Seeking Alpha

New Preferred Stock IPOs, October 2019

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Includes: AEG, AMH, CFG, DLR, EFC, FDUS, FDUSG, GLAD, NTRS, NYMT, PSB, RILY, RILYP, XEC, YCBD
by: Doug K. Le Du
Doug K. Le Du
Newsletter provider, dividend investing, author, preferred stock researcher
Summary

Thirteen new preferred stocks were introduced during October offering an average annual coupon of 6.1 percent.

There are currently 125 high quality preferred stocks selling for an average price of $26.35 per share (investment grade, cumulative dividends) offering an average current yield of 5.3 percent.

U.S.-traded preferred stocks are now returning an average current yield of 6.4 percent.

In anticipation of a drop in rates, preferred stock buyers 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 $26.02 per share, up $0.09 per share over the last month.

October’s new preferred stocks

October’s thirteen 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 6.0 percent and an average Yield-To-Call (which does consider reinvested dividends and capital gain/loss) of 5.9 percent (using October 31 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 $26.35 (October 31), offering an average current yield of 5.3 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 927 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

Buying new shares for wholesale

Note that CIMXP (CIMXP) from Cimarex Energy Company (XEC), PSPBZ (PSPBZ) from PS Business Parks, Inc. (PSB) and NTREL (NTREL) from Northern Trust Corporation (NTRS) 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. PSPBZ will become PSB-Z and NTREL will become NTRSO. The permanent symbol CIMXP has yet to be specified.

About the new issues

As the Fed once again lowered the federal funds rate on October 30, feeding at the low-rate preferred stock trough continued throughout October with 13 new issues to consider. One thing that struck me about October’s crop was the quality of the issues – four are offering investment grade ratings from Moody’s, three have double-investment grade ratings, and three of these new issues are actually Exchange-Traded Debt Securities. As bonds (recorded on the company’s books as debt), ETDS’ often offer a lower risk profile than the same company’s preferred stock (equity).

DLR-L (NYSE:DLR.PL) is a traditional preferred stock offered by Digital Realty (DLR) with an investment grade rating from Moody’s Investors Service. DLR has six preferred stocks trading on U.S. stock exchanges, although it may use the proceeds from the 12 million new shares of DLR-L (5.2 percent) to redeem all 9 million outstanding shares of DLR-G (5.875 percent). DLR-G became callable on April 9, 2018. 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-L pays cumulative dividends.

PRIF-E (PRIF.PE) is an unrated traditional preferred stock issued by the Priority Income Fund offering 6.375 percent dividends. The fund is managed by Priority Senior Secured Income Management, LLC which, in turn, is part of the Destra Capital Investment, LLC stable. On their website, the fund’s objectives are stated in the most non-specific terms possible as “Priority Income Fund seeks to generate current income and long-term capital appreciation by strategically investing in broad pools of senior secured, floating rate loans made primarily to U.S. companies. The Fund's goals are to increase income and portfolio diversification and reduce correlation to traditional fixed-income assets.” (make some investments and make some money). PRIF-E is the fund’s fourth preferred stock offering in the last twelve months. While the prior two securities offered non-cumulative dividends, the new PRIF-E’s dividends are cumulative. Neither Destra nor Priority Senior Secured Income Management, LLC are publicly traded (no common stock).

RILYP (RILYP) from B. Riley Financial (RILY) is an unrated traditional preferred stock offering a 6.875 percent coupon. RILYP is the company’s eighth income security offered within the last three years, its third this year. The company’s other seven currently-trading income securities are Exchange-Traded Debt Securities (baby bonds) while the new RILYP is the company’s first preferred stock. B. Riley always strikes me as a company that has a hard time saying no. Its most recent acquisition was that of magicJack VocalTec, 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 in1973, B.Riley is headquartered in Woodland Hills, California.

NYMTM (NYMTM) is an unrated traditional preferred stock from New York Mortgage Trust (NYMT) paying 7.875 percent cumulative annual dividends. NYMT has four preferred stocks currently trading on U.S. stock exchanges, the most recent two of which use the fixed-to-float dividend structure. With this structure, the security’s coupon rate is fixed (7.875 percent in the case of the new NYMTM) until the security’s call date (January 5, 2025) at which time the rate becomes variable based on the three-month LIBOR rate (currently at 1.94 percent) plus 6.429 percent. Page S-18 of the prospectus specifies how the coupon rate will be calculated in the event the LIBOR rate becomes unavailable. NYMT is a $1.6 billion residential mortgage REIT based in New York City and established in 2003.

YCBD-A (YCBD.PA) is an unrated, optionally convertible traditional preferred stock issued by cbdMD, Inc. (YCBD) offering 8.0 percent cumulative dividends, paid monthly. Convertible preferred stocks come in two flavors – optional and mandatory. An optional preferred stock is one that can be converted to the issuing company’s common stock at the option of the shareholder (although significant conditions and restrictions on the timing and conversion ratio typically apply). Mandatory convertibles, on the other hand, are converted to the issuer’s common stock at a certain point in time and/or under certain conditions whether you want them to or not. Convertibles are typically issued by relatively new, and relatively speculative, companies with the idea being that the preferred shares provide them cash now which the company will presumably use to develop that Next Big Thing, making their common stock skyrocket, providing untold wealth and greatness for all of those who had purchased the preferred shares in the early days (or not). cbdMD is a $105 million company founded in 2015 and produces marijuana-based products. An interesting but risky way to stumble into the ground floor of what could become a significant opportunity (dude!). But note that YCBD-A has failed to reach its $10 par value since its October 11 introduction (indicating overly gleeful, and perhaps impaired, judgement of what the market would pay $10 for by the security’s underwriters).

AEFC (AEFC) is an ETDS from Dutch insurer AEGON (AEG) and is one of three ETDS’ introduced during October. ETDS’ are classified as debt so, by definition, their dividends are actually cumulative interest (taxed as regular income). AEFC is one of three income securities from AEGON, the first since 2005, and offers a 5.1 percent coupon with double-investment grade ratings (Baa1/BBB). This security is call-protected until December 15, 2024.

EFC-A (EFC.PA) is from Ellington Financial, Inc. (EFC), offering 6.75 percent ‘fixed-to-float’ cumulative dividends. The 6.75 percent coupon rate is fixed until the security’s October 30, 2024 call date at which time the rate floats based on a formula equal to the three-month LIBOR rate plus 5.196 percent. Page S-11 of this security’s prospectus describes how the rate will be calculated in the event that the LIBOR rate becomes unavailable. EFC-A is Ellington’s first, and only, preferred stock offering. Ellington is a mortgage REIT, meaning that they raise capital (such as with a new preferred stock offering) and use that cash to purchase bundles of mortgages that, hopefully, pay a higher rate than the cost of the capital used to buy them, the spread becoming gross profit. Ellington was founded in 2007 and is headquartered in Old Greenwich, Connecticut.

FDUSG (FDUSG), like AEFC discussed above, is also an ETDS although FDUSG is unrated. FDUSG offers 5.375 percent annual interest and is issued by Fidus Investment Corporation (FDUS). The $53 million in net proceeds from FDUSG are being used to pay down debt under the company’s Credit Facility, under which it currently owes $62.5 million. While the 5.375 percent annual interest expense that comes with FDUSG is a higher rate than the company is incurring on its Credit Facility, using the proceeds from FDUSG to pay down the Credit Facility has several benefits, including shifting the risk of default from the company’s lender to the stock buying general public (that’s us). FDUS has three ETDS trading, the most recent two of which were both introduced in 2019. FDUS is a business development company investing in U.S.-based companies.

GLADL (GLADL) is an ETDS from Gladstone Capital Corporation (GLAD), the company’s second ETDS introduced within the last 12 months. Both of Gladstone’s ETDS’ become callable a mere two years after their IPO dates, which is an extremely quick trigger. Almost certainly, this very short call protection is likely due to the company anticipating that interest rates will continue to fall and they want to be in a position to issue a new ETDS a couple of years from now at a lower rate and use the proceeds to redeem one or both of their two current issues. According to the prospectus of GLADL, the company is planning on using the proceeds from this new issue to pay down a chunk of the $118.6 million it owes under its Credit Facility. Interestingly, the Credit Facility costs the company a rate calculated as the 30-day LIBOR (currently at 1.82 percent) plus 2.85 percent. Put another way, Gladstone just issued an ETDS costing them 5.375 percent in order to pay down debt costing them 4.67 percent (Seattle School District new math?). While this math may suggest that Gladstone executives may have enjoyed a research road trip to cbdMD headquarters, my guess is that the company is faced with a debt maturity timing issue here and had little choice. Gladstone is a $295 million private equity venture capital investment company.

CIMXP is an unrated optionally convertible traditional preferred stock from Cimarex Energy Company offering 8.125 percent fixed-rate dividends. This is a very odd security in several ways so I’m not going to spend much time on it. Issues: It has a $1,000 par value and only one trade has been recorded since its October 17 introduction – 100 shares at $1,295; the prospectus does not specify a call date whatsoever; usually the “Definition of terms” section of a prospectus takes up about two pages but the prospectus for CIMXP introduces so many terms with special meanings that it gets it down in seven pages; while CIMXP is an temporary OTC wholesale symbol, the prospectus does not state what the symbol will become once retail trading (NYSE) begins; and the conversion terms span six pages with six different algebraic formulas. As I read the prospectus (written by lawyers for lawyers), I kept hoping that it would get better – and I have read thousands of preferred stock prospectuses over the last 15 years – but it just doesn’t. I’m sure they were thinking of something very lofty when this document was crafted, but the wisdom behind this security’s structure is far from obvious. CIMXP is the company’s first, only and hopefully last income security.

CFG-E (CFG.PE) is from regional bank Citizens Financial Group (CFG) and offers 5.0 percent fixed-rate dividends. This security has a speculative-grade BB+ rating from S&P. As with all traditional preferred stocks issued by banks since July 2010, this security’s dividends are non-cumulative. With cumulative dividends, shareholders are still owed any dividends that are skipped when due; dividends of cumulative preferred stock can be “deferred” while those of non-cumulative preferred shares can be “suspended” outright (watch for these key words in prospectuses). The Dodd-Frank Wall Street Reform Act correctly (but unfortunately for us) determined that bank reserves aren’t really any good if holders of cumulative preferred stock shares have a claim to the cash, so all bank-issued preferreds since July 2010 have been non-cumulative. CFG-E is the company’s second new preferred stock introduced this year. CFG is a $16 billion regional bank founded in 1828 and headquartered in Providence, Rhode Island.

PSPBZ/PSB-Z is a traditional preferred stock from property REIT PS Business Parks, Inc. PSB preferred stocks command double-investment grade ratings (Baa2/BBB), which allows the company to offer new income securities at miserly coupons, such as this security’s 4.875 percent. PSB is one of the offshoots of Public Storage’s management genius Ron Havner, now retired. Havner was an amazing CEO and mentor to his management teams for many years, growing Public Storage to the global self-storage standard, primarily using preferred stock issues for capital, and is now the highest-rated property REIT in the United States. For several years, Havner also served as CEO of spin-off PS Business Parks, specializing in office buildings and other commercial real estate. Another successful Havner-inspired spin-off is American Homes 4 Rent (AMH), founded and managed to this day by a group of former Havner Public Storage executives. PSB is using the proceeds from PSPBZ to redeem all outstanding shares of two older, higher-paying preferred stocks – PSB-U (5.75 percent) and PSB-V (5.70 percent) – saving the company about $8.2 million per year in dividend expense.

NTREL/NTRSO from Northern Trust Corporation is a traditional preferred stock paying non-cumulative 4.7 percent dividends. NTREL is one of three October issues that offer double-investment grade ratings (Baa1/BBB+), hence the paltry 4.7 percent coupon. With downward pressure on interest rates, how inflation and taxes affect net returns from low-paying income securities starts to become more important. Annual inflation is running at about two percent, so that has to come right off the top of the 4.7 percent paid by this security. And if you buy these shares in a taxable account, the tax needs to be subtracted from whatever is left. NTRS is going to use the proceeds from the new NTREL to redeem all outstanding shares of NTRSP, a 5.85 percent security that became callable on October 1. Northern Trust is a $21 billion international financial institution founded in 1889 and headquartered in Chicago.

Prospectuses: DLR-L, PRIF-E, RILYP, NYMTM, YCBD-A, AEFC, EFC-A, FDUSG, GLADL, CIMXP, CFG-E, PSPBZ/PSB-Z, NTREL/NTRSO

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 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 LLC’s – at least 90 percent of a REIT’s taxable 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 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 (this double-taxation being a favorite political football every few years).

Unless specified otherwise, traditional preferred stock dividends, including those 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 (RILYP, YCBD-A, CIMXP, PRIF-E).

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 (DLR-L, NYMTM, EFC-A, PSPBZ/PSB-Z).

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 (AEFC, FDUSG, GLADL).

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 (CFG-E, NTREL/NTRSO).

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 6.4 percent (blue line) while the annual return being offered to income investors by the 10-year treasury is 1.8 percent and that of the 2-year bank CD has turned the yield curve upside down at 2.3 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new October preferreds on October 31. It is into this marketplace that October’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.