New Preferred Stock IPO's, December 2017

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Includes: COWN, CSWC, KIM, RILY, SRG, VNO, WBS
by: Doug K. Le Du

Summary

There are currently 92 high quality preferred stocks selling for an average price of $25.73 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 7.29 percent.

Those investing in U.S.-traded preferred stocks since the beginning of 2017 have seen a total annualized return of 11.1 percent.

Common stock investors have also done well this year, seeingan annualized value appreciation of 18.7 percent plus about two percent inaverage dividend yield.

The surge of new preferred stock issues that we have seen over the last several months cooled off a bit during December, with seven new preferred stocks being issued during the last month of the 2017. December’s seven new preferred stocks are offering an average dividend (coupon) of 6.2 percent.

December’s new issues

Here are the seven new issues introduced during December 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 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. 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 92 high quality preferred stocks selling for an average price of $25.73 (December 29), offering an average coupon of 5.54 percent and a current yield of 5.38 percent. And 14 of these high quality issues are selling below their $25 par value, providing an average yield-to-call of 7.29 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 898 of these securities trading on U.S. stock exchanges (including convertible preferred stocks), 118 of which were issued during 2017.

About the new issues

Three of December’s seven new preferreds were issued by property REITs, all of which specialize in retail stores. Three of the new issues come from investment banks with the remaining new issue being issued by a Business Development Corporation.

Property Real Estate Investment Trusts (pREITs)

VNO-M, SRG-A, KIM-M

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).

VNO-M from Vornado Realty (VNO), SRG-A from Seritage Growth Properties (SRG) and KIM-M from Kimco Realty (KIM) are all cumulative, perpetual preferred stocks offering fixed-rate dividends.

“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).

Notice that while the preferreds from Vornado and Kimco enjoy double-investment grade ratings from Moody’s and S&P, SRG-A from Seritage is unrated. SRG-A is Seritage’s first preferred stock issue.

Eighty percent of Seritage’s retail properties are occupied by Sears and Kmart stores. As Sears and Kmart have been vacating leases, Seritage has been subdividing these large retail spaces into multiple, smaller units, hence the need for cash. Sears is obligated to pay Seritage a lease termination fee in these cases and as long as Sears has the cash to meet this obligation, Seritage’s chance of survival improves. But Seritage has an awful lot of eggs in one basket.

Banks

WBS-F, COWNZ, RILYG

WBS-F is a traditional, perpetual, non-cumulative preferred stock from Webster Financial Corporation (WBS). Like VNO-M and KIM-M, discussed above, WBS-F offers an investment grade rating from Moody’s Investors Service. Webster is a holding company for Webster Bank. According to its web page, the company operates 175 banking locations and 350 ATMs throughout the United States. Webster, a $5.5 billion company (market cap), was founded in 1935.

COWNZ from Cowen, Inc. (COWN) and RILYG from B. Riley Financial (RILY), issued one day apart, are nearly identical Exchange-Traded Debt Securities, also known as baby bonds. 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.

Business Development Corporation

CSWCL from Capital Southwest Corporation (CSWC) is also an ETDS but differs from COWNZ and RILYG in some important ways. Where COWNZ and RILYG become callable in three years (December 2020), Capital Southwest re-gains the right to redeem CSWCL shares in just two years (December 2019). More significantly, CSWCL matures in five years (December 2022) while COWNZ and RILYG offer ten year maturities (December 2027).

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses VNO-M, WBS-F, COWNZ, RILYG, SRG-A, KIM-M, CSWCL

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 December’s seven new issues plays out.

Companies incorporated as REITs (Vornado, Seritage, Kimco) 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 (COWNZ, RILYG, CSWCL), 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 Webster’s WBS-F 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 December 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 very low 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 with prices gradually dropping since then.

With the surge of new issues that we have seen over the last six months (78 of the year’s 118 new issues, 66 percent, were introduced since July 1), it also appears that issuers are anticipating upward pressure on rates (which pushes prices down) over the coming months.

With prices gradually decreasing since early-August and companies rushing to introduce new issues, perhaps 2018 will be the year that we finally see preferred stock prices return to something closer to their $25 par value.

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 2.4 percent and that of the 2-year bank CD is a meager 2.0 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new December preferreds on December 29. It is into this marketplace that December’s new issues were introduced.

Income versus Value Investing, Year-To-Date

With an average current yield of 6.5 percent, plus the 4.6 percent annualized value gain, those investing in U.S.-traded preferred stocks since the beginning of 2017 have seen a total annualized return of 11.1 percent (6.5 percent of which is realized in dividend cash).

Starting at 2252 at the beginning of the year (January 3, 2017 open), the S&P500 common stock value index closed on December 29 at 2674, an unrealized value gain of about 18.7 percent plus about two percent in average dividend yield – a 2017 gain of about 20.7 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 RILYG.

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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