- There are over 100 preferred stocks that are either floating or fixed-to-floating dividend rates.
- 19 of these preferreds have dividend rates that are currently floating.
- There are 3 securities that are now yielding 7.9 to 9%.
- Is it time to add more income producing securities to your portfolio?
The “I Prefer Income” database contains over 100 preferred stocks and ETD securities that have “floating” or “fixed-to-floating” dividend rates. Floating rates are securities with dividend rates that float from the first day they are issued. Fixed-to-float are securities that have fixed rates for a period of time (usually 5 years) and then float thereafter.
Most floating rates are based on the 3-month libor rates. LIBOR stands for London Interbank Offered Rate. Libor is considered a benchmark interest rate for many adjustable rate mortgages, business loans, and financial instruments traded on global financial markets.
Purpose of this article is to highlight all preferred / ETD securities whose rates are currently floating and to then provide detailed information on the one security with a yield of 9% with fairly good metrics.
2 charts below show the relationship between the 3-month libor rate and the 10-year treasury rate. On 6/14/2019, the 10-year treasury was 2.09 and the 3 month libor was 2.45. Both have been on a downward trajectory since the end of 2018 and it would appear the trend will continue for the foreseeable future.
This puts pressure on the floating rates and there is a good possibility that dividend rates will be reduced over the next year or so. When interest rates change, here is the potential result:
- When interest rates increase, the floating rate securities could increase their dividends.
- When interest rates drop, the floating rate securities could lower their dividends.
(Chart 1, 3 mo libor rate)
(Chart 2, 10 year treasury rate)
Table1 below shows the preferred stocks that were issued with floating rates that started immediately. The parent is located in the gray row with their preferred stocks located directly under them. These preferreds have 2 parts to the rate agreement:
- A base amount that is considered the floor amount. In the list below, most have a base amount of 4%, but there are also 3, 3.5 and 3.75%
- A second amount is computed using 3-month libor rate + an extra amount.
In the case of AEB, the parent will pay > 4% or 3-month libor + .875. Since the current 3-month libor amount is 2.45, the 2 rates are > 4% OR 3.325%. Since the base of 4% is higher, they will pay 4%.
If we use the current 3-month libor amount of 2.45 for the rate to compute, there are 2 preferreds with higher rates than the base rate. Bank of America corporation (BAC) issued BML-G and BML-H.
When you review the floating rate columns in orange, you will see that the floating rate amount of 3.20 for BML-G is higher than the base amount of 3% so the dividend may increase to reflect the higher rate.
Same pertains to BML-H. The new computed rate of 3.10 is higher than 3% so the company may raise the dividend by that amount if it meets the terms found in the prospectus.
Even though the current rates are somewhat low, they all have good credit ratings, they all have tax advantages, they all have rates higher than inflation and finally, they all have floating rates that could increase if interest rates increase in the future.
Conservative income investors may want to consider this group of preferred stocks as solid choices with excellent features.
Floating Rate Preferred Stocks
(Table 1, Floating Preferreds Stocks)
Preferred stocks and ETD securities with Fixed-To-Floating Rates that are now floating.
Table 2 shows 2 preferred stocks and 1 ETD with Fixed-To-Floating rates that are currently floating. All three had fixed rates that extended until the call date. At that time, they converted to the floating rates.
Currently the fixed-to-floating rates are higher than the coupon rate and all 3 could provide yields over 8%, depending on the actual rates now being paid. Please note that it appears that all companies use a calculating agent to compute the rate dependent upon the terms outlined in the prospectus.
Here is what the NSS prospectus reports in their prospectus:
“After the conclusion of the Fixed Rate Period for the Notes on January 15, 2018, the Notes will begin to bear interest at a floating rate equal to the sum of the Three-Month LIBOR Rate for the related interest period plus a spread of 673.4 basis points.
The floating rate may be volatile over time and could be substantially less than the fixed rate. In addition to experiencing a decline in Current Interest income, holders of the Notes could also encounter a reduction in the value of their Notes”.
“The Notes will bear interest from the date of issuance to but not including January 15, 2018, which we refer to as the “Fixed Rate Period,” at an annual rate of 7.625% of their principal amount, payable quarterly in arrears on January 15, April 15, July 15 and October 15 of each year, commencing April 15, 2013, and thereafter, which we refer to as the “Floating Rate Period,” at an annual rate equal to the sum of the Three-Month LIBOR Rate (as defined in “Description of the Notes — Determining the Floating Rate; Calculation Agent”) for the related interest period plus a spread of 673.4 basis points, payable quarterly in arrears on January 15, April 15, July 15 and October 15 of each year, commencing April 15, 2018”
Fixed-To-Floating Rate Preferred & ETD Securities
(Table 2, Fixed to floating preferreds / ETD that are now floating)
Of the 3 securities that are now floating, Nustar Energy L.P. (NS) is the closest to par and provides the highest yield of over 9% based upon the rate computed above. Since the calculating agent only calculates the new rates at specific dates, there is a good chance that the current rate is higher than what is shown in the table.
I will review NSS using the Where’s the Metrics system to help determine the overall financial health of the parent company and their ability to pay a reliable and sustainable distribution.
If you have not read about the Where’s the Metrics analysis system, please click on this link to review it. The purpose of this general review is not to give recommendations; but to show areas of strengths and weaknesses from each company. From this review, readers will have a better understanding of the company and be able to do further research if warranted.
The 5 metrics that are used to analyze these securities are listed below:
- Earnings of parent
- Payout ratios of parent
- Debt Ratios of parent
- Credit Ratings of the ETD security – ratings from Moody’s and S & P.
- Dividend Metrics of parent
Here is a table of the metrics I will be reviewing.
(Table 3, NS metrics)
Nustar Energy L.P. (NS) is a MLP that claims to be one of the largest independent liquids terminal and pipeline operators in the nation. They have operations in the U.S., Mexico, Canada and an operation at St. Eustatius in the Caribbean that they say is being sold. NSS is an ETD priced at $25.43 with a yield of 9% Since it is a debt and pays interest, it issues a 1099.
Earnings: NS shows fair GAAP earnings, although 2018 not good. They report 4 years of profits and 1 year of loss. They also report 2 quarters of profits and 3 quarters of losses. However, like most MLPs, they also report Non-GAAP earnings of DCF (Distributable Cash Flow). Table 3a shows the comparison between EPS and DCF.
(Table 3a, NS earnings history)
There is a great deal of difference between EPS and DCF. It appears that they have been experiencing some turbulence as both EPS and DCF dropped in 2017, but appear to be bouncing back with DCF.
Payout ratios: The payout ratios for both common dividend and preferred stock payouts look good in spite of the earnings turbulence in 2018. NS also has 3 preferred stocks, but remember that NSS is an ETD, so it is considered safer than the preferreds.
Debt: Debt-to-EBITDA is high, but when I look at the history since 2014, I see that the results for all years have been in the area of 5. Something happened to cause such a huge change. Looking at their Q1 earnings release, they report several issues and an impairment charge of $328 million from their St. Eustatius operations. Here is a quote from NuStar executive vice president and chief financial officer, Tom Shoaf:
“In connection with the agreement to sell our St. Eustatius business to Prostar, our first quarter results include $328 million of non-cash impairment charges, related to our St. Eustatius operations, which resulted in a net loss of $278 million for the first quarter of 2019,” Shoaf noted. “This also resulted in earnings per unit, or EPU, of ($2.91) for the first quarter, and earnings before interest, taxes, depreciation and amortization, or EBITDA, of ($158 million) for the first quarter”.
Table 3b provides historical information about the Debt-To-EBITDA history since 2014.
(Table 3b, NS Debt-To-EBITDA)
Credit ratings: NSS has Moody’s and S&P ratings of B1 / B.
Dividends: Dividends have been paid by NS for years. Here is table 3c that shows results since 2004:
(Table 3c, NS dividend history)
Records show that they started paying dividends in 2002 and were stable until 5/2018 when they lowered the dividend to .60 per quarter. They have been the same since then.
Results of the review: The results are mixed. It is hard to miss the issues with earnings in 2018. In spite of 2018, they still have good DCF and payout results for common and preferred dividends. Debt-to-EBITDA is double the normal years. Credit rating is below investment grade. Dividends metrics show a negative growth rate which is caused by the drop in their dividend in 2018 after a growing and stable dividend paid since 2002.
In spite of the mixed results, there is some good news. The President, Tom Barron lists reasons to be encouraged from the Q1 transcript. These include selling St Eustatius and European assets, simplifying structure and cutting IDR payments, growth in the Permian basin, keeping their forward guidance and more.
Summary of article
The purpose of the article was to highlight the preferred stocks and ETD securities whose dividend rates are currently floating. Those are made up of securities that opened with floating rate, and securities with fixed-to-floating rates where the securities maintained a fixed rate for a number of years after which they converted to a floating rate dividend.
There are currently 19 securities where the rate is floating. Table 1 displays the 16 that had floating rates from the first day of trading. There are 2 (BML-G and BML-H) that may have rates above the base rate. Even though all 16 have low yields of under 5.1%, they do provide some excellent features, including good credit ratings, tax advantages; and of course, the rates float. If interest rates do increase in the future, those rates could go higher.
Table 2 displays the 3 securities that have fixed-to-floating rates. These securities have yields from 7.9% to 9% and the market price above par.
The floating rates of all are now above the initial coupon rate; however, NSS is priced closer to par and may provide a buying opportunity for some investors. I did a general review on NSS and came away with mixed results. However, they do have a long history and some good news from the President that provides encouragement for the future.
Even without the words of encouragement, they currently have good DCF earnings and a payout ratio that covers both the common and preferred dividends. And when you consider the fact that they are an ETD, it means that the security is safer than both the preferred and the common. For those that are willing to take some time to do more research, NSS could provide a good buying opportunity.
I hope this article has brought attention to these companies and that you may have discovered 1 or more gems that warrant further research. If so, I would recommend reading at least the last quarterly report for more information. With the economy doing well and interest rates stabilized (and possibly going lower), many people are turning to preferred stocks and ETD securities as a good source of income.
Is it time to add more income producing securities to your portfolio?
Thanks For Reading.