New Preferred Stock IPOs - July 2017

|
Includes: AMH, CCI, NLY, TPVG, TWO, UMH, VLY
by: Doug K. Le Du
Summary

There are currently 97 high quality preferred stocks selling for an average price of $26.09 per share.

12 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 5.42%.

Those investing in U.S.-traded preferred stocks since the beginning of 2017 are currently on pace for a total annualized return of 16.0%.

Common stock investors have also done well this year, seeing an annualized value appreciation of 16.6% plus about 2% in average annualized dividend yield.

Preferred stock investors have ignored the last three interest rate hikes from the Federal Reserve. Despite three rate hikes since December 2016, preferred stock buyers have pushed the average price of these securities up by $1.39 per share so far this year, a 9.6% annualized value gain for preferred stock investors.

July's new issues

New preferred stock introductions continue to be robust. After June's eight new offerings, seven new preferred stocks were introduced during July 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.

There are currently 97 high quality preferred stocks selling for an average price of $26.09 (July 31), offering an average coupon of 5.60% and a current yield of 5.35%. And, 12 of these high quality issues are selling below their $25 par value, providing an average yield-to-call of 5.42%. 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.

There are now a total of 953 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that the two newest issues - ANNPP from Annaly Capital (NLY) and VLYYP from Valley National Bancorp (VLY) - are still trading on the Over-The-Counter exchange (as of July 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. ANNPP will become NLY-F and VLYYP will become VLY-B.

About the new issues

With the exception of VLYYP, none of July's new issues are rated. And again, with the exception of VLYPP, all offer cumulative dividends, meaning that if the company skips a dividend payment, its obligation to pay you accumulates; it still owes you the money. In such a case, short of a bankruptcy, the company is prohibited from paying dividends to its common stock shareholders until all accumulated dividends owed to its preferred stock shareholders have been paid.

Shortly after the housing collapse that began in 2008, a group of senior executives spun away from Public Storage and formed American Homes 4 Rent (AMH) and, using the same capital raising strategy that they had become accustomed to, issued three new preferred stocks - AMH-A, AMH-B, and AMN-C. With the proceeds, AMH bought tens of thousands of distressed homes throughout the U.S. at bargain basement prices and turned them into rental properties. With the new AMH-G, the company now has seven income securities trading. These issues are unique in that their prospectuses include a provision that allows shareholders to participate in any appreciation of these rental homes over time. Called the "Home Price Appreciation Amount," these securities' $25 par value increases over time as published on the company's website (a variety of exceptions, limitations, and conditions may apply). In the event of a redemption, shareholders can actually receive more than the stated $25 par (see "American Homes 4 Rent Preferred Stocks, Opportunities And Risks").

$50 million of the proceeds from the new TPVY from TriplePoint Venture Growth BDC Corporation (TPVG) are being used to redeem all outstanding shares of the company's older TPVZ security. Doing so saves the company about $500,000 in annual interest expense with about $15 million in cash left over. Both the old TPVZ and the new TPVY are Exchange-Traded Debt Securities, which are bonds recorded on the company's books as debt. As such, these "baby bonds" pay interest, rather than dividends, which is therefore taxed as regular income. TriplePoint is incorporated as a Business Development Company, investing in "venture growth stage businesses."

TWO-B from Two Harbors Investment Corporation (TWO) is the company's second preferred stock offering within the last four months. While its Series A security was introduced with an 8.125% coupon in March at 5.75 million shares, the new TWO-B is composed of a relatively huge 11.5 million shares for the consideration of preferred stock investors. Interestingly, the coupon rates of these two issues, issued a mere four months apart, illustrates an oddity currently playing out within the U.S. preferred stock marketplace - during a period of increasing interest rates, prices, which normally move opposite the direction of rates, have continued to rise as well, putting downward pressure on yields. It is this current oddity that has allowed TWO to issue the new Series B at a substantially lower coupon rate than their Series A just four months ago.

As a mortgage REIT, TWO does not own physical property; rather, the company raises capital (such as through a preferred stock offering) that it uses to buy bundles of residential mortgages from financial institutions. If the cost of the raised capital is less than the bundled mortgage rate, mortgage REITs make money on the spread. The cost of investment capital that mortgage REITs are able to raise is determined by today's prevailing interest rates while the revenue coming from the mortgages, at least to some degree, remains fixed until the mortgages mature. So, during a period of increasing interest rates, the profitability of mortgage REITs tends to get squeezed.

CCI-A from Crown Castle International (CCI) was introduced to help fund the company's pending merger with Lightower Acquisition for $7.1 billion in cash. Crown Castle, a $37 billion company (market cap) with $14 billion in debt, owns an impressive network of wireless communications infrastructure that is leased out to wireless carriers. CCI-A, with a $1,000 par value, is aimed at institutional and commercial investors. This security, raising $1.5 billion, represents significant risk to CCI if the Lightower merger cannot be finalized by its June 29, 2018, deadline. Note too that this security is a mandatory convertible preferred stock, meaning that on the security's August 1, 2020, call date, these preferred stock shares will convert to the company's common shares (see prospectus for conversion terms and rates).

UMH-C from UMH Properties (UMH) is one of three preferred stocks currently trading from this company. 3.6 million of the new UMH-C's 5 million shares will be used to redeem the company's UMH-A, an 8.25% preferred stock originally offered in May 2011. Doing so delivers an annual dividend expense savings of $1.4 million to UMH. After having gone five years without introducing a new preferred stock (its Series A to its Series B), the new UMH-C is the company's second new offering in the last 15 months. UMH is a property REIT and is somewhat unique within the U.S. preferred stock marketplace in that it owns and operates manufactured home communities, leasing manufactured home sites to private owners of manufactured homes. UMH is a $500 million company (market cap) founded in 1968.

Of the four preferred stocks that Annaly Capital currently has trading, the new ANNPP/NLY-F is the company's largest by far. At 28 million shares, this security has raised about $700 million for NLY. About $200 million of these proceeds will go to redeem its 7.875% NLY-A. The company has announced no plans to redeem any of its other three preferreds, even though the new NLY-F leaves it with plenty of cash to do so. According to Annaly's press release, the remaining $500 million will go to "…acquire targeted assets under the Company's capital allocation policy, which may include further diversification of its investments in Agency assets as well as residential, commercial and corporate credit assets." Like TWO-B, this security offers a fixed-to-float rate, meaning that it pays a fixed 6.95% coupon until its September 30, 2022, call date. At that time, the coupon rate becomes variable, pegged to the three-month LIBOR rate (currently 1.30072%) plus 4.993%.

VLYYP/VLY-B from Valley National Bancorp (VLY) is the only rated preferred stock to be introduced during July, albeit a lackluster BB+ from S&P. Founded in 1927, the bank operates 209 branches primarily in New York and Florida, making it virtually unknown to the rest of the country. VLYYP is the company's second preferred stock offering, with VLY-A introduced at 6.25% in 2015. As with most recent bank-issued preferreds, VLYYP pays non-cumulative dividends with a fixed-to-float rate structure. This security pays a 5.5% dividend until its June 30, 2022, call date. At that time, the coupon rate will be pegged to the three-month LIBOR rate plus 3.578%.

(Sources: Prospectuses AMH-G, TPVY, TWO-B, CCI-A, UMH-C, ANNPP/NLY-F, VLYYP/VLY-B. CDx3 Notification Service database, and 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% 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% 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 VLYYP 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 July issues stack up within the context of today's preferred stock marketplace?

We're all taught that during a period of increasing rates the market prices of fixed-return securities (bonds, preferred stocks) will tend to decrease, moving in the opposite direction of rates.

But 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. As they have since the Fed started raising rates in December 2016, preferred stock buyers continued to totally ignore today's upward pressure on rates throughout July.

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 $26.11 per share, an annualized value increase of 9.6% for 2017.

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 6.4% (blue line) while the annual return being offered to income investors by the 10-year treasury is 2.3% and that of the two-year bank CD is a meager 1.8%.

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

Income vs. Value Investing, Year To Date

With an average current yield of 6.4%, plus the 9.6% 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 16.0% (6.4% of which is realized in dividend cash).

Starting at 2,252 at the beginning of the year (Jan. 3, 2017, open), the S&P 500 common stock value index closed on July 31 at 2,470, an unrealized annualized value gain of about 16.6% plus about 2% in average annualized dividend yield - a year-to-date annualized gain of about 18.6% for common stock investors.

Note: 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.

Disclosure: I am/we are long AMH-G, UMH-C. 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.