New Preferred Stock IPOs, July 2018

Summary

• Four new preferred stocks were introduced during July, offering an average annual dividend of 6.5 percent.
• There are currently 121 high quality preferred stocks selling for an average price of $25.08 per share (investment grade, cumulative dividends).
• 52 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.

Preferred stock prices have fallen an average of $0.50 per share so far this year, delivering higher returns to today’s preferred stock buyers. Continuing upward pressure on interest rates is likely to put additional downward pressure on preferred stock prices. But demand for these securities remains high, keeping the average market price at $25.36, $0.36 per share above par.

July’s new issues

July’s four new preferred stocks are offering an average annual dividend (coupon) of 6.5 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 $25.08 (July 31), offering an average current yield of 5.51 percent. And 52 of these high quality issues are selling below their $25 par value offering an average current yield of 5.33 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 901 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that KYYCP from KeyCorp (KEY) is still trading on the wholesale Over-The-Counter exchange (as of July 31). This is a temporary OTC trading symbols until this security moves to the NYSE, at which time it 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. KYYCP will become KEY-J.

About the new issues

SRE-B from Sempra Energy (SRE) is July’s only convertible preferred stock. 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. Southern California Gas is a subsidiary of Pacific Enterprises which, in turn, is a subsidiary of Sempra Energy. Sempra has four preferred stocks trading, including two issued by Southern California Gas many years ago. SRE-B, with a par value of $100 per share, is the company’s second preferred stock issued this year and offers cumulative dividends (if the company misses a dividend payment, they still owe you the money; their obligation to you accumulates).

ETP-D from Energy Transfer Partners, L.P. (ETP) is a Ba2/BB rated traditional preferred stock using the fixed-to-floating dividend rate structure and cumulative dividends. With this structure, this security offers a fixed 7.625 percent coupon until its August 15, 2023 call date. At that time, the coupon varies based on the three-month LIBOR rate (currently 2.34250 percent) plus 4.738 percent. Note that ETP is a limited partnership, meaning that ETP-D 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. ETP-D is the company’s second preferred stock issued this year.

Bank of America (BAC) was back in the preferred stock market during July for the second month in a row with its 5.875 percent non-cumulative Series HH preferred stock, BAC-K, raising net proceeds of about $835 million. This non-cumulative security offers an investment grade rating from S&P (BBB-). The proceeds from last month’s mega preferred, BAC-B, were used to redeem several older issues and the same is true of this month’s BAC-K. In a July 26 press release, BAC announced that it will be redeeming all outstanding shares of BML-I (6.375 percent, originally issued by Merrill Lynch) and BAC-D (6.204 percent).

KYYCP/KEY-J from KeyCorp (KEY) offers an investment grade rating (Baa3 from Moody’s) and a somewhat miserly 5.650 percent fixed dividend. This security is similar to BAC’s BAC-K in many ways, but its comparatively low coupon probably explains why buyers have been discounting the pricing of the new KEY issue since its introduction on July 24. As with BAC-K, the dividends for KYYCP/KEY-J are non-cumulative. KEY has one other preferred stock trading, issued in 2016 at 6.125 percent. Most recently, KEY sold its insurance business to USI Insurance, producing a gain of $78 million on the sale. The bank also noted during July that its 2016 acquisition of First Niagara Financial Corp. has finally produced the hoped for $450 million annualized cost savings. KeyCorp was founded in 1849 and is headquartered in Cleveland.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses SRE-B, ETP-D, BAC-K, KYYCP/KEY-J

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). The same is true for dividends received from partnerships since each partner is responsible for their own tax obligations (ETP-D).

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, 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, three of July’s new issues pay QDI dividends (SRE-B, BAC-K, KYYCP/KEY-J).

In Context: The U.S. preferred stock marketplace

After an initial $0.25 spike upward in early-July, U.S. preferred stock prices came right back down throughout the rest of the month, providing some price relief to today’s buyers by ending slightly lower. Since most U.S.-traded preferred stocks offer a fixed dividend, paying less for your shares delivers an increase in your rate of return in addition to the cash savings. The price settled at $25.36 per share, down $0.17 from the month’s high.

The following chart illustrates the average market price of U.S.-traded preferred stocks over the last twelve 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 3.0 percent and that of the 2-year bank CD has recovered nicely to 2.8 percent.

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.

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.

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.