PREFERRED
STOCK NEWS
New Preferred Stock
IPO’s, January 2020
Given the lousy alternatives for income investors, demand for
U.S.-traded preferred stocks remains very high, pushing up the prices
of these securities, and issuers are taking full advantage. Upward
pressure on prices pushes down the dividend rate (coupon) for new
preferred stock issues, allowing issuers to use the proceeds from a new
lower-payer to redeem the outstanding shares of an older, higher-payer.
We saw several such maneuvers by issuers throughout January.
Specifically, the average market price of U.S.-traded
preferred stocks increased by $0.26 per share during January. This
price increase pushed down the average current yield to today’s buyers
by 0.08 percent, now at 6.3 percent.
January’s new issues
January’s
seven new preferred stocks are offering an average annual dividend
(coupon) of 5.5 percent, an average current yield (which does not
consider reinvested dividends or capital gain/loss) of 5.5 percent and
an average Yield-To-Call (which does consider reinvested dividends and
capital gain/loss) of 5.3 percent (using January 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 123 high quality preferred stocks selling for an average
price of
$26.59 (January 31), offering an average current yield of 5.2
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 918 of these securities trading on U.S. stock
exchanges
(including convertible preferred stocks).
About the new issues
SOJD
is a $1 billion Exchange-Traded Debt Security from Southern Company
(SO). ETDS’ are also referred to as baby bonds and are 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. SOJD pays 4.95 percent annual interest, offering
double-investment grade ratings (Baa3/BBB). About half of the proceeds
from SOJD are being used by Southern Company to pay off short-term
debt. SOJD is the company’s fourth ETDS issued within the last four
years (SOJA, at 6.25 percent, becomes callable this coming October 15).
SO is a $72 billion regulated electric utility operating primarily in
the southern United States. The company was founded in 1945 and is
headquartered in Atlanta, Georgia.
MET-F
is a double-investment grade (Baa2/BBB) traditional preferred stock
from MetLIfe (MET) paying non-cumulative 4.75 percent dividends.
Non-cumulative, as opposed to cumulative, dividends mean that if the
company misses a dividend payment to you, they have no obligation to
pay you later (dividends paid by common stock, for example, are also
non-cumulative). MET-F is a 40 million share issue with a $25 par
value, raising $1 billion for MET. While MET-F is the company’s third
preferred stock that is publicly traded, the company’s MET-C, with a
5.25 percent dividend, is privately placed and became callable last
September. The prospectus for the new MET-F indicates that the company
is likely to use the proceeds from the new MET-F, plus cash on hand, to
redeem outstanding shares of MET-C. MetLife is a $47 billion life
insurance company founded in 1868.
WFC-Z
is a massive 70 million share, $1.75 billion traditional preferred
stock from Wells Fargo and Company (WFC) offering 4.75 percent
double-investment grade dividends. The share count is important here
because WFC has four older preferred stock issues currently trading
that have reached their call dates and pay a higher coupon than the new
WFC-Z. As much as I’m sure WFC would like to call all four, the new
WFC-Z, as large as it is, only raises enough cash to redeem the shares
of three of these older issues (although they could redeem the fourth
with cash on hand). The four redemption candidates are WFC-N, 5.200
percent 27m shares; WFC-O, 5.125 percent 24m shares; WFC-P, 5.250
percent 23m shares; and WFC-T, 6.0 percent 28m shares. If you own any
of these four WFC preferred stocks, watch for a redemption notice from
your broker.
TRTN-D
is a traditional preferred stock from Triton International Limited
(TRTN) offering 6.875 percent cumulative dividends. The issuance of
TRTN-D continues the company’s year-long trend of introducing a new
preferred stock every three months. The company now has four preferred
stock trading, each issued about three months apart. In each case, the
company has used the proceeds, for the most part, to pay down in
indebtedness, converting about $475 million from debt into equity on
the company’s balance sheet. Triton is the world’s largest lessor of
intermodal containers used for shipping goods by rail, ship or truck.
The company was formed in 2016 from the merger of Triton Container
International Limited and TAL International Group. The resulting
company, Triton International Limited, is a $2.8b company headquartered
in Bermuda.
ARR-C
is an unrated traditional preferred stock from ARMOUR Residential REIT
(ARR) paying a 7.0 percent fixed, cumulative dividend. ARR is using the
proceeds from ARR-C to redeem all outstanding shares of ARR-B, the
company’s 7.875 percent preferred stock that became callable on
February 12, 2018. This maneuver will save the company about $650,000
per year in dividend expense. ARR is a mortgage REIT. Mortgage REITs
typically do better during periods of falling interest rates than
during periods when rates are increasing. They make their money by
raising capital, which costs them whatever the prevailing rate is at
that time; then, they use that capital to purchase bundles of mortgages
(residential mortgages, in this case). During periods of falling rates,
the average mortgage rate being paid by fixed-rate mortgages remains
the same, while the cost of raising capital is falling (hopefully below
the average interest rate being paid by the mortgages in the bundle).
Consequently, the balance sheet of mortgage REITs will typically show
large amounts of debt, reflecting the capital that they need to raise
to purchase mortgage bundles. While ARR’s financial statements are no
exception (showing about $12 billion in debt for this company with a $1
billion market cap), the company is also reporting negative
profitability and operating cash flow. And its common stock has lost
about three quarters of its value since the company was formed in 2008.
CPONZ/COF-J
is from big bank Capital One, offering 4.8 percent non-cumulative
dividends rated as investment grade by Moody’s Investors Services
(Baa3/BB). This is a 50 million share issue raising about $1.25
billion. COF-J is the company’s sixth preferred stock currently
trading. The prospectus says that the company may use some of these
proceeds to redeem outstanding preferred stock shares. The only
currently redeemable preferred stock from COF is COF-P, originally
issued in August of 2012 at 6.0 percent, 1.2 percent higher than the
new COF-J. Research shows that if a company can save at least 0.375
percent by using the proceeds of a new preferred stock to redeem the
shares of an older, higher payer, there is a 91 percent chance that
they will do so (source: Preferred Stock Investing, 5th Edition, page
227). Holders of COF-P shares should be on the lookout for a redemption
notice from their broker.
DIMEP/DCOMP
is from small bank Dime Community Bancshares, Inc., offering 5.5
percent unrated, non-cumulative dividends. DCOMP is the company’s
first, and only, preferred stock. Even though Dime has historically
specialized in lending for New York City multifamily real estate, 31
percent of Dime’s current loan volume is to high net worth individuals.
Seeking to diversity, the company embarked on an effort to expand its
business lending and municipal lending businesses in 2017. With a
relatively small footprint, the bank puts up impressive financial
metrics, paying out an average of 1.49 percent on its deposits while
posting an average 4.01 percent yield on total loans. Dime is a $6.9
billion (market cap) regional bank originally founded in 1864 as the
Dime Savings Bank of Williamsburgh. The company is currently
headquartered in Brooklyn with 28 branches providing banking services
to the area.
Sources:
Preferred stock data - CDx3 Notification Service database,
PreferredStockInvesting.com.
Prospectuses:
SOJD, MET-F, WFC-Z, TRTN-D, ARR-C, CPONZ/COF-J, DIMEP/DCOMP
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 (no preferred
stocks were issued by partnerships during January).
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 (ARR-C).
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 (SOJD).
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 (TRTN-D, WFC-Z, MET-F, CPONZ, COF-J,
DIMEP/DCOMP).
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
6.3
percent (blue line) while the annual return being offered to income
investors
by the 10-year treasury is 1.6 percent (the Fed’s multi-month effort to
inject cash now pushing treasury yields down) and that of the 2-year
bank CD at 2.1 percent.
For
comparison, I have set the Yield column in the first table above to
show the current yield of the new January preferreds on January 31.
It is
into
this marketplace that January’s new issues were introduced.
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