The yield curve tipped upside down during May, with longer-term treasuries now paying less than shorter-term notes. The downward pressure on longer-term yields spilled over into the U.S. preferred stock marketplace, pushing prices of U.S.-traded preferred stocks up with strong demand. For the first time in quite a while, seven preferred stocks traded over 500,000 shares on Friday, May 31, with two issues trading over one million shares on that day (the average daily volume for U.S.-traded preferred stocks runs around 35,000 shares).
As the month came to a close, the average market price for all U.S.-traded preferred stocks was $25.19, up $0.06 per share over the last month.
May’s new preferred stocks
May’s six new preferred stocks are offering an average annual dividend (coupon) of 6.1 percent, an average current yield (which does not consider reinvested dividends or capital gain/loss) of 5.9 percent and an average Yield-To-Call (which does consider reinvested dividends and capital gain/loss) of 5.7 percent (using May 31 prices).
Note that TRCBP (TRCBP) from TriState Capital Holdings (TSC) will trade on the NASDAQ Global Select exchange. While introduced on May 22, this security had yet to start NGS trading on May 31 under this NGS symbol, so the Last Price and Yield values are shown as zero in the above table.
Also, 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, 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 122 high quality preferred stocks selling for an average price of $25.46 (May 31), offering an average current yield of 5.4 percent. And 25 of these high-quality issues are selling below their $25 par value, offering an average current yield of 5.0 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 is now a total of 908 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).
About the new issues
NRUC (NYSE:NRUC) is a double-investment grade Exchange-Traded Debt Security offered by National Rural Utilities Coop Finance Corporation. NRUCFC is a cooperative of rural electric utilities, formed for the purpose of providing cost-efficient financial services and products to its member utilities. As a member cooperative, the company is not publicly traded, although its new ETDS is. Offering cumulative 5.5 percent interest, market participants have priced this baby bond above its $25 par value every day since it began trading in early May. NRUC is the coop’s only income security currently trading and raised $250 million. According to the company’s Q3 10-Q filing for the quarter ending February 2019, a mark-to-market revaluation of its assets (existing loans to members) resulted in a net loss of $71 million due to interest rate changes from a year earlier. But loan demand from members totaled $26 billion, an increase of $839 million from May 31, 2018.
RILYO (NASDAQ:RILYO) from B. Riley Financial (RILY) is an unrated Exchange-Traded Debt Security offering a 6.750 percent coupon. RILYO is the company’s sixth ETDS offered within the last three years, its third within the last twelve months. B. Riley always strikes me as a company that has a hard time saying no. Its most recent acquisition was that of magicJack VocalTec (NASDAQ:CALL), a company that manufactures a voice over IP telephone device. The $519 million 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.
AGM-D (NYSE:AGM.PD) is a 5.7 percent traditional preferred stock offered by Federal Agricultural Mortgage Corporation (AGM), also known as Farmer Mac. While AGM now has four income securities trading, AGM-D is the first issue since 2014. The proceeds from the new AGM-D are being used to redeem all outstanding shares of the 6.875 percent AGM-B on June 12, 2019, producing a dividend expense savings of about $800K per year. AGM-D is unrated and offers non-cumulative dividends. AGM is “a federally chartered instrumentality of the United States of America” and provides a variety of financial services to agricultural entities. AGM was founded in 1987 and is headquartered in Washington D.C.
SR-A (NYSE:SR.PA) is a traditional preferred stock from Spire Inc. (SR) offering an investment grade S&P rating (BBB) and 5.9 percent cumulative dividends. Cumulative means that if the issuing company misses a dividend payment to you, they still owe you the money; their obligation to pay you accumulates. This new issue was perhaps the most popular with investors among May’s new offerings, trading above $25.50 since it began trading. The company intends to use the $250 million raised by this new preferred stock to “(i) refinance long-term and short-term holding company debt and (ii) fund capital expenditures at both the utility and gas-related businesses.” Spire, a $4.3 billion regulated gas utility, provides natural gas to about 1.7 million residential, commercial and industrial customers across Missouri, Alabama and Mississippi. Previous known as Laclede Group, the company was founded in 1857 and is headquartered in Saint Louis.
AQNB (NYSE:AQNB) is an ETDS from Algonquin Power & Utilities Corporation (NYSE:AQN) offering 6.2 percent in cumulative annual interest and a BB+ rating from S&P. The coupon uses the fixed-to-float structure, so the interest rate paid by this security will become variable on the security’s July 1, 2024 call date. This security is somewhat unique in how it treats the floating rate period; you might say that the floating rate period itself floats. From July 1, 2024 to July 1, 2029, the interest rate will be calculated as the three-month LIBOR plus 4.01 percent. After that, the rate changes to the three-month LIBOR plus 4.26 percent. Then on July 1, 2049, the rate changes again, calculated as the three-month LIBOR plus 5.01 percent. The LIBOR, remember, is scheduled to be replaced by 2021 so if you hold shares of this security beyond 2021, determining whether or not you are receiving the correct interest payment each quarter is going to require some work. AQN, founded in 1988, is a $5.7 billion utility based in Oakville, Ontario, Canada, and provides a variety of regulated and non-regulated electric, gas and water services throughout Canada and the United States.
TRCBP (TRCBP) is from TriState Capital Holdings, Inc., offering non-cumulative dividends. This security uses the fixed-to-float dividend rate structure, paying 6.375 percent until its July 21, 2024 call date. The rate becomes variable at that time, using the three-month LIBOR rate (currently at 2.58 percent) plus 4.088 percent. Page S-12 of the prospectus explains how the floating rate will be calculated should the 3-month LIBOR become unavailable. TriState is a $640 million regional bank, providing banking services in Cleveland, Philadelphia, New York City and Edison, New Jersey. The bank’s financial results are impressive, with net income running around 35 percent of gross revenue for the last four quarters, generating about $245 million in cash at the end of the March 2019 quarter. TriState was founded in 2006 and is headquartered in Pittsburgh.
Preferred Stock Tax treatment
The 2017 Tax Relief Act included a provision aimed at small businesses that also delivers 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. Such income is reported to you on the 1099 for received from your broker as “Section 199A” income.
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 (none of these were issued during May).
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, taxable dividends received from REITs are taxed as regular income (i.e., they do not qualify for the special 15 percent dividend tax rate). There were no REIT-issued preferred stocks during May.
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 (NRUC, RILYO, AQNB).
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 three of May’s new issues state that their dividends are QDI-qualified (AGM-D, SR-A, TRCBP).
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 6.7 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 2.9 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 May preferreds on May 31. It is into this marketplace that May’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.