves when someone else (namely
shareholders of the bank’s cumulative preferred stock) has a claim to
the bank’s cash? In order for a bank to count the value of their
preferred stock toward their Tier 1 Capital reserves, those preferred
stock shares must be non-cumulative and pretty much all bank-issued
preferred stock since July 2010 have been.
takes us back to FCNCP which pays non-cumulative dividends. FCNCP is
First Citizens Bancshares’ first and only preferred stock. The bank is
a very profitable $3.5 billion regional bank founded in 1898 operating
through over 500 branches throughout the United States. It would be
hard to argue that their non-cumulative preferred stock dividends
represent a sign of increased risk. Rather, as with other banks, FCNCP
offers non-cumulative dividends because the bank would be irresponsible
to configure this new security any other way.
Preferred stock data - CDx3 Notification Service database,
Preferred Stock Tax treatment
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.
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
paid tax on the cash that is being used to pay you or not? If not, the
going to collect the full tax from you; if so, you still have to pay
at the special 15 percent rate.
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.
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
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
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
In Context: The U.S.
preferred stock marketplace
following chart illustrates the average
market price of U.S.-traded preferred stocks over the last twelve
things affect the market prices of these securities
such as the proximity to their call or maturity date, proximity to
ex-dividend date, industry and/or overall health of the issuer,
direction of interest rates, pending government regulatory or policy
cumulative versus non-cumulative dividends and tax treatment of
payments. So what we really need to look at is current yield, which
the average annual dividend yield per dollar invested (without
re-invested dividend return or any future capital gain or loss).
is a “bang-for-your-buck” measure of value that normalizes differences
coupon rate and price to give us a single, comparable metric.
down the risk scale, the next chart compares the
average current yield realized by today’s preferred stock buyers when
to the yield earned by those investing in the 10-year Treasury note or
bank Certificates of Deposit.
preferred stocks are currently returning an average current yield of
9.1 percent (blue line) while the annual return being offered to income
investors by the 10-year treasury is 0.7 percent and that of the
2-year bank CD is at 1.8 percent.
comparison, I have set the Yield column in the first table above to
show the current yield of the new March preferred on March 31.
this marketplace that March’s new issue was introduced.