New Preferred Stock IPOs, November 2017

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Includes: AHT, DTE, EPR, FBIO, INN, JMP, LTS, MBFI, MVC, NS, REXR, SBLK, SO, TWO
by: Doug K. Le Du

Summary

There are currently 96 high-quality preferred stocks selling for an average price of $25.80 per share.

14 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 5.69 percent.

Those investing in U.S.-traded preferred stocks since the beginning of 2017 are currently on pace for a total annualized return of 11.4 percent.

Preferred stock issuers continued to introduce new issues at a blistering pace throughout November with 14 new securities. November's 14 new preferred stocks are offering an average dividend (coupon) of 6.8 percent.

November's new issues

Here are the 14 new issues introduced during November 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.

A special note regarding preferred stock trading symbols: Annoyingly, unlike common stock trading symbols, the format used by brokers and other online quoting services for preferred stock symbols is not standardized. For example, the Series A preferred stock from Public Storage (NYSE:PSA) is "PSA-A" at TDAmeritrade, Google Finance and several others, but this same security is "PSA.PR.A" at E*Trade. For a cross-reference table of how preferred stock symbols are denoted by 16 popular brokers and other online quoting services, see "Preferred Stock Trading Symbol Cross-Reference Table."

There are currently 96 high-quality preferred stocks selling for an average price of $25.80 (November 30), offering an average coupon of 5.54 percent and a current yield of 5.36 percent. And 14 of these high-quality issues are selling below their $25 par value, providing an average yield-to-call of 5.69 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.

There are now a total of 906 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that the two newest issues - EPRRP from EPR Properties (EPR) and NSSTP from NuStar Energy LP (NS) - are still trading on the wholesale over-the-counter exchange (as of November 30). These are temporary OTC trading symbols until these securities move to the NYSE exchange, 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. EPRRP will become EPR-G and NSSTP will become NS-C.

About the new issues

The diversity of the 14 new November issues is robust. Securities from four property REITs, one mortgage REIT, a shipping company, one pharmaceutical company, a business development company, three banks, two utilities, and one company from the petroleum industry were introduced during the month.

Property Real Estate Investment Trusts (pREITs)

INN-E, REXR-B, AHT-I, EPRRP/EPR-G

REITs come in two flavors - property REITs and mortgage REITs. While property REITs make money by owning physical property and leasing it out, mortgage REITs make money by investing in residential and/or commercial mortgages (the idea being to borrow cash at a low rate and use that cash to buy mortgages that pay a higher rate).

Diversity can also be found within this group - Summit Hotel Properties (NYSE:INN) and Ashford Hospitality (NYSE:AHT), hotels; Rexford Industrial (NYSE:REXR), industrial facilities; and EPR Properties, retail.

INN-E from Summit Hotel Properties, REXR-B from Rexford Industrial Realty, AHT-I from Ashford Hospitality and EPRRP/EPR-G from EPR Properties are all cumulative, perpetual preferred stocks offered by property REITs.

"Cumulative" means that if the issuer misses a dividend payment to you, they still owe you the money (short of a bankruptcy); their obligation to you accumulates. "Perpetual" means that the issuer is not required to ever redeem your shares (i.e. the shares have no maturity date).

All of these property REIT issues are traditional preferred stocks offering fixed-rate dividends.

Mortgage Real Estate Investment Trusts (mREITs)

Mortgage REITs typically do not own physical property; rather, they raise capital (such as through a preferred stock offering) that is used to buy bundles of residential and/or commercial mortgages. 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 the prevailing interest rates at the time 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, cost is rising while revenue remains relatively flat, squeezing the profitability of mortgage REITs.

Two Harbors Investment Corporation (TWO) is a mortgage REIT, investing in a variety of residential and commercial mortgages. TWO-C pays a fixed 7.25 percent dividend until its January 27, 2025, call date. At that time, the dividend rate of this security becomes variable based on the three-month LIBOR rate (currently at 1.38 percent) plus 5.011 percent.

Shipping

SBLKZ is an Exchange-Traded Debt Security from Greece-based shipper Star Bulk Carriers (SBLK). ETDS are bonds 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.

The new SBLKZ offers an 8.3 percent coupon; the proceeds from which are being used to redeem all outstanding shares of the company's 8.0 percent SBLKL on December 11. Both of these securities are ETDS. While using the new 8.3 percent SBLKZ to redeem the old 8.0 percent SBLKL increases the company's annual interest expense, this maneuver extends the maturity of this debt by three years.

Pharmaceutical

Fortress Biotech (FBIO) is new to the preferred stock marketplace, offering its FBIOP on November 6. Founded in 2006, the company was formerly operating as Coronado Biosciences. Fortress acquires and/or develops companies that produce what it feels are promising pharmaceutical and biotechnology products. FBIOP, with a $25 par value, was introduced with a fixed, cumulative 9.375 percent coupon in early-November. But the security's underwriters appear to have missed the mark here as investors are currently pricing FBIOP at $22.30 (November 30), a mere three weeks after introduction.

Business Development Corporations

MVCD from MVC Capital, Inc. (MVC) is an Exchange-Traded Debt Security offering a fixed 6.25 percent coupon. The proceeds from MVCD are being used by the company to redeem all outstanding shares of its 7.25 percent MVCB on December 21, 2017.

Typically, these types of income securities will offer a five-year call period and a maturity date that is several decades into the future. But the new MVCD becomes callable in just two years (November 30, 2019) and matures in just five years (November 30, 2022).

Banks

MBFIO, LTSL, JMPD

MBFIO is offered by MB Financial (MBFI), a financial services firm offering banking services to businesses in or near Chicago and Philadelphia. MBFIO is a non-cumulative, traditional preferred stock and offers a speculative-grade Ba3 rating from Moody's Financial Services.

LTSL, an Exchange-Traded Debt Security from Ladenburg Thalmann Financial Services (LTS), is the company's second income security and offers a coupon of 6.5 percent. Thalmann is an investment banking company founded in 1876 and is headquartered in Miami.

JMPD from JMP Group, Inc. (JMP) is also an Exchange-Traded Debt Security, offering a 7.25 percent coupon. The $50 million proceeds from this new issue will be just enough for JMP to redeem its nearly identical 7.25 percent JMPC on December 28, 2017. While this maneuver is cash even to the company (no interest expense savings since the coupons are the same), the end result extends the maturity on this debt from JMPC's January 15, 2021, to JMPD's November 15, 2027.

Utilities

DTW, SOJC

DTW from DTE Energy (DTE) and SOJC from Southern Company (SO) are nearly identical - both are Exchange-Traded Debt Securities, both offer the same 5.25 percent coupon, both have the same call date and maturity date (December 1, 2022, and December 1, 2077, respectively) and both have the same $25 par value. Further, both of these securities offer double investment grade ratings from Moody's and S&P.

Petroleum

NuStar Energy is a petroleum pipeline, storage and fuel marketing limited partnership founded in 1999. Those purchasing shares of the company's new NSSTP/NS-C preferred stock should expect to receive a K-1, rather than a 1099, at tax time. The NSSTP/NS-C is NuStar's second new income security introduction this year with the nearly identical NS-B being offered last April at 7.625 percent. The new NSSTP/NS-C offers buyers a 9.0 percent coupon until the security's December 15, 2022, call date. At that time, the dividend rate offered by this security becomes a floating rate pegged to the three-month LIBOR rate, plus 6.88 percent. Buyers should be cautious of this structure since while sounding especially attractive during a period of increasing rates, issuers will frequently call the shares on the call date if not doing so means increasing their dividend expense to shareholders (see "Variable-Rate Preferred Stocks Underperform Their Fixed-Rate Cousins").

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses INN-E, SBLKZ, FBIOP, REXR-B, AHT-I, MVCD, MBFIO, DTW, LTSL, TWO-C, SOJC, JMPD, EPRRP/EPR-G, NSSTP/NS-C

Tax treatment

The tax treatment of the 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.

With that rule in mind, here is how the tax treatment of November's 14 new issues plays out.

Companies incorporated as REITs, be they property REITs (Summit, Rexford, Ashford, EPR) or mortgage REITs (Two Harbors), 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, dividends received from REITs are taxed as regular income (i.e. they do not qualify for the special 15 percent dividend tax rate).

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 (i.e. interest payments made to lenders are paid with pre-tax dollars). Since Exchange-Traded Debt Securities are debt (Star, MVC, DTE, Ladenburg, Southern Company, JMP Group), ETDS shareholders are on the hook for the taxes. Income received from ETDS is taxed as regular income.

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. Looking at the Status column in the above table, dividends received from Fortress Biotech's FBIOP and MB Financial's MBFIO 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 November issues stack up within the context of today's preferred stock marketplace?

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. Through July of this year, preferred stock buyers totally ignored the Fed's federal funds rate increases.

But that started to change during early August. And prices have remained relatively flat since then as investors appear to be anticipating another federal funds rate hike when the Fed's next meeting adjourns on December 13.

With the surge of new issues that we have seen over the last six months, it also appears that issuers are anticipating upward pressure on rates (which pushes prices down) as well.

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 percent (blue line) while the annual return being offered to income investors by the 10-year Treasury is 2.4 percent and that of the 2-year bank CD is a meager 1.9 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new November preferreds on November 30. It is into this marketplace that November's new issues were introduced.

Income versus Value Investing, Year-To-Date

With an average current yield of 6.4 percent, plus the 5.0 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 11.4 percent (6.4 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 November 30 at 2,648, an unrealized annualized value gain of about 19.2 percent plus about 2 percent in average annualized dividend yield - a year-to-date annualized gain of about 21.2 percent for common stock investors. The sustainability of this performance has become the focus of many common stock investors.

Disclosure: I am/we are long REXR-B, AHT-I.

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.

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