The U.S. preferred stock marketplace experienced a monumental change during September and preferred stock issuers seem to have seen it coming.
Increasing rates deliver increased income to preferred stock buyers as the dividends paid by new issues go up. But increasing dividend rates means an increase in dividend expense to the issuing company. While we usually see five or six new preferred stock issues each month, we saw sixteen during September, just ahead of the Fed’s September 26 interest rate increase.
Preferred stock prices fell an average of $0.41 per share during September, delivering higher returns to today’s preferred stock buyers. The average share price of U.S.-traded preferred stocks is now $25.03, just above these securities’ $25 par value, delivering an average current yield of 6.7 percent.
September’s new issues
September’s sixteen new preferred stocks are offering an average annual dividend (coupon) of 6.4 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 (NYSE:PSA) is “PSA-A” at TD Ameritrade (NASDAQ:AMTD), Google Finance and several others but this same security is “PSA.PR.A” at E*Trade (NASDAQ:ETFC). 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 124 high quality preferred stocks selling for an average price of $24.53 (September 28), offering an average current yield of 5.64 percent. And 80 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 907 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).
Buying new shares for wholesale
Note that JPMLL from JPMorgan (JPM), ABCCL from Associated Banc-Corp (ASB) and CNPLL from CenterPoint Energy (NYSE:CNP) are still trading on the wholesale Over-The-Counter exchange (as of September 30). These are temporary OTC trading symbols until these securities move to the NYSE, 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).
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. JPMLL will probably become JPM-I, ABCCL will become ASB-E and CNPLL will become CNP-B.
About the new issues
NCZ-A from AllianzGI Convertible & Income Fund II (NCZ) is an unrated traditional preferred stock offering 5.5 percent cumulative dividends. NCZ is a closed-end fund investing at least fifty percent of its portfolio in convertible securities. The fund seeks to use capital secured at a relative low rate to invest in equity securities offering a higher rate. The $105 million in proceeds raised by NCZ-A “…will be used to refinance outstanding indebtedness or other forms of leverage.” The fund commenced operations in 2003 and is headquartered in New York City.
BHFAL from Brighthouse Financial (BHF) is rated as investment grade by S&P and offers a 6.25 percent cumulative dividend. This security is an Exchange-Traded Debt Security (green font in the above table). 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. Brighthouse is a $5.3-billion life insurance company founded in 2016 and headquartered in Charlotte, North Carolina.
MRCCL from Monroe Capital (MRCC) is an unrated ETDS offering a 5.75 percent coupon and trades on the NASDAQ Global Select exchange. Monroe is a relatively small business development company with a market cap of $280 million. Headquartered in Chicago, the company invests primarily in middle-market companies throughout North America. The $60 million in proceeds from MRCCL will be used primarily to pay down debt, which this company has plenty of. With annual revenue (2017) of $51 million, MRCC is carrying $114.4 million in debt under their ING credit facility. MRCCL is the company’s first and only income security.
RILYI from B. Riley Financial (RILY) is an unrated Exchange-Traded Debt Security offering a 6.875 percent coupon. RILYI is the company’s fifth ETDS offered within the last two years. B. Riley always strikes me as a company that has a hard time saying no. While the prospectus for RILYI does not specifically say so, the proceeds from this security may help with B. Riley’s recent acquisition of magicJack VocalTec, a company that manufactures a voice over IP telephone device. The company is in a multitude of businesses from financial services, retail store liquidation, internet domain and email hosting and, now, magicJack. Founded in 1973, B.Riley is headquartered in Woodland Hills, California.
QVCD is offered by QVC, Incorporated. But QVC, Inc. is not a publicly traded company. Rather, all of its common stock is owned by Liberty QVC Holding, LLC which, in turn, is a subsidiary of Qurate Retail Group, Inc. (QRTEA). QVC, Inc. is the outfit that sells everything from jewelry to fishing poles on cable TV, hosted by the overly friendly. As a TV-based retailer, the company’s customer base is undergoing radical change in that (1) online retail has essentially taken over and (2) younger generations do not shop on TV like previous generations. Nevertheless, the company is able to secure an investment grade S&P rating for this ETDS, offering an attractive 6.375 percent coupon. The proceeds raised by QVCD are being used to pay down debt.
DUKB from Duke Energy (DUK) is another ETDS issued during September and offers double investment grade ratings (which explains its rather miserly 5.625 percent coupon). The proceeds generated by DUKB are being used to pay down debt. Duke is a $56-billion regulated utility providing electric and gas service throughout the southern United States.
SSW-I is a traditional preferred stock from Hong Kong-based shipper Seaspan Corporation (SSW). Seaspan now has five preferred stocks and two ETDS trading on U.S. stock exchanges. Only one of these older securities is currently redeemable (SSW-D, 7.95 percent) so those holding shares do not need to be concerned about the proceeds from SSW-I being used to redeem your shares. SSW-I offers eight percent cumulative dividends until the security’s October 30, 2023, call date, at which time the rate will float based on the three-month LIBOR (currently at 2.31563 percent) plus 5.008 percent. None of Seaspan’s income securities are rated.
Shortly after the housing collapse that began in 2008, a group of senior executives spun away from Public Storage and formed American Homes 4 Rent (AMH) and, using the same capital raising strategy that they had become accustomed to, issued three new preferred stocks – AMH-A, AMH-B and AMN-C. With the proceeds, AMH bought tens of thousands of distressed homes throughout the U.S. at bargain basement prices and turned them into rental properties. With the new AMH-H, the company now has five income securities trading, all of which offer cumulative dividends.
IFFT from International Flavors & Fragrances (IFF) is the most unique preferred stock offered in September. IFF is a biotech company that produces exactly what their name says – flavors and fragrances. If you need street gravel to taste like a T-bone or need to smell like fresh ocean spray for that special someone, IFF has just the product for you. If you ever get a chance to read up on how IFF creates potions that, when sniffed or tasted, fool just the right nerves in the human brain, you will find it absolutely fascinating. IFFT has a somewhat unusual $50 par value and a call date of June 18, 2019, less than one year after its introduction (I believe this is the first time I have seen such a short call period), so no such thing as a long-term capital gain opportunity here. As a mandatory convertible preferred stock, IFFT is as complex as it is unique, so be sure to read the prospectus carefully. For example, from page 1 of the prospectus “Each Unit is comprised of (i) a prepaid stock purchase contract issued by us and (ii) a senior amortizing note due September 15, 2021 issued by us. Each amortizing note will have an initial principal amount of $8.45436 and a final installment payment date of September 15, 2021.” IFF is a $12.7-billion company founded in 1833.
CIM-C from Chimera Investment Corp. (CIM) is an unrated traditional preferred stock offering a 7.750 percent cumulative dividend until its September 30, 2025 call date. At that time, the rate will float based on the three-month LIBOR (currently at 2.31563 percent) plus 4.743 percent. CIM is a $3.5 billion mortgage REIT, meaning that rather than owning physical properties as a property REIT would, Chimera seeks to generate earnings from the spread between yields on its investments and its cost of borrowing. Its investments are bundles of mortgages (residential and commercial), many of which can be long-term in nature. Consequently, during periods of increasing interest rates, the shorter-term cost of borrowing tends to increase while revenues tend to be locked in at lower rates for longer periods of time. This math often squeezes the earnings of mortgage REITs, requiring nimble management of their investment portfolio (often moving toward bundles of variable rate and/or shorter-term mortgages).
NCV-A raises $100 million for the AllianzGI Convertible & Income Fund (NCV), following closely on the heels of NCZ-A introduced by AllianzGI Convertible & Income Fund II earlier in the month (the Roman numeral “II” being just about the only difference between the two). NCV-A pays a slightly more generous coupon at 5.625 percent compared to its more miserly NCZ-A cousin at 5.5 percent. Comparing the two prospectuses, the fund description, use of proceeds and investment objectives and policies of these two funds are identical (see my notes regarding NCZ-A above).
JPMLL from JPMorgan Chase is currently trading on the Over-The-Counter exchange, so this is a temporary trading symbol. The permanent NYSE symbol has yet to be assigned, but will probably be JPM-I although JPMorgan has issued so many preferred stocks for so many years, all conceivable symbols, including JPM-I, have been previously used. Consequently, be very careful when reviewing information related to this Series DD security. After being absent from the preferred stock market since 2015, JPMorgan issued JPMLL on September 17, generating about $1.5 billion in net proceeds. JPM now has seven preferred stocks trading. As with all bank-issued preferred stocks since the Dodd-Frank legislation was passed in July 2010, JPMLL dividends are non-cumulative. JPM is a $396 billion “Too-Big-To-Fail” bank founded in 1799.
CNFRL is an unrated ETDS from Conifer Holdings (CNFR), offering a 6.75 percent coupon. Note that as I am writing this on Friday, September 28, CNFRL has yet to start trading ($0.00 last price and volume in the above table), but should start shortly on the NASDAQ Global Market exchange. Conifer is a newcomer to the income security market with CNFRL being its first issue. Founded in 2009, Conifer is a small $48-million property and casualty insurance company headquartered in Birmingham, Michigan.
ABCCL/ASB-E from Associated Bancorp. offers a Moody’s investment grade rating and 5.975 percent non-cumulative dividends. The company has two other nearly identical preferreds trading, none of which are redeemable until at least June of 2020. ASB is using the $100 million proceeds from this security to repurchase common stock. ASB is a regional bank offering banking services through 270 banking locations throughout Wisconsin, Illinois and Minnesota. Profitability, cash flow, cash on hand, current ratio and other financial metrics are impressive here. The $4.6-billion company was founded in 1861 and is headquartered in Green Bay.
HCXY from Hercules Capital, Inc. (HTGC) is an unrated ETDS offering a 6.25 percent fixed coupon. HCXY is the company’s second ETDS issue within the last six months, with HCXZ being issued last April at 5.25 percent (illustrating the upward pressure on interest rates). Hercules also has a third ETDS currently trading. Originally issued in July 2014, HTGX became callable last April. Hercules is a $1.2-billion venture capital firm located in Palo Alto, California. While the firm was originally focused on technology start-ups, it has since branched into so many areas that the company’s organization chart on page S-2 of HCXY’s prospectus looks more like a nuclear power plant wiring diagram. Some of the $40 million proceeds from the new HCXY may go toward partially redeeming HTGX shares but the prospectus is not specific on this point.
CNPLL/CNP-B from CenterPoint Energy Inc. is one of the most complex securities, and took one of the most tortured paths to market, that I have ever seen. CNP introduced this mandatory convertible preferred stock simultaneously with a common stock offering in order to fund the pending merger of CenterPoint Energy, Vectren Corporation and Pacer Merger Sub, Inc. (and Pacer is currently a subsidiary of CenterPoint Energy just to make it easier for everyone). The underwriters for this deal originally purchased the preferred stock shares from CNP in August (so that was the published IPO date at that time) with a preliminary SEC filing stating that CNPLL/CNP-B “…is a new issue of securities with no established trading market. We do not intend to list the Series A Preferred Stock on any national securities exchange or to arrange for quotation on any automated dealer quotation systems.” So that was the end of that until Wednesday, September 27, when the OTC exchange assigned a temporary trading symbol (CNPLL), the IPO date was updated to September 24 (no indication as to why) and these preferred stock shares began trading, despite the August declaration that they would not. Further, the updated 424B5 SEC filing (one of several) provides a multi-page table for figuring out how one is to convert CNPLL/CNP-B shares into CNP common stock shares down the road. After half an hour, I stopped trying to figure it out. My guess is that these shares were originally intended for private placement as part of the merger deal but were subsequently designated for public trading as an afterthought.
Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: NCZ-A, BHFAL, MRCCL, RILYI, QVCD, DUKB, AMH-H, SSW-I, IFFT, CIM-C, NCV-A, JPMLL, CNFRL, ABCCL/ASB-E, HCXY, CNPLL/CNP-B
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.
Traditional preferred stock dividends are typically paid out of pre-tax profits so are taxable as regular income; you pay the full tax since the company has not (IFFT). The same is true for dividends received from partnerships since each partner is responsible for their own tax obligations.
Companies incorporated as REITs (AMH-H, CIM-C) 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 (BHFAL, MRCCL, RILYI, QVCD, DUKB, CNFRL, HCXY), 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, six of September’s new issues pay QDI dividends (NCZ-A, SSW-I, NCV-A, JPMLL, ABCCL/ASB-E, CNPLL/CNP-B).
In Context: The U.S. preferred stock marketplace
Preferred stock prices have been artificially elevated for several years, but that ended in September. September was a pivotal month for preferred stock investors as the upward pressure on rates finally produced a meaningful price correction for U.S. preferred stocks. The average market price for U.S.-traded preferred stocks is now at $25.03, just above these securities’ $25 par value. With their September 26 declaration that their monetary policy is “no longer accommodative,” the Fed is finally leaving our market to its participants (buyers and sellers).
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.
The 10-year treasury finally broke through the three percent barrier for only the second time in the last twelve months.
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 3.1 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 September preferreds on September 30. It is into this marketplace that September’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.