New Preferred Stock IPOs, March 2019

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Includes: AFG, AFGB, AFIN, AFINP, AI, AIG, AIG.PA, BC, BC.PC, BHF, BPY, BPYPP, DLR, DLR.PK, DUEKL, DUK, MBIN, MRBPP, NEE, NGL, NGLPP, OCCI, OCCIP, TRTN, TRTN.PA
by: Doug K. Le Du
Summary

Fourteen new preferred stocks were introduced during March, offering an average annual dividend of 6.9 percent.

There are currently 123 high quality preferred stocks selling for an average price of $24.38 per share (investment grade, cumulative dividends).

39 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 6.8 percent.

March delivered a spectacular crop of new preferred stock issues, almost all of which are offering cumulative dividends and half come with investment grade ratings. Last December no new preferreds were issued; for January I described only four new preferreds while February’s preferred stock market delivered a slightly better six new issues. During March, fourteen new preferred stocks were issued (and began trading by press time).

As the month came to a close, the average market price for all U.S. traded preferred stocks was $24.93, up $0.21 per share over the last month.

The good news is that $24.93 is still below these securities’ $25.00 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.

March’s new issues

March’s fourteen new preferred stocks are offering an average annual dividend (coupon) of 6.9 percent, an average current yield (which does not consider reinvested dividends or capital gain/loss) of 6.9 percent and an average Yield-To-Call (which does consider reinvested dividends and capital gain/loss) of 6.8 percent (using March 29 prices).

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 (NASDAQ:AMTD), 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 123 high quality preferred stocks selling for an average price of $24.38 (March 29), offering an average current yield of 5.5 percent. And 39 of these high-quality issues are selling below their $25 par value, offering an average current yield of 5.5 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 is now a total of 905 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that OCCIP from OFS Credit Company (OCCI), MRBPP from Merchants Bancorp (MBIN), AFINP from American Finance Trust (AFIN), DUEKL from Duke Energy (DUK) and NGLPP from NGL Energy Partners LP (NGL) are still trading on the wholesale Over-The-Counter exchange. OTC trading symbols are typically temporary until these securities move to their retail exchange, 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. OCCIP will keep this symbol as it moves to the NCM, MRBPP will become MBINP, AFINP will keep this symbol, DUEKL’s new NYSE symbol has yet to be specified and NGLPP will become NGL-C.

About the new issues

Fourteen new issues; okay, here we go…

DLR-K (DLR.PK) is a traditional preferred stock offered by Digital Realty (DLR.PK) with an investment grade rating from Moody’s Investors Service. DLR has six preferred stocks trading on U.S. stock exchanges, although it is using the $200 million proceeds from DLR-K (5.850 percent) plus cash on hand to redeem all outstanding shares of DLR-H (7.375 percent) on April 1, saving the company about $3 million per year in dividend expense. DLR is incorporated as a property REIT specializing in data centers with properties throughout North America, Europe, Asia and Australia. With cloud and mobile computing demand pushing expansion, the company has announced a joint venture with Mitsubishi, purchasing a five-acre parcel in Tokyo upon which it will build a new data center hub. DLR-K pays cumulative dividends.

AI-C is an unrated traditional preferred stock from Arlington Investment Corporation (AI). This security offers cumulative dividends using the fixed-to-float rate structure, paying 8.25 percent until its March 30, 2024, call date. The rate becomes variable at that time, using the three-month LIBOR rate (currently at 2.59 percent) plus 5.664 percent. Page S-17 of the prospectus explains how the floating rate will be calculated should the 3-month LIBOR become unavailable. AI is a $300-million mortgage REIT, meaning that rather than owning physical properties as a property REIT would, the company seeks to generate earnings from the spread between yields on its investments and its cost of borrowing. Its investments are bundles of mortgages (primarily residential), 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). Looking at the March price chart for AI-C, it looks like its underwriters completely blew the 8.25 percent coupon as this security has traded well below its $25 par value since its March 5 introduction.

NEE-N is offered by NextEra Capital Holdings (NEE), the latest of the company’s five income securities that are currently trading on U.S. stock exchanges. NEE-N is a double-investment grade Exchange-Traded Debt Security offering a 5.650 percent coupon (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 may be listed on brokerage statements as such. NEE generates and distributes 24,500 megawatts of electricity throughout North America. The $582 million proceeds from NEE-N are expected to be used to reduce debt, including the outstanding obligation from its purchase of Gulf Power on January 1, 2019 (due June 25, 2019). The company was founded in 1925 and is headquartered in Juno, Florida.

Global insurer American International Group (AIG) re-entered the preferred stock market during March with the introduction of AIG-A (AIG.PA), a double-investment grade traditional preferred stock. AIG-A offers a cumulative 5.85 percent annual dividend. “Cumulative” dividends are those that can be deferred but not suspended. Put another way, if the company misses a dividend payment they still owe you the money (their obligation to you accumulates). AIG is a $38-billion insurer founded in 1919 and headquartered in New York City.

BC-C (BC.PC) is a 6.375 percent ETDS from Brunswick Corporation (BC) offering double-investment grade ratings. The next time you’re hauling in a bass from a Boston Whaler or jumping a double wake behind a Bayliner with a big Mercury outboard, thank Brunswick. Or while you are telling exaggerated stories of your greatness over a game of pool, don’t forget to notice that the table is almost certainly made by this company. BC is the Procter & Gamble (NYSE:PG) of recreational products; there’s very little outdoor or indoor fun you can have without coming into contact with something they make. Brunswick has three income securities trading, all of which were introduced within the last six months. Established in 1824, this $5.1 billion company is headquartered in Mettawa, Illinois.

AFGB (AFGB) is from property and casualty insurer American Financial Group (AFG). As an ETDS offering double-investment grade ratings and cumulative interest, this security is very similar to Brunswick’s BC-C. The most obvious difference is in AFGB’s miserly 5.875 percent interest rate, compared to BC-C’s 6.375 percent. AFGB is the third income security that AFG has introduced within the last five years. AFG is a $8.7 billion company founded in 1872 and headquartered in Cincinnati.

TRTN-A (TRTN.PA) is offered by Triton International Ltd. (TRTN), the world’s largest lessor of shipping containers and chassis. Coming off of a multi-year container glut, Triton posted a 25 percent profit margin on December 30, 2018, and managed to beat analysts EPS estimates every quarter last year. While the company’s operating performance is enviable, its whopping $7.5 billion long-term debt probably explains in large measure the meager B+ rating from S&P. During March the company executed a common share buyback, whereby all 7.1 million shares held by Warburg Pincus LLC were sold to underwriter Morgan Stanley (NYSE:MS), with Triton then buying 1.5 million of these shares from MS. TRTN’s common stock has lost about 10 percent of its value since March 1. This indirect buyback burned about $45 million of the $75 million generated by the TRTN-A preferred stock introduction. TRTN-A is the company’s first and only income security. TRTN is a $2.4-billion company founded in 1980 with headquarters in Bermuda.

BPYPP (BPYPP) is from Brookfield Property Partners L.P. (BPY) offering 6.5 percent cumulative dividends and a BB+ speculative grade rating from S&P. This issuer is a partnership so holders of their preferred stock units will receive at least one K-1 at tax time (rather than form 1099). In February 2019, BPY announced its intent to buy back up to $405 million of its LP units (analogous to common stock) from unitholders. This offer expired on March 25, 2019. While the BPYPP prospectus does not specify how the company will use the proceeds from this preferred stock introduction, the $184-million coming from this new income security would presumably go toward the unit buyback, should the offer be taken up by unitholders. BPY is a $17-billion commercial real estate company headquartered in Bermuda.

BHFAP is an investment grade traditional preferred stock from life insurance company Brighthouse Financial (BHF). BHFAP pays a non-cumulative 6.6 percent dividend. 2018 was BHF’s first full-year operating as an independent company after its separation from MetLife (NYSE:MET). Brighthouse became an independent company in 2017. By any measure, operating as an independent company has been good for Brighthouse. Throughout 2018, the company grew top-line revenue from $1.8B in Q1 to $3.9B in Q4. Net income grew from a $67-million loss in Q1 to a $1.4 billion gain in Q4. And all while expanding cash on hand from $1.9 billion to $4.1 billion by year-end. And this is after the company embarked on an aggressive common stock buyback throughout 2018, purchasing $105 million in shares last year and another $19 million during January 2019. BHF has no debt maturing prior to 2024. Oddly, in the face of this strong performance, the common has lost about 30 percent of its value over the last year. BHFAP is the company’s second income security introduced within the last six months.

OCCIP (OCCIP) is an unrated “term” preferred stock issued by OFS Credit Company, Inc. paying a 6.875 percent dividend. Most preferred stocks are “perpetual” preferreds, meaning that they will continue to trade until the issuer redeems them, if ever (they trade perpetually). A “term” preferred stock, on the other hand, is one that the issuer is required to call on a specific future date (i.e., the shares will only trade for a specific term). Only about 25 percent of U.S.-traded preferred stocks are term preferreds. OCCIP has an optional call date of March 31, 2021, meaning that the company regains the right to redeem the shares for par on that date, but is not required to do so. The term date is March 21, 2024; the shares will be called on that date. This security is currently trading on the Over-The-Counter exchange as OCCIP but the Term Sheet indicates that the company has applied for the shares to trade on the NASDAQ Capital Markets exchange using the same symbol. OCCIP is also a monthly dividend payer. No specification is made regarding whether the dividends are cumulative or non-cumulative, so assume non-cumulative. From their website: “OFS Credit Company, Inc. is a newly-organized, non-diversified, closed-end management investment company. The Company’s investment objective is to generate current income, with a secondary objective to generate capital appreciation primarily through investment in collateralized loan obligation equity and subordinated debt securities.”

MRBPP/MBINP (OTCPK:MRBPP) from Merchants Bancorp is an unrated traditional preferred stock paying non-cumulative 7.0 percent dividends using the fixed-to-float rate structure. The rate becomes variable on the security’s April 1, 2024, call date, using the three-month LIBOR plus 4.605 percent. Page S-14 of the prospectus explains how the floating rate will be calculated should the 3-month LIBOR become unavailable. Merchants is a $543-million regional bank headquartered in Indiana with 14 offices. MRBPP/MBINP is the company’s only income security, raising $50 million in gross proceeds. No specific use for the proceeds of this new security was provided by the company (“general corporate purposes”). Importantly, but perhaps coincidentally, MBIN has lost about a third of its value since last summer despite impressive financial performance and plenty of cash on hand. The bank was established in 1990.

AFINP (AFINP) from American Financial Trust is an unrated traditional preferred stock paying cumulative 7.5 percent dividends. AFINP is the company’s only income security. AFIN is a $1.1-billion REIT focused on retail property acquisition and management. The company has an aggressive growth strategy, closing 130 property acquisition during 2018 with an average remaining lease period of over 15 years. The company also sold 19 properties in the fourth quarter of 2018, 14 of which were dogs (unleased). $15.5 million of the $46.4 million of proceeds from these 19 sales went to pay down debt. While top-line revenue growth has been impressive for several years, earnings have alluded the company, explaining at least in part the six-month-slide in the company’s stock price. Another drag is pending shareholder litigation against the company with complainants claiming that the company was less than forthcoming with material information related to its 2016 merger with American Realty Capital. AFIN is headquartered in New York City.

Go big or stay home! DUEKL (OTCPK:DUEKL) is from Duke Energy. While the company has two ETDS already trading, DUEKL is a double-investment grade traditional preferred stock offering 5.750 percent cumulative dividends. DUEKL is a temporary OTC exchange symbol; the prospectus does not specify what the permanent NYSE symbol will be, once assigned. DUEKL is one of the largest income securities issued since the financial crisis ten years ago, raising a whopping $1 billion for Duke. And this while centerfielder Mike Trout was able to convince the Los Angeles Angels to pay him $430 million and the Troutster did not even need to issue any type of income security (catch the ball, throw it to the cut-off man). It took an underwriting group of twenty-one investment bankers to come up with the cash to buy the 40 million DUEKL shares from Duke. Duke is a $66-billion regulated electric utility primarily serving the southeast and the midwest United States.

NGLPP/NGL-C (OTCPK:NGLPP) from NGL Energy Partners, LP is an unrated 9.625 percent traditional preferred stock paying cumulative dividends. The 9.625 percent coupon rate will reset on the security’s April 15, 2024, call date to a variable value based on the then-current three-month LIBOR plus 7.384 percent. Prospectus page S-18 describes how the rate will be set in the event that the LIBOR rate becomes unavailable. NGL is a $1.7-billion partnership organized into crude oil logistics, water solutions, liquids, retail propane, and refined products and renewables businesses. As a partnership, NGLPP/NGL-C shareholders will receive a K-1 form at tax time, rather than a 1099. The company has struggled to post a profit for several years. Although Q4/2018 was solid, NGL’s $23 million in cash seems meager for a $1.7-billion business. NGL was founded in 1940 and is headquartered in Tulsa, Oklahoma.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: DLR-K, AI-C, NEE-N, AIG-A, BC-C, AFGB, TRTN-A, BPYPP, BHFAP, OCCIP, MRBPP/MBINP, AFINP, DUEKL, NGLPP/NGL-C

Preferred Stock Tax treatment

The 2017 Tax Relief Act included a provision aimed at small businesses that is also going to deliver an enormous benefit to those holding shares of preferred stocks issued by REITs (which is pretty much all of us). Most small businesses are incorporated as a Limited Liability Corporation (LLC). Under this structure, the company’s earnings are passed through to the owners who then pay the tax on their personal returns. The Act allows those receiving such income to deduct, right off the top, up to twenty percent of this “pass-through income.”

But remember that REITs do the same thing as LLCs – at least 90 percent of a REIT’s earnings are passed to the REIT’s shareholders primarily in the form of preferred stock dividends; the shareholders then pay the tax on their personal returns. In other words, preferred stock dividends received from REITs qualify under the Act’s “pass-through income” provision and are therefore up to twenty percent deductible. Put another way, you can reduce your taxable dividend income from REIT dividends by up to twenty percent under the 2017 Tax Act. Check your 1099s for a line labeled “Section 199A dividends” and be sure to consult your tax accountant.

The tax treatment of the taxable 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 paid by partnerships as pass-through income or are otherwise paid out of pre-tax profits are taxable as regular income; you pay the full tax since the company has not (BPYPP, NGLPP/NGL-C).

Companies incorporated as REITs (DLR-K, AI-C, AFINP) 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, taxable 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, ETDS shareholders are on the hook for the taxes. Income received from ETDS’ is taxed as regular income (NEE-N, BC-C, AFGB).

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 six of March’s new issues state that their dividends are QDI-qualified (AIG-A, TRTN-A, BHFAP, OCCIP, MRBPP/MBINP, DUEKL).

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 6.8 percent (blue line) while the annual return being offered to income investors by the 10-year treasury is 2.4 percent and that of the 2-year bank CD has turned the yield curve upside down at 3.0 percent (shorter term money very rarely offers a higher return than longer term money).

For comparison, I have set the Yield column in the first table above to show the current yield of the new March preferreds on March 29. It is into this marketplace that March’s new issues were introduced.

Disclosure: I am/we are long BC.PC. 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.