Term Preferred Stocks Remain Our Favorite Investment

November 27, 2017

By  Tim McPartland

From time to time, we like to write about our favorite income investments, which happen to be term preferred stocks.

While the current available universe of term preferreds is only 11 issues, it is our opinion that relatively conservative income investors would do well to own a few of them. In our case, we personally hold five of the 11 issues available.

For those unfamiliar with term preferred issues, they are simply preferred stocks that have a mandatory redemption date, usually within 6-10 years of issuance, which means shares trade with less volatility than perpetual preferred shares. Additionally, most of the issues pay monthly dividends, which is always a bonus to us.

We always need to explain that we really are conservative when it comes to investing. Our goal has been for an annual gain of 7% for quite a number of years. However, as interest rates have dropped, attaining a 7% return with reasonable safety has become more and more difficult.

With our risk tolerance in mind, a number of attributes of term preferreds are very attractive to us. Most term preferreds now outstanding have been issued by closed-end funds (CEFs), which due to the SEC act of 1940 must have asset coverage of 200% on their preferred stock to provide a great margin of safety to “senior securities.” Such senior securities are preferred stock.

Now there are some investors who may believe that management of the issuing company might tend to overvalue their assets and thereby render the 200% asset coverage meaningless relative to the safety of the preferred stock. We agree, but we understand that as long as the economy remains fairly strong and there is no inkling of a recession on the horizon, these issues likely are safe.

At the present time, there is just one outstanding term preferred that we consider investment grade and that is the Kayne Anderson MLP 3.50% term preferred (NYSE: KYN-F). Certainly, the 3.50% coupon is meager, but Kayne Anderson MLP (NYSE: KYN) is a typical closed-end fund which invests in common and preferred shares of master limited partnerships, so we clearly are able to see that the 200% asset coverage ratio protects our investment. Personally, we hold substantial amounts of this issue. Investors should note that the shares trade at $25.45 a share right now and are currently redeemable, so there is capital risk if the company should redeem shares now.

The various Gladstone companies have five term preferred issues outstanding. Three issues from Gladstone Investment (NASDAQ: GAIN) have coupons between 6.25% and 6.75%.  These issues are trading at between $25.22 and $25.61 a share for current yields of 6.10% to 6.69%.

Gladstone Capital (NASDAQ: GLAD) has a newer 6% issue outstanding that is trading at $25.60/share. Gladstone Land (NASDAQ: LAND) has one issue outstanding with a coupon of 6.375%, which is trading at $26.06/share. Gladstone Investment and Gladstone Capital are both closed-end funds and thus covered by the 200% asset coverage rule, while Gladstone Land is a real estate investment trust (REIT).

Eagle Point Credit (NYSE: ECC) has two term preferred issues outstanding, both with coupons of 7.75%. ECC is a specialty finance company investing primarily in collateralized loan obligations (CLOs). Oxford Lane (NASDAQ: OXLC) also has two issues outstanding and, like Eagle Point Credit, invests in CLOs. We personally own none of these issues since trying to understand CLOs is enough to make my head spin and I find no reason to own what I have trouble understanding. We do note that we own one of the Eagle Point Credit issues in one of the model portfolios and it has performed well.

Lastly, RiverNorth Marketplace, a non-exchange-traded closed-end fund, recently sold a 5.875% term preferred which is trading at $25.49. RiverNorth Marketplace invests in loans that are generated off the peer-to-peer lending sites, such as Prosper Marketplace, SOFI and the Lending Club. Personal experience with the peer-to-peer lending is that loans perform okay, as long as a recession is avoided.

Long-time readers will know that we have used these term preferred issues extensively in the 2015/2016/2017 Medium Duration Model Income with Zip Portfolio, which mimics our personal investment style and which has been very successful with almost a 8.5% annual return.

For those who want to watch the term preferreds, you can find our spreadsheet here.

As always, investors should buy as close to $25/share as possible to minimize capital loss in case of a redemption. It is our opinion that one likely has to take some risk of capital loss in a redemption situation, but hopefully it can be kept to less than 1%.

In summary, we have been very satisfied owning term preferred shares. Shares prices generally move only modestly on a day to day basis. Most issues pay monthly dividends and there is a date certain for redemption. These attributes, coupled with a reasonable coupon, make these issues our favorites.