New Preferred Stock IPOs, April 2019

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Includes: ET, KEY, KEYLL, RF, RXFCL, SOHEP, SOHO
by: Doug K. Le Du
Summary

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

There are currently 124 high quality preferred stocks selling for an average price of $25.49 per share (investment grade, cumulative dividends).

35 of these high-quality issues are now selling below their $25 par value, offering an average current yield of 5.4 percent.

U.S.-traded preferred stocks are now returning an average current yield of 6.8 percent.

Compared to March’s fourteen new preferred stock issues, April was a quiet month. Just four new preferred stocks were introduced during April. But even with this small group, there was some diversity – two pay tax-advantaged dividends while one offers an investment grade rating. There is industry diversity to be found here, too – one property REIT, one energy partnership and two regional banks.

As the month came to a close, the average market price for all U.S. traded preferred stocks was $25.13, up $0.20 per share over the last month.

April’s new issues

April’s four new preferred stocks are offering an average annual dividend (coupon) of 6.8 percent, an average current yield (which does not consider reinvested dividends or capital gain/loss) of 6.8 percent and an average Yield-To-Call (which does consider reinvested dividends and capital gain/loss) of 6.7 percent (using April 30 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 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 124 high quality preferred stocks selling for an average price of $25.49 (April 30), offering an average current yield of 5.5 percent. And 35 of these high-quality issues are selling below their $25 par value, offering an average current yield of 5.4 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 909 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that KEYLL (OTCPK:KEYLL) from KeyCorp (KEY) and RXFCL (OTCPK:RXFCL) from Regions Financial Corporation (RF) 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. KEYLL will become KEY-K (NYSE:KEY) and RXFCL will become RF-C (RF.PC).

About the new issues

SOHEP (OTCPK:SOHEP) is an unrated traditional preferred stock from Sotherly Hotels, Inc. (SOHO). Sotherly Hotels, Inc. owns approximately 89% of the units of limited partnership interest in the company’s operating partnership, Sotherly Hotels LP. In February 2018, the partnership issued SOHOK, an Exchange-Traded Debt Security (baby bond) at 7.25 percent with a February 15, 2019 call date. The partnership wants to redeem SOHOK, so it is selling preferred stock units to Sotherly Hotels, Inc. in a private placement transaction (converting 7.25 percent debt into 8.25 percent equity on the partnership’s books). Those holding the partnership’s SOHOK shares should expect a redemption announcement shortly. In turn, to generate the cash needed to purchase these private placement preferred units from its operating partnership, Sotherly Hotels, Inc. issued SOHEP on April 11, paying 8.25 percent cumulative dividends. Sotherly is a $105 million hotel REIT established in 2004.

ETP-E (OTCPK:ETP.PE) is an unrated traditional preferred stock issued by Energy Transfer Operating, LP (ET). Over the last two years there have been a variety of mergers and acquisitions that created this partnership. To summarize, in April 2017 Energy Transfer Partners, LP merged with Sunoco Logistics. Then on October 19, 2018, Energy Transfer Partners, LP, trading as ETP, merged with Energy Transfer Equity, LP. With this merger, ETP changed its symbol to ET and, just to avoid any confusion, its name to Energy Transfer Operating, LP. ETP had two preferred stocks trading at the time which kept their original trading symbols – ETP-D and ETP-E – and are still trading today under those symbols. And even though the company’s common symbol is now ET, they requested that the NYSE assign the symbol ETP-E to this new preferred stock. Imagine working the phones in their Investor Relations department. ET is using the proceeds from this new issue to pay down debt. This security offers cumulative dividends using the fixed-to-float rate structure, paying 7.60 percent until its May 15, 2024 call date. The rate becomes variable at that time, using the three-month LIBOR rate (currently at 2.58 percent) plus 5.161 percent. Page S-23 of the prospectus explains how the floating rate will be calculated should the 3-month LIBOR become unavailable. This $40 billion company owns and operates a variety of natural gas pipelines and storage facilities throughout the US and China.

KEYLL/KEY-K from KeyCorp offers an investment grade rating (Baa3 from Moody’s) and a somewhat miserly 5.625 percent fixed dividend. Its comparatively low coupon probably explains why buyers have been discounting the price, as this security has failed to reach its $25 par value during OTC trading. The dividends for KEYLL/KEY-K are non-cumulative. KEY has two other preferred stocks trading, KEY-I issued in 2016 at 6.125 percent and KEY-J issued last summer at 5.65 percent. Most recently, KEY sold its insurance business to USI Insurance, producing a gain of $78 million on the sale. KeyCorp is a $17.5 billion regional bank founded in 1849 and is headquartered in Cleveland.

RXFCL/RF-C is a traditional preferred stock from Regions Financial Corporation paying non-cumulative dividends. RXFCL is one of three income securities currently trading from Region’s, with the other two having the symbols RF-A and RF-B. RXFCL/RFP-C uses the fixed-to-floating rate structure with the dividend rate being 5.7 percent until August 15, 2029. Normally, the dividend rate paid by preferred stocks using this rate structure begins floating on the security’s call date (May 15, 2029 in this case) so that the company is able to redeem the shares if the resulting rate floats too high (can’t have that happening). But I believe this is the first case I have seen where the rate begins floating on a different date, three months after the call date in this case. By the way, RF-A, paying a fixed 6.375 percent, became callable a long time ago (December 15, 2017), but Regions has not called it (although they certainly could at any time so be careful here). While I was expecting the company to use the proceeds of the new RXFCL/RF-C to redeem all RF-A shares, the Use of Proceeds section of the prospectus says nothing about doing so. RF is a $16 billion regional bank founded in 1852 and headquartered in Birmingham, Alabama.

Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: SOHEP, ETP-E, KEYLL/KEY-K, RSFCL/RF-C

Preferred Stock Tax treatment

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 (ETP-E).

Companies incorporated as REITs (OTCPK:SOHEP) 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 (no ETDS’ were issued during April).

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 April’s new issues state that their dividends are QDI-qualified (KEYLL, RXFCL).

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 2.5 percent and that of the 2-year bank CD has turned the yield curve upside down at 2.8 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 April preferreds on April 30. It is into this marketplace that April’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.