Seeking Alpha

New Preferred Stock IPOs, August 2019

Includes: ALL, BPY, MBIN, NRZ
by: Doug K. Le Du

Five new preferred stocks were introduced during August, offering an average annual coupon of 6.1 percent.

There are currently 125 high-quality preferred stocks selling for an average price of $26.40 per share (investment grade, cumulative dividends).

One of these high-quality issues is now selling below its $25 par value, offering an average current yield of 5.0 percent.

U.S.-traded preferred stocks are now returning an average current yield of 6.5 percent.

After holding off during July to see if the Fed was going to reduce interest rates, preferred stock issuers crept back into the market with five new issues introduced throughout August.

In anticipation of a drop in rates, buyers and those seeking to reduce their risk continued to push up the prices of previously issued higher payers. As the month came to a close, the average market price for all U.S.-traded preferred stocks was $25.80, up $0.08 per share over the last month.

August’s new preferred stocks

August’s five 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 5.4 percent (using August 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 125 high-quality preferred stocks selling for an average price of $26.40 (August 30), offering an average current yield of 5.3 percent. Only one of these high-quality issues is selling below its $25 par value, offering a 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 916 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

About the new issues

ALL-H (ALL.PH) is a 46 million share issue from Allstate Corp. (ALL), the insurer’s eighth preferred stock issue currently trading and the second since March 2018. ALL-H offers double investment grade ratings. The 5.100 percent dividends are non-cumulative, and the shares become callable on October 15, 2024. Several of Allstate’s preferreds are trading beyond their call dates, including ALL-A (5.625%), ALL-D (6.625%) and ALL-F (6.625%). These three securities were issued at 10 million shares, 26 million shares and 10 million shares, respectively - a total of 46 million shares. While there has been no formal announcement, it would not be surprising for Allstate to announce the redemption of ALL-A, ALL-D and ALL-F shortly.

AHL-E (AHL.PE) is a double-investment grade preferred stock from Aspen Insurance Holdings Limited, an insurance and reinsurance company. While the company was taken private in February of this year as part of its acquisition by Apollo Global Management, their three preferred stocks, none of which are currently redeemable, remain publicly traded. Based in Bermuda, Aspen may have an opportunity to exercise its claim-paying ability as Hurricane Dorian does what hurricanes do to the American southeast. AHL-E pays 5.625 percent non-cumulative dividends.

NRZ-B (NRZ.PB) was introduced by New Residential Investment Corp. (NRZ) on August 8, just six weeks after introducing NRZ-A on June 25. The introduction of NRZ-B is what the company referred to as “an opportunistic introduction,” taking advantage of a dip in interest rates. Specifically, NRZ-A was introduced on June 25 at 7.5 percent, followed by NRZ-B, just six weeks later, at 7.125 percent. NRZ-B is an unrated traditional preferred stock offering cumulative dividends. The rate will remain fixed at 7.125 percent until this security’s August 15, 2024 call date. At that time, the coupon will float based on the three-month LIBOR rate plus 5.640 percent. NRZ is a $6.4 billion mortgage REIT founded in 2011.

MBINO (MBINO) from Merchants Bancorp (MBIN) is another case of interest rate opportunism, as MBINO is Merchants’ second new preferred stock issued in just over four months. MBINP, introduced in March at 7.000 percent, has now been followed by MBINO at 6.000 percent, a full percentage point lower. MBINO is an unrated traditional preferred stock paying non-cumulative 6.0 percent dividends using the fixed-to-float rate structure. The rate becomes variable on the security’s October 1, 2024 call date, using the three-month LIBOR plus 4.569 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. The bank was established in 1990.

Not to miss the opportunity, Brookfield Property Partners LP (BPY) introduced BPYPO (BPYPO) on August 13 just five months after its introduction of BPYPP last March. Where BPYPP carries a 6.5 percent coupon, the new BPYPO was introduced at 6.375 percent. BPYPO’s 6.375 percent dividends are cumulative and offer 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 what had to be good news to BPY, Sears (OTCPK:SHLDQ) announced additional store closures earlier this month, including stores in eight high-demand REIT-owned malls, four of which are owned by Brookfield. BPY is a $17 billion commercial real estate company headquartered in Bermuda.

Sources: Preferred stock data - CDx3 Notification Service database, Prospectus: ALL-H, AHL-E, NRZ-B, MBINO, BPYPO

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 (rather than Exchange-Traded Debt Securities (ETDS)) 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 taxable earnings are passed to its 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 Form 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 (BPYPO).

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 (NRZ-B).

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. 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 (there were no EDTS issued during August).

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 (ALL-H, AHL-E, MBINO).

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 6.5 percent (blue line), while the annual return being offered to income investors by the 10-year treasury is 1.5 percent and that of the 2-year bank CD has turned the yield curve upside down at 2.5 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 August preferreds on August 30. It is into this marketplace that August’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.