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Preferred

A Creates Opportunities

A Continuing Education Course Sponsored by

FOR INVESTMENT PROFESSIONAL USE ONLY V-18-60 | CE ID: 249138 FOR INVESTMENT PROFESSIONAL USE ONLY 2 About Preferred

§ Preferred stocks have been around for a time. The earliest issue was in 1836 in Maryland and gained greater popularity in the 1990s § A is a class of in a that has a higher claim on its and earnings than § must be paid out before dividends to common § Shares usually do not carry voting rights FOR INVESTMENT PROFESSIONAL USE ONLY 3 Sample Capital Stack FOR INVESTMENT PROFESSIONAL USE ONLY 4 A Hybrid Investment

Preferred stock is a hybrid form of financing, combining features of (bonds) and common stock § Like Common Stock § they represent a class of ownership in a § can include the potential to appreciate in price § Generally trade on an exchange (unless non-traded) § Do not have voting rights § Like Bonds § must pay on a regular basis a set amount of § Possess a § must be paid before dividends can be paid on the common stock, § Dividends are typically taxed at ordinary income or “qualified” tax rates § Traded preferred stocks can be very sensitive § Pricing also impacted by call features and sinking fund provisions (if any) § Most call features provide for a minimum period after the date of issue § Sinking funds create implied maturity date § Like Debt § Pays a fixed or adjustable-rate dividend

The details of each preferred stock depends on the issuance. FOR INVESTMENT PROFESSIONAL USE ONLY 5 Types of Preferred Stock

§ Traditional Preferred Stocks § Fixed Dividends

§ Adjustable-rate (or Floating Rate) Preferred Stocks (sample: ) § Generally indexed to Treasury rates § Can against rising interest rates

§ Trust Preferred Stocks (sample: holding companies) § Pay interest not dividends which impacts taxes § Convertible Preferred Stocks § Conversion to common stocks § Preference (or Prior Preferred) Stocks § Has higher priority in the capital stack than other preferred stocks § Non-traded Preferred Stock (IBDs) FOR INVESTMENT PROFESSIONAL USE ONLY 6 Non-Traded Preferred Stock

§ May be issued by Public or Private companies

§ May be part of a continuous (shelf) offering § Generally have sponsor-call and -put features § Favorable to FINRA 15-02 account statement requirements if the common stock is bearing the cost of the offering costs (i.e. full stated value on client statement)

§ Dividends may be non-cumulative or cumulative depending on offering § May include Warrants

§ Do not have the of daily traded preferred stocks Non-Traded Preferred Stocks vs. FOR INVESTMENT PROFESSIONAL USE ONLY 7 Non-Traded Common Stocks

Typical Non-Traded Typical Non-Traded Preferred Stock Common Stock

Dividend Coverage Generally covered by Generally covered only operating cashflow / FFO / when reaches AFFO at onset critical mass

Client Account Statement Stated (Par) Value Stated Value less offering expenses

Publicly Listed Yes No

Call / Put Features Yes Limited

Dividends Cumulative Yes No

Warrants Sometimes No FOR INVESTMENT PROFESSIONAL USE ONLY 8 Why Companies Issue Preferred Stock

Companies issue prefer stock for any number of reasons: § want them § Flexibility: can be redeemed by the issuing company before they are scheduled to mature - like a - and this gives the company the ability to use preferred stock for a specific purpose § May be easier to access capital than borrowing § Does not count as common, therefore no dilutive impact on Earnings Per (EPS) § In cases where the stock can be treated as , it does not count as debt § Keeps ratios low § Helps bond ratings because the leverage is lower § Does not absorb the issuers borrowing capacity § Usually does not interfere with bank covenants § May be accretive to issuing common stock if preferred yields are below their common yields (i.e. lower ) § Preserves voting rights FOR INVESTMENT PROFESSIONAL USE ONLY 9 Use in Corporate Financing

Bonds vs. Preferred Stock Tax Considerations Tax-deductible Not tax-deductible Equity Dilution No dilution No dilution; unless converted Control Company Maintains Company Maintains Control Control Cost of Capital Lower Rate Higher than Debt Leverage Increases debt-to- No impact to debt-to- equity ratios equity ratios

Maturity Date Fixed Callable FOR INVESTMENT PROFESSIONAL USE ONLY 10 Dividends

§ Typically, the rate is fixed § Can be paid as a dividend or interest, usually quarterly or semi-annually § Preferred dividends must be paid first or made-up in full before common dividends § However, dividends may be suspended or “passed” by the issuer

§ Most preferred stocks are issued on a cumulative preferred basis (i.e. cumulative dividends)

Dividend Coverage Ratio (Core) Funds from Operations (CFFO) + Preferred Dividends Preferred Dividends FOR INVESTMENT PROFESSIONAL USE ONLY 11 Par (or Stated) Value

§ Preferred shares have a stated par value § In case of the claim of preferred stock holders is restricted to the par value of the preferred stock § The preferred stockholder’s claim on assets comes after that of creditors but before that of common stockholders § Public preferred stock may trade at a discount or premium to par value = pricing volatility § Non-traded preferred stock are intended to have no pricing volatility = no pricing volatility § Validation by third-party to address FINRA 15-02 FOR INVESTMENT PROFESSIONAL USE ONLY 12 Voting Rights

§ Preferred stockholders are not typically given a voice in unless the company is unable to pay preferred stock dividends during a specified period § If such a situation presents itself, the class of preferred stockholders would be entitled to elect a specified number of directors § Any situation in which the company defaults under restrictions in the agreement (similar to bond indenture) may lead to the voting power for preferred shareholders § Preferred shareholders cannot force the immediate repayment of obligations (like debt obligations) New Tax Act Provides Substantial Tax FOR INVESTMENT PROFESSIONAL USE ONLY 13 to REIT Shareholders*

§ The Tax Cuts and Jobs Act (TCJA) provides substantial tax savings to REIT investors that allows individuals to deduct up to 20% of ordinary REIT dividends, with the remainder of the income taxed at the filer’s marginal rate.* § The effect on REIT investors who paid the top income tax-rate of 39.6% on 2017 distributions will be a drop in taxable rate to 29.6%, producing an after- tax savings of 25.3%.

Please check with your individual tax advisor to determine how your individual tax profile is affected. 1Income levels vary between the old and new tax rates. 2Assumes a 6% distribution rate and the maximum tax rate payable. 3The hypothetical does not take into account the 3.8% Medicare tax on net investment income or any applicable state and local taxes. *REIT are included in the TCJA definition of qualified income, with qualified REIT dividends, qualified cooperative dividends and qualified publicly traded partnership income specifically identified.* Section 199A of the Internal Code provides a deduction for “pass-through” , that allows for a 20% deduction of any qualified REIT dividends against income, resulting in an effective 20% reduction in the tax rate on REITs (where the top 37% tax rate becomes 29.6%. FOR INVESTMENT PROFESSIONAL USE ONLY 14 Acquiring Public, Non-Traded Preferred Stock

§ Can be purchased in primary offering or secondary § Possess a CUSIP § Can be purchased thru DTCC for -dealer brokerage accounts or “check and app” § Options for a “mini” subscription document FOR INVESTMENT PROFESSIONAL USE ONLY 15 Suitability

§ No individual state suitability restrictions on income or percentage allocation based liquid net worth requirements § No minimum net worth or gross annual income requirements § Depending on the structure, may be considered a public stock or an § Broker-dealers will likely invoke specific suitability requirements specific to certain offerings

Covered : refers to a class of securities that enjoys federally imposed exemptions from state restrictions and regulations. Most stocks traded in the U.S. are covered securities. FOR INVESTMENT PROFESSIONAL USE ONLY 16 Potential Advantages

§ Typically, a higher fixed-income payment than bonds or common stock Preferred stocks are § Because preferred stock normally has higher designed to provide a and more regular dividends, it is less volatile than common stock and carries less risk steady income stream through regular interest § A preferred stock with a guaranteed dividend is often considered a fixed-income investment similar to a or dividend payments, bond and their yields tend to be § Lower investment per share compared to bonds higher than those of other traditional § If a company stops paying a preferred dividend the company must repay all the it would investments have paid to preferred shareholders before it can pay any dividends to common

§ In some cases, preferred holders may have the right to convert that preferred stock into common stock at a pre-arranged price § This is attractive to preferred stock holders because they are entitled to the steady stream of dividends, plus they can enjoy appreciation in value if the company's common stock rises § Greater liquidity than corporate bonds of similar quality FOR INVESTMENT PROFESSIONAL USE ONLY 17 Potential Disadvantages

§ Callability: Preferred stock can be called by the issuer at its discretion usually after an established time period. § Fixed Dividends: If the company does increasingly well, dividends for preferred shareholders are unlikely to increase as earnings increase, while a common shareholder could benefit from higher dividend payments. § Risk. Just as with common stock, preferred stockholders are behind bond / debt holders in line for a company's assets if it runs into a financial problem. If a company fails, money is repaid to bond / debt holders first. § Lack of Voting Rights. Preferred shareholders are usually excluded from voting on matters such as board of director elections. § Lack of Rating System. There is no preferred stock rating system similar to what's available with bond ratings. § Market Volatility (excludes Non-Traded). Preferred stock may trade at a premium or discount to its stated value. § Interest Rate Risk. An increase in market interest rates would likely increase our borrowing costs and potentially decrease funds available for distribution. § Risk. As inflation occurs, the real value of preferred stock and dividends payable on such shares declines. FOR INVESTMENT PROFESSIONAL USE ONLY 18 Preferred Stock Risks

§ Default Risk: As with any investment, there is default risk. Default is slightly different with preferred stocks. Most preferred stocks can delay paying their dividends/interest without being in default. Typically, this deferral must be preceded by an elimination of the dividend on the common stock. In the case of cumulative preferred stocks, all missed dividends/interest payments must be paid to preferred holders before the common stock dividend is restored.

§ : Prices of preferred stocks change all the time, based on interest rate fluctuations and . The price of preferred stocks, like common stock, drop by the amount of the dividend on the ex-dividend date.

§ Liquidity: Liquidity on listed preferred stocks varies. The more liquid issues may have as little as a few pennies difference between the buy price and the sell price. Some less popular issues may trade with as much as a full dollar difference.

§ Call Risk: Most preferred stocks are callable. Before buying a preferred, investors should find out the ' to first call' or 'yield to worst' on the preferred they are considering. FOR INVESTMENT PROFESSIONAL USE ONLY 19 Other Terms

§ Cumulative Preferred: If the issuer omits a dividend payment, the payments accumulate and are paid if the issuer can ever resume making dividend payments. All accumulated preferred dividends must be paid by the issuer prior to making a dividend distribution on their common stock.

§ Callable Preferred: The issuer has the right to call in the shares after a set date, usually at par value. Issuers tend to call in the shares if interest rates have fallen. After retiring the old high rate shares, new preferred shares can be issued at the current lower rates.

§ Convertible Preferred: The preferred shareholder can convert his shares into the common stock of the issuer based on a predetermined price. If the market price of the common rises, the convertible's perceived value is generally pushed up as well. The security may act more like a bond in its early years, and more like a stock later on. Some convertibles have a mandatory conversion into common stock on a specified date.

§ Participating Preferred: In addition to the fixed dividend rate, the preferred participates in any 'extra' dividends declared by the . For example, if the company has a very strong year, and wishes to reward its common stockholders with a special year-end dividend, the preferred stock as well as the common stock will receive the dividend if the preferred has a participating feature. FOR INVESTMENT PROFESSIONAL USE ONLY; NOT FOR USE WITH PUBLIC 20

Non-Traded Preferred Stock in a Fixed Income Portfolio FOR INVESTMENT PROFESSIONAL USE ONLY 21 NT Preferred: High Yield with Price Stability

Trailing 5 Years (through June 30, 2019)

Source: Morningstar FOR INVESTMENT PROFESSIONAL USE ONLY 22

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