Last Friday, Barron’s Amey Stone published an Income Investing blog post entitled: “Preferred Shares: High-Yielding but Pricey.” The crux of the article was that preferred securities currently offer high yields, but they are getting expensive on a risk/reward (credit spread) basis and that some preferreds which are callable are trading with low or even negative yields to call. Ms. Stone reminds readers that preferreds are not always called when they become callable. However, call probabilities are not total guesses.
We can at least gauge the Street’s opinion as to whether a preferred may or may not be called. If the yield-to-call is less than the current yield or the yield-to-maturity (if the security has a stated maturity), the consensus view of the market is that the preferred is likely to be called at its next call date. If the YTM or CY is less than the YTC, the Street consensus opinion is that the preferred is unlikely to be called. If the preferred is trading with a negative yield-to-call either the Street believes that a preferred with a short time to its next call date will not be called or some investors are not aware of the YTC (I have seen both).
In my opinion, there are few attractive preferreds. With Libor going away, in less than five years, one of my favorite segments of the preferred market, fixed-to-floaters, are less attractive due to the uncertainty of what happens when FTFs lose their floating benchmarks. However, there is still one more relatively attractive segment of the preferred market, for some investors.
That segment is $25-par notes and preferreds with stated maturities. Because they are little-known and because they tend to be of small issue size, they tend to trade at higher yields than similar $1,000-par bonds, even those which have equal standing on the capital structure. Some also trade at wider spreads because they are not rated by Moody’s and S&P.
In today’s wealth management industry, many investors and advisors are unwilling or unable to purchase non-rated preferreds (for advisors it depends on how an account’s risk level is coded). In today’s world of pre-fabricated investing, few investors and advisors have access to a resource which will analyze individual securities (Bond Squad provides this service). As such, these $25-par notes and preferreds with stated maturity dates go unnoticed by many investors and advisors.
Bond Squad and our parent, Wealth Strategies and Management LLC have been active in this area of the preferred market. We have been buying these $25-par preferreds with maturities not as trading vehicles, but as a way to generate income in a low interest rate environment without taking on inordinate amounts of credit and/or duration risk, where in clients’ best intereests. However, there is no such thing as a free lunch. Many $25-par notes and preferreds with stated maturities tend to have less liquidity than the large perpetual preferreds which come to market. However, because we do our credit homework and do not peg our portfolios to a model, it is fairly unlikely that we will have to sell large quantities of these $25-par notes and preferreds, at one time.
About Thomas Byrne
Thomas Byrne has achieved a 26-year career in financial services, 23 of which have been spent in the fixed income market sector. In his role as Director of Fixed Income for Wealth Strategies & Management LLC., Byrne is responsible for providing strategic analysis and portfolio management to private clients and institutions, in addition to offering strategic advisory services to other financial services organizations. Byrne's areas of expertise include trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt, and convertible bonds. Additionally, Byrne provides analysis, strategy, and commentary within the fixed income market. Prior to joining WS&M, Byrne worked as Director in the Taxable Fixed Income Department of Citigroup, Inc., in addition to predecessor companies in New York, NY.