DEFINITION–I use the term ‘potential coupons’ below. This refers to the coupon TODAY with the 3 month Libor rate at TODAYS level and TODAY being the dividend determination date (the date the quarterly coupon is locked in). When looking at floating rate securities one has to make some assumptions. I also have this on the google spreadsheet of fixed-to-floating and floating rate issues with real time interest rates.
FLOATER–a preferred issue which has a floating rate with a minimum coupon since the date of issuance and which resets every quarter based on 3 month Libor (to be 3 month SOFR in June). All currently trading floaters are investment grade issues with the exception of the Zions Bancorporation ZIONP issue.
FIXED-TO-FLOATING–a preferred issues (or a few baby bonds) which has a fixed coupon for about 5 years (although some are as much as 10 years) before moving to a floating rate which is reset quarterly based on 3 month Libor. I currently show 10 fixed-to-floating rate issues trading in the floating period. Another 17 issues will begin to float in 2023.
FIXED-RATE-RESET–a preferred issue that has a coupon which is fixed for about 5 years and then is reset every 5 years based on the 5 year treasury yield. There are no issues trading now in the floating rate period.
I am referring here to only $25/share preferred issues—their are some $1000/share issues outstanding which I do not cover at this time.
We have pure floaters and we have fixed-to-floating rate preferreds trading in the marketplace at this point in time. More recently we have had fixed-rate-reset preferreds being issued–but none of these are currently trading with their reset rates active.
The pure floaters have been around for quite a while (issued back in the early 2000’s) and have not traded with coupons above their ‘minimum’ coupons for many years until the last 3-6 months. The floaters all have ‘minimum’ coupons of 3% to 4%. The floating rates all are at very low ‘spreads’ which is added to 3 month Libor–obviously with 3 month Libor near zero for years and ‘spreads’ in the .35% to 1% area these issues have been trading at their respective minimum coupons. With the recent rise in interest rates the ‘potential coupons’ have risen into the 5.13% – 5.78% range–but the current yields are in the 7% area.
An example — Bank of America (BAC) has 5 pure floaters outstanding–with current potential coupons of 5.13% to 5.53%—with current yields in the 7% area–at current interest rates (they trade in the $19/shares area)–of course as 3 month Libor goes up or down this moves. On the other hand BAC has many fixed rate issues outstanding where a 6% current yield can be locked in now.
So should one buy a pure ‘floater’? I can not give an answer for that–only you can answer that question. To me 1st you need to have a opinion on where interest rates are going. If you believe that rates are going higher and that they will remain high for years and years then the answer might well be yes. If you believe that rates are near a peak and will move lower this year or next the answer may be no. Remember that there is only a minimal chance that these will be redeemed at $25 so one will not have pricing pegged to liquidation preference–when rates fall the price/share will drift down as your yield moves lower.
So the answer is not easy at all whether to buy or not.
Should I buy a fixed-to-floating rate preferred? Just like the floaters I can’t answer the question for you, but once again you should have an opinion of where interest rates are going (not that you will be correct since none of us know for sure). Unlike the floaters the 10 current issues of fixed-to-floating rate that are in the floating period are all junk rated (less than investment grade) and 1 of them has a suspended dividend. The potential coupons range from 8.36% to 11.66% (NGL-B would be higher but the dividend is suspended). So obviously one wants to buy an issue that fits their risk tolerance range. Additionally one should have an opinion if an issue will be redeemed anytime soon–and thus how much call risk is in the price of the shares (if it is above $25).
For instance I own the Customers Bancorp 6.45% perpetual fixed to floating rate preferred (CUBI-E). Shares are only redeemable on a dividend payment date. Shares are trading at $25.34 right now and the next dividend in 3/15/2022. The potential coupon is 9.92% (62 cents)–so there is no call loss risk in the issue, but one would see their net proceeds be reduced upon a call on 3/15/2022. This issue is a smaller issue (2 million shares) and the cost of dividends each quarter is about $1.2 million at the current floating rate coupon (estimated). I guesstimate they could refinance the shares at maybe 8.75% to 9% at this time (based on the 8.25% Merchants Bancorp issued shares in September) so their savings would equate to 10% on the dividend–quarterly savings of $120,000. The cost to issue new shares is just shy of $1.00/share (3.15% underwriting discout plus administration costs)–or close to $2 million on 2 million shares. At this rate it will take around 4 years for ‘payback’. Is 4 years a good enough payback for the bank? Do they want to issue high yield shares at this time that they will be stuck with for 5 years–or do they want to take a chance rates will fall and then refi at a lower coupon (say 7% or 7.5%).
So there is never an easy answer to whether to buy floaters or fixed to floating rate issues. Additionally while we as investors are stuck having to forecast interest rates–company’s are stuck having to make the same forecasts and assumptions.
Above is actually a very simplified look at these issues–there are plenty more factors. Issuers could issue common shares and call all of their preferreds–regardless of coupon. They could float debt at much lower coupons typically, but if you are a bank it is likely you don’t want to do that since non cumulative preferreds are Tier 1 capital and an issuer has much more flexibility with preferreds than debt.
What do readers think–do you owners some of these issues and what is your logic?
