New Preferred Stock IPOs, November 2018

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Includes: BHR, BHR.PD, ESGR, GLAD, GLADD, GLOP, GLOP.PC, WHF, WHFBZ
by: Doug K. Le Du
Summary

Five new preferred stocks were introduced during November, offering an average annual dividend of 7.3 percent.

There are currently 126 high quality preferred stocks selling for an average price of $23.21 per share (investment grade, cumulative dividends).

95 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 7.2 percent.

The Federal Open Market Committee is scheduled for a two-day meeting December 18 and 19 and is widely expected to increase the federal funds rate for the fourth time this year.

As rates go up, market prices of fixed-return income securities (preferreds, bonds) come down, creating a buyer-friendly market for preferred stock investors.

For preferred stock buyers, upward pressure on interest rates boosts the dividends paid by new issues, increasing your income, and lower prices bring not only cash savings on your share purchases but higher yields since you earn the same dividend income without having to invest as much of your cash; your income, cash balance and yield all respond favorably to the Fed’s interest rates increases.

I’ll show you a chart of this shortly, but in response to increasing rates, the average market price of U.S.-traded preferred stocks fell by $1.89 per share this year, now sitting at $23.79, creating the best opportunity for preferred stock buyers that we have seen since 2016.

Importantly, note that $23.79 is below these securities’ $25 par value. Remember that the par value is what shareholders will receive in cash should the issuing company decide to redeem your shares so buying shares below par sets you up for a downstream capital gain on top of the regular dividend income provided by these securities.

November’s new issues

November’s five new preferred stocks are offering an average annual dividend (coupon) of 7.3 percent compared to 7.0 percent from October’s new issues.

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.

Regarding BHRPP: Notice that I am using the temporary OTC symbol BHRPP for the new preferred stock from Braemar Hotels and Resorts (BHR). By the time you read this, this security will probably have started trading under its permanent NYSE symbol BHR-D. If you are looking for information on this security, be extra careful that you are using the current symbol.

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 and “PSA.PA” at Seeking Alpha. 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 126 high quality preferred stocks selling for an average price of $23.21 (November 30), offering an average current yield of 6.0 percent. And 95 of these high quality issues are selling below their $25 par value, also 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 897 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that BHRPP from Braemar Hotels and Resorts and ESGRL from Enstar Group (ESGR) are still trading on the wholesale Over-The-Counter exchange (see above note regarding BHRPP). These are temporary OTC trading symbols until these securities move to their retail exchange (NYSE and NGS, respectively), at which time they will receive their permanent symbols.

But there is no need to wait. 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. BHRPP will become BHR-D and ESGRL will become ESGRO.

About the new issues

GLADD (GLADD) from Gladstone Capital Corporation (GLAD) is an unrated Exchange-Traded Debt Security (green font in the above table) offering a 6.125 percent coupon. 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. Gladstone is incorporated as a business development corporation, investing in small to middle-market companies. GLADD was introduced on November 1, ten days prior to the company’s November 11 quarterly filing. The filing disclosed that FDF Energy, which GLAD has a significant stake in, filed for bankruptcy on September 29. GLADD is the company’s second ETDS offering within the last fourteen months.

GLOP-C (GLOP.PC), issued by GasLog Partners LP (GLOP) offers the fixed-to-float rate structure and pays a fixed 8.5 percent dividend until its March 15, 2024 call date. The rate becomes variable at that time, calculated by adding 5.317 percent to the then-current three-month LIBOR rate. GasLog, founded in 2014 and headquartered in Monaco, charters its fleet of twelve LNG tankers. With multi-year leases, it is unclear how shorter-term energy price fluctuations affect the company. GLOP-C is the company’s third income security issued within the last eighteen months, with two new issues this year. Note that GasLog is structured as a foreign limited partnership. Those considering buying GLOP-C shares should consult a tax specialist regarding the taxation and reporting requirements of income from such securities.

WHFBZ (WHFBZ), an Exchange-Traded Debt Security, was issued by WhiteHorse Finance, Inc. (WHF) on November 8 but did not start trading on the NGS exchange until November 30. WhiteHorse has a market cap of $270 million and is incorporated as a business development company providing debt financing to small, privately held companies. WHFBZ raised about $33 million with which the company intends to further its invested portfolio and reduce Credit Facility debt.

BHRPP/BHR-D (NYSE:BHR.PD) from Braemar Hotels and Resorts (BHR) is an unrated traditional preferred stock offering 8.25 percent dividends. Dividends from BHR-D are cumulative meaning that if the company misses a dividend payment to you, they still owe you the money (their obligation to pay you accumulates). In January 2017 the company announced a revised strategy to realign its hotel portfolio around luxury properties. That announcement has been followed by a series of well-timed property sales, acquisitions and upgrades. According to Smith Travel Research, 2018 revenue per available room for luxury-class properties is up 4.9 this year, compared to 3.1 percent for the industry overall. On the downside, hurricane Irma significantly damaged BHR’s Ritz-Carlton St. Thomas with the company working through $3.8 million in insurance recoveries on the property during the last quarter.

ESGRL/ESGRO (ESGRO) comes from Enstar Group Limited (ESGR). This security offers a BB+ S&P rating with a fixed 7.0 percent coupon paying non-cumulative dividends. Enstar, founded in 2001, is a diversified international insurance company with a $3.8 billion market cap and is headquartered in Bermuda. North American hurricanes usually mean bad news for property and casualty insurers, with those based in Bermuda getting a front row seat. On the upside, Enstar has some pretty solid financials with impressive profitability and net cash flow. ESGRL/ESGRO is the company’s second income security issued within the last five months.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: GLADD, GLOP-C, WHFBZ, BHR-D, ESGRL/ESGRO

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.

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 (BHR-D).

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).

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 (GLADD, WHFBZ), 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, the prospectuses for two of November’s new issues state that their dividends are QDI-qualified (GLOP-C from GasLog Partners and ESGRL/ESGRO from Enstar Group).

In Context: The U.S. preferred stock marketplace

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.

U.S.-traded preferred stocks are currently returning an average current yield of 7.2 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 caught up to the 10-year treasury once again at 3.0 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new November preferreds on November 30. It is into this marketplace that November’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.