August’s nine new preferred stocks are offering an average annual dividend (coupon) of 6.7 percent, an average current yield (which does not consider reinvested dividends or capital gain/loss) of 6.5 percent and an average Yield-To-Call (which does consider reinvested dividends and capital gain/loss) of 4.9 percent (using August 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 K preferred stock from Public Storage is “PSA-K” at TDAmeritrade, Google Finance and several others, but this same security is “PSA.PR.K” at E*Trade and “PSA.PK” 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 $26.58 (August 31), offering an average current yield of 5.2 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 940 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).
Buying new shares for wholesale
Note that three of August’s new issues are still trading on the wholesale Over-The-Counter exchange: CCNEL from CNB Financial Corporation (CCNE), SABRP from Sabre Corporation (SABR) and DRHPP from DiamondRock Hospitality Company (DRH). 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’s 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. CCNEL will become CCNEP, SABRP will trade on the NGS exchange under the same symbol and DRHPP will become DHR-A.
About the new issues
WSBCP (WSBCP) is an unrated traditional preferred stock from WesBanco, Inc. (WSBC) paying an annual non-cumulative 6.75 percent dividend. This coupon resets every five years, beginning November 15, 2025, based on the then-current five-year U.S. treasury rate plus 6.557 percent. November 15, 2025 is also the call date for this security, meaning that the company regains the right to redeem your shares rather than pay a higher coupon at that time. Like many banks, WesBanco is struggling to meet the challenges of the pandemic and the effect it has had on its business. Low interest rates, reduced consumer spending, ballooning cash on deposit, PPP loans, and uncertain economic trends produced Q2/2020 Net Income of $4.5 million compared to $44.8 million for Q2/2019. WesBanco, founded in 1870, is a $1.5 billion (market cap) regional bank primarily serving the mid-Atlantic states.
UZD (UZD) is a speculative grade Exchange-Traded Debt Security from United States Cellular Corporation (USM) offering 6.25 percent annual interest. UZC is the only ETDS introduced during August and is the fourth such security from USM currently trading. ETDS’s are also referred to as baby bonds and are recorded on the company’s books as debt (rather than as equity, as in the case of preferred stock). As bonds, ETDS’s are often seen as having lower risk than the same company’s preferred stock shares. ETDS’s are very similar to preferred stocks and are often listed on brokerage statements as such. Unless the prospectus says otherwise, the interest paid by ETDS’s is cumulative, meaning that in the event the issuer skips a payment to you, they still owe you the money (their obligation to pay you accumulates). It’s too bad you can’t spend the same money twice, because that’s the situation USM finds itself it. UZD raises a net of $484 million, with which USM would dearly love to pay down some of its outsized long-term debt ($2.2 billion as of June 30, 2020, including UZD) and fund the implementation of its 5G network. If USM does decide to use some of the proceeds from the new UZD to redeem one of its older, more expensive ETDS, it would probably be UZB, which costs the company 7.25 percent in interest expense and became callable in December of last year. USM is a $3 billion telecommunications company founded in 1983 and headquartered in Chicago.
KKR-C (KKR.PC) is one of two investment grade (BBB+) preferred stocks among August’s new issues. KKR-C is offered by KKR and Company, Inc. (KKR), the company’s third preferred stock currently trading but its first convertible. Convertible preferred stocks come in two flavors – mandatory convertibles, where the issuing company determines when your preferred stock shares will convert to the company’s common stock, and optionally convertibles, where the power to convert or not is in the hands of shareholders. KKR-C is a mandatory convertible preferred stock. The $1.5 billion raised by KKR-C will be used to fund the company’s acquisition of Global Atlantic Financial Group Limited, a privately held financial services company. KKR is a $30 billion financial services company founded in 1976 and headquartered in New York City.
PSA-M (PSA.PM) is a double-investment grade traditional preferred stock from Public Storage, Inc. (PSA) paying cumulative 4.125 percent dividends. As the highest-rated property REIT in the U.S., earning an A3 rating from Moody’s and BBB+ from Standard & Poor’s, PSA has adeptly leveraged those rating to reduce the coupon rates offered by their preferred stock issues from 5.6 percent (PSA-H issued in February 2019) down to today’s PSA-M at 4.125 percent. Even at a miserly 4.125 percent, market participants almost immediately pushed the price of the new PSA-M up well above its $25 par value. PSA has fourteen preferred stocks currently trading, although two of its older issues were called during August (PSA-X, 5.2 percent; PSA-W, 5.2 percent). On September 30, 2020, holders of PSA-X and PSA-W shares will receive $25 in cash, plus any accrued dividends, in exchange for their shares, and the shares will stop trading on that date. PSA is a $36 billion self-storage company operating throughout the U.S. and Europe.
AGM-F (AGM.PF) is an unrated, non-cumulative traditional preferred stock from the Federal Agricultural Mortgage Corporation (AGM), also known as Farmer Mac, paying 5.25 percent in annual dividends. Note that because of government-sponsored enterprise registration exemptions, this security does not have a prospectus; rather, it is issued via an offering circular available from Morgan Stanley. This security, AGM’s fifth currently trading preferred stock, raised $120 million for the company, $60 million of which is being used to redeem all outstanding shares of AGM-A (5.875 percent). AGM was founded in 1987 and serves as a guarantor of a wide variety of loans to agricultural interests and rural utilities.
CCNEL/CCNEP (CCNEP) is an unrated, non-cumulative traditional preferred stock from CNB Financial Corporation offering a 7.125 percent annual coupon. This is the bank’s first preferred stock issue. The only thing that strikes me about the prospectus terms of this security is how un-striking they are. This security is about as “vanilla” as a bank-issued preferred stock can get. The 7.125 coupon is a bit generous, as reflected by its above-par price. This security began OTC trading late in the day on Friday, August 21, at $25.75 and, with a brief exception, has traded above $25 ever since. The dividends paid by this security are non-cumulative (meaning that if the issuer skips a dividend payment to you, they no longer owe you the money, just like the case with common stock dividends), but all bank-issued preferred stocks since the Wall Street Reform Act was signed into law in July 2010 have been non-cumulative. CNB is a $278 million regional bank with branches in Pennsylvania, Ohio, and New York, and just completed its acquisition of Bank of Akron in July. The bank was founded in 1865 and is headquartered in Clearview, Pennsylvania.
OTRKP (OTRKP) is an unrated, traditional preferred stock from medical care provider Ontrak, Inc. (OTRK). Formed in 2003 as Catasys, Inc., the company changed its name to Ontrak, Inc. in July 2020. Ontrak is a newcomer to the preferred stock marketplace, with OTRKP being its first preferred stock introduction. As inducement to investors, beyond this security’s 9.5 percent cumulative annual dividends, the prospectus includes an odd provision – OTRK has created a segregated account into which it has deposited the first two years’ worth of dividend cash with the covenant that the company cannot use that cash for any other purpose other than to pay those dividends. That pencils out to $8,075,000 of the $40 million in net proceeds raised by the new OTRKP. But Ontrak is in a high-risk business, providing medical treatment to patients using its artificial intelligence-based PRE (Predict-Recommend-Engage) system, which “… predicts people whose chronic disease will improve with behavior change, recommends care pathways that people are willing to follow, and engages people who aren’t getting the care they need.” The company’s common stock has boomed from $9.69 in March, now closing in on $70.
SABRP (OTCPK:SABRP) is an unrated preferred stock offered by Sabre Corporation paying 6.5 percent cumulative dividends. SABRP, like KKR-C described above, is a mandatory convertible preferred stock, with the mandatory conversion into common shares occurring on September 1, 2023. However, the prospectus for this security includes a provision allowing shareholders to convert their shares to SABR’s common shares prior to the mandatory conversion date, although such a conversion would be subject to the minimum conversion rate (as defined within the prospectus). The folks at SABR had a very busy August, simultaneously issuing this new 3 million share preferred stock (at a $100 per share par value), 35.7 million new common stock shares with an underwriter option to purchase another 5.3 million shares and announced their intent to conduct a private offering of an additional $300 million of senior secured notes. No specific use for the preferred stock or common stock cash is provided beyond “… general corporate purposes” (that’s a lot of purposes). SABR, founded in 2006, is a $2 billion company providing a variety of software and other technology products to the travel industry.
DRHPP/DRH-A (DRH.PA) is an unrated, traditional preferred stock from DiamondRock Hospitality Company offering 8.25 percent cumulative dividends. DiamondRock is a hotel REIT, a tough business during the COVID-19 shutdown, to be sure. If you are looking for an excellent indicator of how the COVID-19 economic recovery is coming along, watch hotel occupancy rates. The hotel business is starting to show some encouraging signs (green shoots), starting with “drive-to” properties, then luxury or destination hotels, following by those catering to business travelers and, lastly, those appointed for group conventions. In April, 20 of DiamondRock’s 30 hotels were closed but, working with health officials, the company was able to open 12 more properties by the end of Q2. Starting with its drive-to properties, weekly occupancy rates went from 6.8 percent at the end of March to over 42 percent by the end of June. And the average room rate at many properties is starting to increase as well. DRH’s drive-to resort at Lake Tahoe boasted 80 percent occupancy during July, with the average rate up about $100 per night over last year to just over $519 per night. While occupancy has a long way to go until DiamondRock and many other hotel REITs return to profitability, there is some reason for optimism. DRH is a $1.1 billion company headquartered in Bethesda, Maryland.
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’s) 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 Form 1099 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 that are otherwise paid out of pre-tax profits, are taxable as regular income; you pay the full tax, since the company has not (SABRP).
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 (PSA-M, DRHPP/DRH-A).
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’s is taxed as regular income (UZD).
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 (WSBCP, KKR-C, AGM-F, CCNEL/CCNEP, OTRKP). See the Status column in the first table in this article.
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 a 2-year bank Certificates of Deposit or the 10-year treasury note.
U.S.-traded preferred stocks are currently returning an average current yield of 6.8 percent (blue line), while that of the 2-year bank CD is at 0.85 percent and the annual return being offered to income investors by the 10-year treasury is 0.74 percent.
For comparison, I have set the Yield column in the first table above to show the current yield of the new preferreds on August 31. 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.