New Preferred Stock IPOs - April 2018

Summary

• Four new preferred stocks were introduced during April, offering an average annual dividend of 6.9 percent.
• There are currently 121 high quality preferred stocks selling for an average price of $24.58 per share (investment grade, cumulative dividends).
• 70 of these high quality issues are now selling below their $25 par value, offering an average current yield of 6.0 percent.
• U.S.-traded preferred stocks are now returning an average current yield of 6.8 percent.

Conditions in the U.S. preferred stock marketplace continue to favor buyers. Falling prices have delivered higher dividend rates for new issues and increasing yields for previously introduced shares.

Another noteworthy milestone was reached during April for income investors. Often cited as a predictor of the dividends to be offered on newly introduced preferred stock, the 10-year Treasury note blew through the magic three percent threshold on April 24 for the first time since July 2011.

While the extent to which new preferred stock dividend rates and the 10-year Treasury yield are related is actually questionable (see "How Well Do Government Money Rates Predict Preferred Stock Dividend Trends?" for correlation values), there is a certain body of historical research indicating that when the 10-year moves above three percent, the risk/reward math starts to turn away from value (common stock) investors to favor income investors (bonds, preferred stocks).

April's new issues

April's four new preferred stocks are offering an average annual dividend (coupon) of 6.9 percent 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 121 high quality preferred stocks selling for an average price of $24.58 (April 30), offering an average current yield of 5.62 percent. And 70 of these high quality issues are selling below their $25 par value offering an average current yield of 6.0 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 are now a total of 895 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that ETPPP from Energy Transfer Partners, L.P. (ETP) is still trading on the wholesale Over-The-Counter exchange (as of April 30). This a temporary OTC trading symbols until this security moves to the NYSE exchange, at which time they will receive its permanent symbol.

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 if prices drop (if they choose to sell).

Your broker will automatically update the trading symbols of any shares you purchase on the OTC. ETPPP will become ETP-C.

About the new issues

The April issues have several things in common, but each is also unique in its own way.

OFSSL from OFS Capital Corporation (OFS) is an Exchange-Traded Debt Security, also referred to as a baby bond. 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. OFS is a closed-end management investment company incorporated as a business development company. OFS provides primarily debt capital to middle market companies. OFSSL is unrated and becomes callable in April 2020, a relatively short two year call protection period compared to the more common five years.

ECCX is from Eagle Point Credit (ECC), offering a 6.6875 percent coupon. Like OFSSL, ECCY is also an ETDS. Being incorporated as a management investment company, ECC invests in equity positions and loan instruments that are "…unrated or rated below investment grade and are considered speculative with respect to timely payment of interest and repayment of principal." The company is using the proceeds from the new ECCX to redeem the outstanding shares of their 7.0 percent ECCZ. While doing so does not produce much in the way of an interest expense savings, it does extend to maturity of this debt to 2028 from 2020.

SJIU is offered by South Jersey Industries (SJI), a regulated New Jersey gas utility founded in 1910. The proceeds from SJIU, and the company's concurrent common stock offering, are being used to fund its pending acquisition of Elizabethtown Gas and Elkton Gas. SJIU, April's only convertible preferred stock, is the company's first income security since it issued SJI-T in 1997 (called in 2003). There are two types of convertible preferred stock - mandatory convertibles, where the shares will be converted to some number of shares of the issuer's common stock on a specific date, and optionally convertibles, where shareholders have the option to convert their shares to the issuer's common stock (or not). The various conversion ratios, limitations, timing and conditions are spelled out in the security's prospectus. SJIU is a mandatory convertible preferred stock with a somewhat unusual $50 par value.

ETPPP/ETP-C from Energy Transfer Partners, L.P. is a Ba2/BB rated traditional preferred stock using the fixed-to-floating dividend rate structure. With this structure, this security offers a fixed 7.375 percent coupon until its May 15, 2023 call date. At that time, the coupon varies based on the three-month LIBOR rate (currently 2.32084 percent) plus 4.530 percent. Note that ETP is a limited partnership, meaning that ETPPP/ETP-C shareholders will receive a K-1 at tax time, rather than a 1099 form. The $21 billion (market cap) company, based in Texas and founded in 1995, collects and transports natural gas. After completing its merger with a subsidiary of Sonoco last year, ETPPP/ETP-C is the company's only income security currently trading.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: OFSSL, ECCX, SJIU, ETPPP/ETP-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.

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, dividends received from REITs are taxed as regular income (i.e. they do not qualify for the special 15 percent dividend tax rate). There were no REIT-issued preferred stocks during April.

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 (April's OFSSL and ECCX), 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, none of April's new issues pay QDI dividends (otherwise, "QDI" would appear in the Status column). All of April's new issues pay dividends that are taxed as regular income.

In Context: The U.S. preferred stock marketplace

The Federal Open Market Committee is meeting again on May 1 and 2. We'll see if they continue to raise interest rates, but given that household income and personal consumption are finally increasing for the first time in many years, another quarter point increase of the federal funds rate would not be too surprising.

The following chart illustrates how increasing interest rates over the last twelve months have delivered a $1.00 per share cost savings to today's preferred stock buyers.

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. Note that the average current yield realized by preferred stock since January has increased by 0.3 percent.

U.S.-traded preferred stocks are currently returning an average current yield of 6.8 percent (blue line) while the annual return being offered to income investors by the 10-year treasury is 3.0 percent and that of the 2-year bank CD has recovered nicely to 2.5 percent.

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

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.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.