Preferred Stock IPOs For May 2017

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Includes: AI, BDX, CLNY, GLOP, PSA
by: Doug K. Le Du
Summary

There are currently 102 high quality preferred stocks selling for an average price of $25.73 per share.

25 of these high quality (investment grade, call-protected, cumulative dividends) issues are selling below their $25 par value, providing an average yield-to-call of 6.81 percent.

Those investing in U.S.-traded preferred stocks since the beginning of 2017 are currently on pace for a total annualized return of 17.2 percent.

Common stock investors have also done well this year, seeing an annualized value appreciation of 16.9 percent plus about 2 percent in average annualized dividend yield.

Preferred stock investors have ignored the last two interest rate hikes from the Federal Reserve. Despite two rate hikes over the last six months, preferred stock buyers have pushed the average price of these securities up by $1.10 per share so far this year, a 10.7 percent annualized value gain for preferred stock investors. The Federal Reserve's Open Market Committee will hold its next two-day meeting on June 13-14.

May's new issues

Five new preferred stocks were introduced during May for the consideration of preferred stock investors.

There are currently 102 high quality preferred stocks selling for an average price of $25.73 (May 31), offering an average coupon of 5.60 percent and a yield-to-call of 3.87 percent (although calls of these relatively low coupon issues are becoming less likely). And, 25 of these high quality issues are selling below their $25 par value, providing an average yield-to-call of 6.81 percent. By high quality, I mean preferreds offering the characteristics that most risk-averse preferred stock investors favor such as investment grade ratings, cumulative dividends, and call protection.

But with 25 high quality issues currently available for less than their $25 par value to pick from, the number of new preferred stock IPOs becomes much less relevant to today's buyers.

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.

There are now a total of 959 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that the two newest issues - PBSPP from Public Storage (NYSE:PSA) and CLNYP from Colony NorthStar (CLNS) - are still trading on the Over-The-Counter exchange (as of May 31). These are temporary OTC trading symbols until these securities move to the NYSE, at which time they will receive their permanent symbols.

But there is no need to wait; during a period of relatively high prices, individual investors, armed with a web browser and an online trading account, can often purchase newly introduced preferred stock shares at wholesale prices just like the big guys (see "Preferred Stock Buyers Change Tactics For Double-Digit Returns" for an explanation of how the OTC can be used to purchase shares for discounted prices during a period of high preferred stock prices).

Those who have been following this strategy of using the wholesale OTC exchange to buy newly introduced shares for less than $25 are more able to avoid a capital loss as prices start to drop (if they choose to sell).

Your broker will automatically update the trading symbols of any shares you purchase on the OTC. PSBPP will become PSA-F (see cautionary note below) and CLNYP will become CLNS-I.

About the new issues

All five of May's new issues offer cumulative dividends, meaning that if the issuing company skips a dividend payment to you, they still owe you the money; their obligation to pay you accumulates.

AI-B from Arlington Asset Investment Corporation (NYSE:AI) is the company's first preferred stock, although it also has two Exchange-Traded Debt Securities currently trading. AI is a small-cap company ($341 million), making its money by leveraging its portfolio of primarily residential mortgage-backed securities. Somewhat uniquely, the company has chosen to not incorporate as a mortgage REIT. AI-B is a very small issue of 135,000 shares raising just over $3 million.

GLOP-A, issued by GasLog Partners LP (NYSE:GLOP), is May's only fixed-to-float security, meaning that it pays a fixed 8.625 percent dividend until its June 15, 2027, call date. The rate becomes variable at that time, calculated by adding 6.31 percent to the then-current three-month LIBOR rate (currently at 1.17372 percent). GasLog, founded in 2014 and headquartered in Monaco, charters its fleet of nine LNG tankers. GLOP-A is the company's first and only income security. With total 2016 gross revenue reported at $229 million, the $125 million raised by GLOP-A represents about half of this company's annual sales volume. Note that GasLog is structured as a foreign limited partnership. Those considering buying GLOP-A shares should consult a tax specialist regarding the taxation and reporting requirements of income from such securities.

BDXA from Becton, Dickinson and Company (NYSE:BDX) is easily the most complex preferred stock issued during May. BDXA is a "term, mandatory convertible preferred stock," meaning that it will only trade for a specific term (until its May 1, 2020, call date), and on that date, the shares will convert from preferred stock shares to the company's common stock shares, the conversion ratio formula being specified within the security's prospectus. Note that this conversion is mandatory, meaning that the preferred shares will convert to common shares whether or not the conversion is beneficial to shareholders. This security also includes a provision stating that prior to its May 1, 2020, call date, shareholders may convert their BDXA shares to BDX common shares at the option of the shareholder. BDX is a $43 billion (market cap) medical supply company founded in 1897. BDXA is the company's only income security.

The new "Series F" PBSPP is the newest of 14 preferred stocks from Public Storage currently trading. PSA offers the highest rated preferred stocks of any U.S. REIT (A3/BBB+), which explains the miserly 5.15 percent coupon of this new issue. Typically, PSA uses the proceeds from a new, lower-paying preferred to redeem the shares of an older, higher payer. But while three of PSA's 14 currently-trading preferreds are redeemable (PSA-S, -T, and -U), the new PBSPP only generates enough cash to redeem the lowest payer of the group, PSA-U at 5.625 percent. PSA favors preferred stock issuance over debt to raise capital. Consequently, over any five-year call period, the company issues so many preferred stocks that the NYSE frequently finds itself having to issue the same trading symbol for the new security as one that has been recently redeemed by the company (e.g. PSA-A, PSA-F). As discussed earlier, PBSPP is a temporary OTC trading symbol with this Series F security being destined to become PSA-F in early June. But since PSA-F was the symbol used by a PSA preferred stock introduced in 2005 and redeemed in 2012, those researching this new issue should be certain that you are looking at information for the new security.

CLNYP from Colony NorthStar is an unrated traditional preferred stock offering a 7.15 percent cumulative dividend. The proceeds from CLNYP (a 12 million share issue) will be used by CLNS to redeem two of the company's older preferreds - CLNS-A (2.2 million shares initially issued by NorthStar Realty at 8.75 percent) and CLNS-F (5.2 million shares at 8.5 percent issued by Colony Financial). This move will leave the company with about $115 million in leftover CLNYP cash plus an annual dividend expense savings of about $5.6 million. Colony NorthStar is an $8.3 billion (market cap) diversified REIT founded in 2009 and invests in a wide range of commercial and residential real estate throughout North America and Europe.

(Sources: Prospectuses AI-B, GLOP-A, BDXA, PBSPP/PSA-F, CLNYP/CLNS-I. CDx3 Notification Service database, PreferredStockInvesting.com)

Tax treatment

When purchasing preferred stock in a non-retirement account, many preferred stock investors will favor shares that are designated as paying Qualified Dividend Income ("QDI" in the Status column of the above table) since QDI dividends are taxed at the more favorable 15 percent tax rate.

If a company pays your dividend out of its after-tax cash (i.e. the company has already paid tax on the cash), you are obligated to pay additional tax on this same money but at the lower 15 percent rate (this taxing of the same money twice is the "double taxation" of dividends that often serves as a favorite political football).

On the other hand, if the company pays your dividend out of pre-tax earnings, such as the case with REIT preferred stocks (both property REITs and mortgage REITs), the government collects the full tax from you, taxing such dividends as regular income (no tax break).

Looking at the Status column, dividends received from Arlington Asset's AI-B, GasLog's GLOP-A, and Becton's BDXA are a distribution of the company's after-tax earnings and are therefore designated as being Qualified Dividend Income (see prospectus for exceptions and conditions).

In Context: The U.S. preferred stock marketplace

So, how do the new May issues stack up within the context of today's preferred stock marketplace?

After the Fed's December 2015 rate hike, market prices of income securities predictably fell at least for about eight weeks. But throughout 2016, skeptical income investors came to doubt that the rate hike of the previous December was anything more than a one-shot deal; prices shot up shortly thereafter by an average $3.05 per share, all the way to $26.40 per share.

Similarly, anticipating a Q4 2016 hike, sellers started selling their shares in August 2016 with the expected rate hike becoming a reality in December 2016. But notice in the next chart how income investors starting pushing prices back up immediately following the December 2016 hike.

On March 15, 2017, the Fed raised the federal funds rate for the second time within four months, but income investors remain undeterred. Demand for U.S.-traded preferred stocks has remained high, as indicated by the continuation of increasing prices, despite the rate hikes.

The average market price of U.S.-traded preferred stocks is now at $25.82 per share, an annualized value increase of 10.7 percent for 2017.

For many months now, two of the most significant contributors to upward price pressure have been (1) continued zero-to-negative rates implemented by foreign central banks and (2) insensitivity by member banks toward changes in the federal funds rate.

Foreign investors continue to be attracted by U.S. income securities since they are facing zero to negative rates at home. This foreign demand puts upward pressure on prices here. And, U.S. banks are holding over $2 trillion in excess reserve cash - that's above and beyond the elevated 2010 Dodd-Frank requirements. The demand by member banks for overnight loans from the Fed has been, and remains, minimal, rendering changes to the federal funds rate less compelling.

But 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.

While the continuing strong demand for U.S. preferred stocks can be attributed to several factors, the next chart makes it pretty clear that the lack of attractive alternatives is certainly among them.

U.S.-traded preferred stocks are currently returning an average current yield of 6.5 percent (blue line) while the annual return being offered to income investors by the 10-year treasury is 2.2 percent and that of the two-year bank CD is a meager 1.6 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new May preferreds on May 31. It is into this marketplace that May's new issues were introduced.

Income versus Value Investing, Year To Date

With an average current yield of 6.5 percent, plus the 10.7 percent annualized value gain, those investing in U.S.-traded preferred stocks since the beginning of 2017 are currently on pace for a total annualized return of 17.2 percent (6.5 percent of which is realized in dividend cash).

Starting at 2,252 at the beginning of the year (January 3, 2017, open), the S&P 500 common stock value index closed on May 31 at 2,411, an unrealized annualized value gain of about 16.9 percent plus about 2 percent in average annualized dividend yield - a year-to-date annualized gain of about 18.9 percent for common stock investors.

Disclosure: I am/we are long CNLYP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The CDx3 Notification Service is my preferred stock email alert and research newsletter service and includes the database of all preferred stocks and Exchange-Traded Debt securities used for this article.