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The Fixed-to-Floating Rate Preferred Conundrum

As we have watched interest rates go down, down, down over the last few years it was only a matter of time before fixed-to-floating rate preferreds began to be impacted.

Up until this point we have had just a few issues that were in their respective ‘floating rate periods’ where the coupon would reset every quarter–normally to 3 month Libor plus a fixed spread.

As most of you know 3 month libor has been on a downward trend for years and now is in the .3% area. This means that almost all fixed-to-floating rate issues which were issued years ago will see falling coupons when they enter the floating rate period.

We have a list of all the issues with their ‘potential’ coupons here.

Even worse these issues have no floor to the 3 month Libor reset level–if 3 month Libor goes negative coupons will keep right on falling.

So let’s look at the most recent example and that is the Customers Bancorp 7% Fixed to Floating non cumulative preferred (CUBI-C).

This issue was tooling along with pricing in the $26 area all the way until March 1, 2020–of course shortly thereafter we had the COVID 19 disruption and the share price fell to $14—but now recovered to $21.24

The terms of the issue would become 3 month Libor plus 5.30% on 6/15/20 — the first dividend payment date would not be until 9/15/2020 under the floating rate structure. If 3 month Libor remains at .3% the new coupon will be 5.60% for the next payment in September.

Knowing what we know today about interest rates the conundrum is whether the CUBI-C issue is a good buy at $21.24? With a coupon of 5.60% the current yield would be 6.60%.

3 month Libor has never traded at negative levels (going back to 1986), but these are not normal times we live in and one should never say never when making a forward looking forecast.

If 3 month Libor falls the coupon will fall for this issue and share pricing would likely follow.

But let’s make this a little more complex. What if interest rates generally and the 3 month Libor in particular jump by 1%? With bond like securities you would normally expect price to move in the opposite direction to rates–but not here. If 3 month Libor moved higher it is likely the share price would move higher, although it probably is more complex–meaning the level of the 10 year treasury would affect pricing as well.

In the case of CUBI-C if 3 month Libor moved sharply higher while the 10 year treasury moved only modestly higher it is possible that Customers Bancorp (CUBI) could potentially redeem the issue in which case a huge capital gain could be realized by the investor. It is hard to fathom this scenario occurring–but as I wrote above never say never.

Currently this is the only fixed-to-floating rate issue that Customer Bancorp has that is in the floating rate period, but they have another 3 issues that will go into the floating rate period in the next 18 months–all currently priced in the $19 to $22 range–all of which are already factoring in reduced coupons.

So it is quite the puzzle—and your action really depends on your personal outlook for interest rates.

Currently only a handful of fixed-to-floating rate issues are trading in the floating rate period–but in the number of years we will see bunches of issues go floating.

As noted by many we are starting to see large spreads coming with the new issues. Additionally as DoubleV pointed out we have the Fixed-Rate Reset issues coming with large spreads–for instance the newer Wintrust 6.875% non cumulative preferred comes with a spread of 6.507%.

What we are still missing is a ZERO floor in the variable portion of the coupon–if 3 month Libor–or alternatively SOFR or the 5 year treasury goes negative–the rate is zero—I won’t hold my breath for this in preferred stocks.

Errors and Omissions

On this page reader/participants can post comments pointing out ERRORS AND OMISSIONS on our various lists.

I think we are dealing with near 1000 pages on site at this moment (1/5/2019) and we always say we have maybe 98% good data with 2% being incorrect or simply missing.

For instance this week Affinity4Investing let us know we were missing one of the Allstate Corp preferred issues–fortunately we stumbled on his comment so we were able to get the issue added, BUT there is so much commenting activity we can only skim through them.  Thus if they are posted here were can, at a glance, find out issues.

We will respond to comments on this page, but we will clear it off every week or two.

Monday Morning Kickoff

Last week was a loser week for the S&P500 as it traded with a low of 3004 and a high of 3155 before closing the week near the low at 3009–down about 3% on the week. With the SP500 around 3000 the index is off 7% year to date and about 12% off of the 52 week high.

The 10 year treasury traded in a range of .63% to .73% and closed the week at around .64%.

3 month Libor (as the reset variable for most fixed-to-floating preferreds) closed last week at .37%. As fixed-to-floating rate preferreds move into their floating rate period this is an important number.

The Fed balance sheet FELL by $12 billion last week. The balance sheet has fallen by $86 billion in the last 2 weeks. The REPO market has been very quiet the last few weeks–obviously there is plenty of liquidity in the system, at least temporarily.

The average$25/share preferred stock and baby bond fell by 28 cents (around 1%) last week. Every sector fell, with lodging REIT preferreds falling hardest with the average share off around 6%.

Last week was a quiet week for new preferreds and baby bonds. There we no new issues.

Brookfield Infrastructure Partners (BIP) announced a new issue of preferred units–but as of this moment we are not aware of any pricing of the shares.

We did see the start of trading of the WESCO International 10.625% preferred (WCC-A). This is a fixed-rate-reset with a reset spread of 10325%. This is a special situation and investors should make sure to do their due diligence.

Investor Confidence In Check as Unknowns Multiply

The last 3 weeks we have seen common stocks move lower by over 6%–which means that at current levels the S&P500 is 11% below the 52 week high.

This mover lower is something I have expected–and the way it is occurring–not in a panic, but in an orderly fashion (in spite of 500-700 dow point moves) is just the way I want to see stocks fall. When common stocks move lower in an orderly fashion we don’t reach the point where the ‘baby gets thrown out with the bath water’ so most of the issues I now own have been pretty stable.

As always we all can predict (known as a WAG–wild ass guess) the future–of course we have no real clue as to what the future holds–to guide our investing. I used to always formulate what I thought the economy, both domestically and globally, would look like 6-12 months out to formulate my investing, but NOW it is a waste of my time as we are in totally uncharted waters–but I do it anyway.

Right now it looks like we are going to see more ‘lock downs’ throughout the country. So all of the zombie companies that are out there will have to finally toss in the towel. I’m talking some of the airlines, cruise lines, restaurants and bars, some retailers and lodging companies. As I type this airlines are making plans to layoff huge numbers of folks and cruise lines are pushing out sailings further and further. Air travel, while being touted as staging a comeback, is still off 77% from last year. In a business like airlines if your business is off 5 or 10% year over year you are going to be in poor shape–let alone down by 25, 50 or 75%!! I understand some of the amusement parks have reopened in Florida, but no one is showing up. With little air travel crowds are small – will they lose more money when open than they do when they are closed?

Of course my sour mode on the economy can change rapidly if we have a breakthrough treatment for COVID 19, or a vaccine. Neither of these will be in time to rescue the zombies. Borrow more and more money to stay afloat which simply raises your cost of operating as all of the free cash goes toward servicing debt.

I haven’t even touched upon the state and local governments that are barreling toward insolvency. In Minnesota many local governments can’t even open their public swimming pools for the kids–sad. On the other hand if these local governments were managing the city correctly they would have some reserves–but no, they spend every penny they can lay their hands on. In my town they are finally opening the pool on Monday since the governor has finally released the CARES act money to the local governments–helicopter money to bail out the local governments. Everyone complains about high taxes–just wait!!

So I stay invested in the income issues I truly and totally believe in–preferred stocks of closed end funds and utility preferreds and baby bonds. After doing some around the edge trimming in the last 10 days I am down to around 65% invested–I’m fine there and am very willing to forgo some income to sleep at night.

Down We Go But I’m Not Buying

Markets are taking a leg lower as folks wake up a bit from the never ending ‘v recovery’ chant.

I’m doing nothing really. I have been selling a bit in the last week around the edges–i.e. for some of the utility baby bond issues which I held full positions in I have taken a portion off the table. Really they were pretty extended–and given my expectations for better buying opportunities ahead I just banked some profits.

I had held a full position in the Wintrust 6.875% Fixed Rate Reset preferred issued on 5/2/2020 and I unloaded that for 2-3% gain. I am not enamored by any of the smaller community banks issuing high yield preferreds (i.e. 7%+/-). When I look at the exposure they have to ‘main street’ and in particular lodging and retail I think I can safely predict they are going to take some pretty massive write downs.

Bottom line is I think that we will see some nice buying opportunities in preferreds and baby bonds, but it is likely that until we start seeing 2nd and 3rd quarter earnings (or losses) we won’t have any real fundamental data to base investments on–or at least fundamental data that I can hang my hat on.

Right now 3 of 4 accounts we have are in the black–one is in the red yet by 5% so don’t know if I can get back to even this year on this one–the good part is this account had a nice double digit gain last year so likely my 6-7% annual average will remain intact.

VEREIT to Redeem 6 Million Preferred Shares

Giant triple net lease REIT VEREIT (VER) has announced that they will be redeeming 6 million shares of the 6.70% perpetual preferred (VER-F) issue.

Last week the company sold some debt and at the time stated they would likely redeem more of this giant sized preferred issue.

Bob-in-DE caught the announcement today that they will redeem 6 million shares for $25 plus accrued dividends on 7/22/2020. The 6 million shares is around 19% of the total currently outstanding–this will leave around 24.9 million shares yet outstanding.

VER-F is a monthly payer and goes ex-dividend on 6/30/2020 for 13.9 cents for payment 7/15. There will be an additional ‘stub’ dividend payment for 7/15/2020 to 7/21/2020 of 3.3 cents on the redeemed shares.

VER-F is now trading around $25.05.

It is likely that in the next few days you will see around 19% of your shares segregated in your brokerage account if you are a holder. NOTE I hold a full position of this one.

The company announcement is here.

Still Awaiting Brookfield Infrastructure Partners Pricing

I have not yet seen any pricing on the new Brookfield Infrastructure Partners (BIP) preferred issue..

I have noted that since the start of the pandemic that pricing is slower as is the movement from the OTC grey market to the permanent exchange. Some of the new issues are taking a month or more to move to their permanent exchange–typically it would be a week to 10 days.

WESCO International to Issue Preferred Stock–UPDATE

AS NOTED BELOW IN THE COMMENTS FROM GRIDBIRD THIS ISSUE IS NOW TRADING UNDER TICKER WCC-A AND LAST PRICED AT $27.10 NOW ON ALMOST 200,000 SHARES.

WE FIND NO RATING ON THE NEW ISSUE, BUT WESCO WAS RATED BB- BY STANDARD AND POORS AND ANIXTER WAS RATED BB. MOODYS RATES WESCO B1

Supply house WESCO International (WCC) will be issuing a new issue of $25 preferred stock in connection with the company’s acquisition of Anixter International (AXE). These shares were issued directly to Anixter shareholders as partial consideration in the merger.

These cumulative shares will be fixed-rate reset with a giant initial coupon of 10.625%.

The coupon will reset every 5 years at the 5 year treasury plus a spread of 10.325%

Dividends will be paid on the last day of March, June, September and December being 9/30/2020.

The registration statement is here.

Additional information is shown here in the Depository Agreement.

NOTE–while we see the shares are registered to trade on the NYSE we don’t know all of the details as of this moment.

I will post more detail as I dig through the merger agreement documents.

MCG WAS ON THIS ONE EARLY TODAY

Brookfield Infrastructure Partners LP to Sell Preferred Units

Giant Canadian partnership Brookfield Infrastructure Partners (BIP) will be selling a new issue of preferred units (preferreds issued by partnerships are call ‘units’, not ‘stock’).

This security will issue a K-1 at tax time.

The shares will trade on the NYSE under permanent ticker BIP-A after a short stint on the OTC grey market (ticker not announced).

They will have a optional redemption period starting on 7/31/2025.

The preliminary prospectus can be found here.

Eugene was right on top of this one.