New Preferred Stock IPOs, May 2018

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Includes: BAC, DCP, NBR, OAK, RILY, UNM
by: Doug K. Le Du
Summary

Five new preferred stocks were introduced during May, offering an average annual dividend of 6.8 percent.

There are currently 120 high-quality preferred stocks selling for an average price of $24.80 per share (investment grade, cumulative dividends).

60 of these high-quality issues are now selling below their $25 par value, offering an average current yield of 5.5 percent.

U.S.-traded preferred stocks are now returning an average current yield of 6.7 percent.

The upward pressure on interest rates that has been building for some time now continues to deliver benefits to preferred stock investors. For the first time since November 2016, there were multiple investment-grade preferred stocks issued during May, paying 6+ percent dividends.

May's new issues

May's five new preferred stocks are offering an average annual dividend (coupon) of 6.8 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 TD Ameritrade, 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 120 high-quality preferred stocks selling for an average price of $24.80 (May 31), offering an average current yield of 5.57 percent. And 60 of these high-quality issues are selling below their $25 par value offering an average current yield of 5.51 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).

About the new issues

Bank of America (BAC) started off the month's new offerings with its 6.0 percent non-cumulative Series GG preferred stock, BAC-B, with an investment grade BBB- rating from S&P. BAC-B is a massive issue raising $1.2 billion and allows BAC to redeem all outstanding shares of BAC-I (6.625%), MER-P (7.375%), CFC-B (7.0%) and a partial redemption of BAC-D (6.20%). MER-P and CFC-B were two of the last Big Bank Trust Preferred Stocks, issued prior to the global credit crisis when BAC was "required to volunteer" to acquire Countrywide and Merrill Lynch. Finally getting clear of the related litigation, these two securities will stop trading on June 6 followed by BAC-I on July 2.

DCP-B from DCP Midstream, LP (DCP) is a B1/B rated traditional preferred stock using the fixed-to-floating dividend rate structure. With this structure, this security offers a fixed 7.875 percent coupon until its June 15, 2023, call date. At that time, the coupon varies based on the three-month LIBOR rate (currently 2.35375 percent) plus 4.919 percent. Dividends from DCP-B are cumulative, meaning that if the company misses a dividend payment to you, it still owe you the money (its obligation to pay you accumulates). Note that DCP is a limited partnership, meaning that DCP-B shareholders will receive a K-1 at tax time, rather than a 1099 form. The $6 billion (market cap) company, based in Denver and founded in 2005, collects, sells and transports natural gas.

NBR-A is offered by Nabors Industries Ltd. (NBR), a $2.5 billion onshore and offshore oil and gas drilling company headquartered in Bermuda and founded in 1952. The proceeds from this unrated offering, together with an accompanying common stock offering, are being used to repay debt, converting debt into equity on the company's balance sheet. NBR-A, May's only convertible preferred stock, is the company's first income security and pays cumulative dividends. 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. NBR-A is a mandatory convertible preferred stock with a somewhat unusual $50 par value.

OAK-A from Oaktree Capital Group, LLC (OAK) carries an investment grade BBB S&P rating and offers 6.625 percent non-cumulative dividends. OAK is a $6.2 billion investment management firm founded in 2007 and headquartered in Los Angeles. OAK-A is the company's first preferred stock issue raising gross proceeds of $180 million.

RILYH (RILYN) from B. Riley Financial (RILY) is an unrated Exchange-Traded Debt Security, also referred to as a baby bond. ETDSs 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, ETDSs are often seen as having lower risk than the same company's preferred stock shares. ETDSs are very similar to preferred stocks and are often listed on brokerage statements as such. The proceeds from RILYH will go toward RILY's acquisition of magicJack VocalTec, a company that manufactures a voice-over-IP telephone device. RILY has four ETDSs trading with RILYH being the company's third ETDS issued within the last eleven months.

A special note this month: There's a new ETDS from Unum Group (UNM) with an IPO date of May 21 that, as of May 31, has yet to start trading (so is not shown on the above list of May IPOs). Its trading symbol has yet to be assigned, but underwriting closed on May 30, so this new security should start trading within the next few days. Unum Group's new ETDS offers a 6.25 percent coupon and a Baa3 investment-grade rating from Moody's Investors Service. According to the prospectus for this security, UNM will use the $289 million net proceeds from this offering to "…repay, redeem or repurchase $200 million aggregate principal amount of our 7% Senior Notes due 2018." UNM, an $8.2 billion insurer founded in 1848 and headquartered in Chattanooga, offers a wide variety of insurance products throughout the U.S. and the U.K.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses BAC-B, DCP-B, NBR-A, OAK-A, RILYH, Unum ETDS

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 May.

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 (May's RILYH and Unum), ETDS shareholders are on the hook for the taxes. Income received from ETDSs 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, two of May's new issues pay QDI dividends (BAC-B and NBR-A).

In Context: The U.S. preferred stock marketplace

The Federal Open Market Committee is meeting again on June 12 and 13 and is widely expected to continue to raise the Federal funds rate. Doing so puts upward pressure on the dividends paid by newly introduced income securities (preferred stocks, bonds), treating today's preferred stock buyers to a long overdue income boost.

Further, upward pressure on rates puts downward pressure on the prices of previously issued lower-payers, creating additional buying opportunities for income investors.

The following chart illustrates the effect of the Fed's rate increases on the average market price of U.S.-traded preferred stocks over the last 12 months:

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 how the lower prices seen since January in the above chart have pushed up the current yield being earned by today's preferred stock investors.

U.S.-traded preferred stocks are currently returning an average current yield of 6.7 percent (blue line) while the annual return being offered to income investors by the 10-year Treasury is 2.8 percent and that of the 2-year bank CD has recovered nicely to 2.6 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.

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.

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.