I continue to be fairly conservative – still plenty of money in CDs and money markets–although I have been slowly moving to some higher yield vehicles over the last few months.
With the inflation news just released (PPI) today is one to believe there is no inflation–or there is no inflation coming? It doesn’t make sense with all the tariff information—if inflation comes this month–instead of last month does that mean that interest rates are going to shoot higher? Are we going to see strong downward pressure on fixed income securities?
My uncertainty leads me to the conclusion that I need to continue to stay investing in shorter duration securities. I am thinking one of the Saratoga (SAR) baby bonds may fit the bill (I already have the SAZ issue) I can lock in around a 8% current yield for the next 2 years—and the BDC just released earnings a week ago that seemed pretty good in this environment.
We’ll see what happens–I am sure I will add something in the next couple of days.
72% of my funds are in issues whose rates will ultimately float or adjust with interest rates. About 50% of that is SGOV, paying roughly 4.1%. The reality is that this is not cash sitting around earning 0%. It is a valid investment choice. Would I like to up my yield on this another 2.4% – 3% or so? Sure. But I am not going to do that with a pure fixed-rate purchase at this point.
I will wait for the right issues to hit the market. The right plan for me is to acquire investment-grade preferreds and baby bonds that float off SOFR or reset off the 5-year treasury.
Whatever happens with inflation in the coming months, someone will claim they had the right call on tariffs. That might mean something if tariffs were the only contributing factor. If the argument is about should the Fed cut, it doesn’t matter because the real question is will the Fed cut. The Fed has been clear for many months: show us labor market weakness.
IMO, Congress is likely to do more damage than the Fed can fix. It’s ridiculous to expect the Fed to (preemptively) counteract bad fiscal policy with rate cuts.
plenty of short duration opps exist, here are a few that come to mind, altho no free lunches..
SPNT-B near par
ATCO-H below par, they already announced a partial call and will eventually call the whole thing
PMTU- near par (div adj) – it has about 36 cents accrued now so it trades slightly below par, div adj. yes, I know the coupon is only 8.5%, much lower than the other mREIT BBs, but PMT is one of the safer names.. so 8.5% to wait ~3.5 yrs is A/OK w me. check out NYMTG at 24.10 for 10.5% YTM if you want more juice.
ATH-C -similar to SPNT-B, it trades near/below par (div adj) and highly likely to be called
RITM-D near $24, of all the floater mREIT prefs, this is the name most likely to be called as it has a 6.2% reset spread and RITM is relatively high quality
RJF-B, another names that trades below par (div adj) and highly likely to be called. the negative with this name is still fixed but currently callable, a unique issue
best of bunch is prob ATCO-H. people are suspicious of private shipping cos (for good reason), but would be very strange to call the others (ATCO-D, ATCOL) and then play games w the one remaining. plus, they are well resourced and can prob get cheap, 6% type financing in the private credit market., insurance companies cant get enough!
Regarding RITM-D don’t you have to keep in mind how the F/F rate issues are based on 3 mo SOFR which is about 25 basis points higher than the 5 Yr that D will reset off of and they have been callable for a few years now and they’ve still only done a partial call on A only? That would lead me to think “highly likely” to be called might be an overstatement on D….. I don’t disagree that the likelihood should be considered high, but I wouldn’t think it’s a overly high given their slow call history on their F/F issues (which I do own). I’ll also point out that unlike most resets, D is continuously callable after the first Reset date, not only callable every 5 years.
You make some good points!
I will change it to likely to be called (greater than 50%) and also add “within a year of the reset date.”
I often underestimate the optionally the 5 year resets present to the issuer. Keep them outstanding and see if rates tick up..
With that said, at the current forward curve.. I believe we are looking at close to a 10% reset coupon, which is high for a shop like RITM.. they have a ton of lower risk MSRs, and have a growing asset mgmt division, not a normal mREIT. They also have outstanding debt that trades slightly below 8%.
And in regards to the SOFR floaters, I believe most think the curve will eventually turn back to upward sloping.. so they are keeping their floaters live for that type of scenario.
Add HROWl&M. I cannot see these failing at all.
Hrowl is currently callable..they do not currently have the funds to redeem but are in talks with oaktree to refinance… I would not purchase above par.. the 8.5 issue is better…
Getting back to the discussion regarding 5 year resets- where the issuer can call every quarter.
Assuming the spread is fair/attractive, my working theory is that these will gravitate towards par as the reset (calculation) date approaches. After all, they will reset based on the prevailing 5 year rates.. so the yield/coupon will both be near market as the reset date approaches.
Should they have a disco to account for the issuers ability to call? Yes
How big should that discount be? Not sure of the answer.. maybe a 0.25 to 0.5 haircut to the price.
Would love to get constructive criticism on this line of thinking.
Also, I think part of the discussion is how the market “will” price it vs “should.”
I believe a fair reset rate for RITM-D is in the 5 area, maybe 5.5% tops.. hence why I think it will eventually get called w a reset rate of 6%+.
Sorry, one last thought.. I would guess pricing will get more dynamic as the reset date approaches.. i.e. it becomes clearer how much the optionality is worth to the issuer.. said another way.. comparing the market movement of the 5 year to the level it is striked at, the level on the reset date calc.
Your thinking mostly matches my own. If the drift lower in price is because underlying interest rates, have gone up, it seems reasonable to assume that resetting to the current rate plus the original spread would cause the issue to trade close to par. A few thoughts, though.
First, this depends on being able to consider the spread as a constant over time. If it was issued at a time when spreads were historically tight, and if current spreads are wider, it might still fall significantly short of par. Conversely, if it was issued when spreads were wider, it should easily pin to par and/or be called.
Next, I’m not sure that a fixed discount is the way to account for callability. Rather, the discount is part of the “pinned to par” phenomenon, where it’s more of a cap on possible price rather than a discount below par. And once you are significantly below par, I’m doubtful there is actually a discount.
Lastly, I still don’t understand how to project whether a given issue will be called. I think the transaction costs for the company are large enough that future projections matter a lot. If the company thinks that rates are going to drop in the next couple years, they may choose to keep paying a “too high” rate much longer than one might guess.
I too would like to see more discussion of how this actually works.
Nathan, appreciate your insights!
“First, this depends on being able to consider the spread as a constant over time. If it was issued at a time when spreads were historically tight, and if current spreads are wider, it might still fall significantly short of par. Conversely, if it was issued when spreads were wider, it should easily pin to par and/or be called.”
>> That makes sense to me. And of course, we have no idea what spreads will be 1 year+, but we can take an educated guess, using current spreads as a healthy starting point.
“Next, I’m not sure that a fixed discount is the way to account for callability. Rather, the discount is part of the “pinned to par” phenomenon, where it’s more of a cap on possible price rather than a discount below par. And once you are significantly below par, I’m doubtful there is actually a discount.”
>> I agree, you just said it better than I did! Just to flush this out even further.. using a hypothetical.. I would take a 5 yr reset over a floater with identical terms, for a name that will float/reset a year from now. i.e. I am banking on an upward sloping yield curve over the long term, even if it gives the issuer more optionality.
Lastly, I still don’t understand how to project whether a given issue will be called. I think the transaction costs for the company are large enough that future projections matter a lot. If the company thinks that rates are going to drop in the next couple years, they may choose to keep paying a “too high” rate much longer than one might guess.
>> I think this is just case by case basis, mostly the strength of the issuer and ability to issue similar debt/prefs at lower yields. I am excited for all the of the floaters/resets to triggers over the next year or two – it really opens up the risk characteristics of our universe. Discounted (non-live) floaters really are the best!
One thing to keep in mind that as a general rule of thumb, the “spread” is almost always equivalent to the original spread at issuance between the RESET issue and the 5 Year Treas… There are exceptions when companies think they can get away with it, but that’s the general rule…. So if you’re willing to assume a steady spread relationship between the issuer and US treas, you have a pretty good idea of where the spread will be in any interest rate environment when it resets…. My theory is, though, that as rates go down, the spread between corporates and Govs also narrows because at lower rates the absolute differences become narrower because they mean much more relatively…..
BTW, I don’t think you guys are covering the population of RESETS that now trade at a substantial discount and may not make it to par even when they reset…. Examples would be a couple of the ENB preferreds, EBBNF and EBBGF, both USD denominated. Just looking at EBBNF right now it’s trading at about a 6.50% current yield and I would argue that that already is beginning to reflect a compressing of price value in anticipation of the reset in 2027. IMHO, if rates are the same in 2027, I don’t think it will reach par, but I think it’s already experiencing a run to par phenomenon at the time that could continue…. I think there are other examples out there of this, but these are the first to come to mind for me.
“ So if you’re willing to assume a steady spread relationship between the issuer and US treas”
I definitely wouldn’t recommend this. The appropriate spread should be dynamic based on two main factors: 1)the evolving fundamentals of the company and 2) the level of spreads in the market, HY or IG OAS.
Looking at the two factors above is a critical reason I believe RITM-D will eventually be called, but this evolves w the market. For example, if HY spreads are 500 bps at the time of the reset/call date, I don’t think they will call it until spreads come back in.
Regarding issues with unattractive reset spreads, these have a place in my portfolio.. if the price is right. I currently many floaters w spreads that are below market. How do I know the spread is below market? For live floaters that trade below par… or non-live issues which have a very high YTC.. ie it is implied it will not be called on the float/reset date. Here are a few examples:
Live Floaters
Name/ Cusip , current price
PPL 69352PAC7 98.5
RGA 759351AE9 96
GS 381427AA1 84.25
Not Floating Yet
Flagstar 33930AD3 93.6
Ally 02005NBN9 89.5
Personally, I have found the best value in non-live discounter FtF/R. My belief is that many investors have assumptions that are incorrect, or simply not doing the math to determine the expected return until the call/float date. This is especially true for $25 par issues that are sold to retail, mREITS or small less liquid issues.
Related, it is amazing how many pref investors simply look at current yield, or the buy and hold types that will keep a high coupon issue priced way above par and a poor YTC. Trading around these is how I hope to pay the bills.
Your response prompted me to do a little more research on EBBNF, which I’m currently holding on the theory that it will move (close to) par when it resets in Sep 27. I’ll skip the source links for now so this comment doesn’t get rejected as spam.
It looks like EBBNF (Series L) was issued in May 12, when the HY spread (BAMLH0A0HYM2) was about 6%. This makes its 3.15% spread at issue quite a bit less than I would have guessed, but it’s a BBB- so maybe it makes sense. I presume it traded at par at issue, but haven’t been able to confirm this.
At its first reset in Sep 17, the HY spread was about 3.5% and it reset for 4.96%. It started traded for about $24 in starting in Mar 17, and stayed just under that for the rest of the year, never hitting par.
At its second reset in Sep 22, the HY spread was about 4.6% and it reset for 5.86%. It had traded in the $24s for May-Jul 22, then dropped to about $20 at the reset.
Currently, the HY spread is about 3.2%, and it’s trading at $23. If EBBNF were to reset at the current 5-year rate it would pay 7.2%. If the HY spread stays the same or narrows, my guess would be this means it’s going to trade pretty close to par. If the spread widens, then it won’t.
One thing this quick dive did tell me was that if it does go up to par or real close in the months before the reset, I might be wise to play it safe and get out at a good price. That sharp drop after the Sep 22 reset might be a good lesson to learn from!
I also am carrying this issue and I agree with your analysis..I picked it up from preferred stock trader..
RITM-D floats based on 5yr T rate not SOFR. 10% YTC at the current price it’s been higher. Whether called or not it’s a good one.
Hi Maine—think I have almost everyone you mentioned already.
Maine, I like “close to” free lunches.
How about an interest rate arbitrage:
Borrow at 3.94 till 12/28 using SPX options.
Invest the money in a higher yielding CD.
For a little risk, invest in a 3 year annuity from an A+ insurer at 5.3%
The real questions are:
1) How much can I deploy?
2) Do I have capital gains to offset the capital losses generated from the borrow?
The answers may be 1) as much as I want and 2) I’m not sure I do
lol, I think the same way.. get a little carried away when the going gets good. I remember way back when..some folks made a boat load by buying coins from the treasury mint website, getting the credit card points, and dragging all the coins to the bank!
I’ve heard about getting cheap financing via futures.. get mine the old fashioned way for now.. borrow at IBKR in their second tier.. not as cheap but (being a yield hog) I have lots of interest income too offset. I love your line of thinking, tho..
lt, can you give us less experienced folks an example of how you would “borrow” using SPX options?
Thanks in advance if you can, and no problem if you don’t have time to.
you set up a box trade. it will use your margin power, but not charge you margin interest. You could use it to buy a house, car, or securities, if you wished. I think they fill like 50bps above risk free rate, and you’re the one providing the collateral from your own portfolio. the three year box is 4.5 now that the curve changed….you can use them to lend or borrow. (or borrow then lend, like these guys say … a carry trade)
https://www.boxtrades.com/SPX/15DEC28
Borrow 86,560 today, repay 100,000 for a cost of 13,440 on December 15th, 2028
Example trade
Sell 1 SPX 15DEC28 5000 CALL
Buy 1 SPX 15DEC28 5000 PUT
Buy 1 SPX 15DEC28 6000 CALL
Sell 1 SPX 15DEC28 6000 PUT
jb,
I believe boxtrades.com calculates the rate differently than the manner in which it would be calculated for a margin loan, as pointed out by syntheticfi.com (which provides the market data to boxtrades.com).
I’m pretty sure synthetic fi is correctly calculating the rate.
They provide a chrome extension to enter the order free of charge
syntheticfi is cool, that’s what I was looking for.
there is a dude I follow who uses the box to create a swap for the high yield index … loan to the people who want to short the hy index and get the extra return while using the option market as the counterparty instead of the bonds themselves…mimic the hy while ignoring credit risk – it’s clever. I think the institutional investors don’t really want to hold the bonds themselves and prefer the derivatives/futures and just make a synthetic portfolio.
https://www.simplify.us/etfs/cdx-simplify-high-yield-etf#:~:text=The%20Simplify%20High%20Yield%20ETF,and%20flexible%20credit%20hedge%20techniques.
Sure Scott,
The best thing to do is read over this website,syntheticfi.com. then google for the CBOE handout on lending/borrowing using SPX options.
Basically, you are creating a market-based margin loan.
Thanks jb and lt.
I am familiar with box trading but never really considered it from the standpoint of being a source for a loan and what the tax implications might be. I will check out the info that was suggested.
The One, Big, Beautiful Bill will increase our enormous deficit unless it can generate a substantial tax revenue increase. Over the next few weeks, as the bill moves through Congress and is debated, we may well see concern registered in the bond market via rising interest rates. If that happens and triggers a fall in the stock market, then based on what we saw in April, baby bonds likely will fall, too, along with preferreds, even the FTF. I’m puckered up and on hold for now. The deficit is a bigger problem than inflation.
Lyn Alden says deficit spending is inflationary. And I would add stimulative (until it’s not). Both factors could lift long rates. A Fed rate cut might add fuel to the fire, as it did in September.
10-year yield daily about one year
https://www.tradingview.com/x/CVldWqdn/
Tim, the only thing that can cause inflation is increase in money supply. If anything, tariffs should be deflationary. Imagine lemonade stand where prices suddenly raised 50%. Sales should drop accordingly. Then less workers at the stand are required and less lemons so same effect at the lemon farm. I don’t think U.S. consumers are going to pay up for cheap Chinese crap. If they do they will have to buy less of something else. Zero sum like trading. Deflation = market down. Inflation = market up. Thats why initial reaction of market to Liberation day was down. Unfortunately, tariff induced “deflation” sounds great after the last few years, which is why it was struck from the MSM narrative. and replaced with double-speak.
Need to position for deflationary environment.
Good thoughts Dan
This is where the “inflation” debate gets murky. Multiple Fed officials have gone on the record saying that tariffs are inflationary, so that is how they are operating. Half of the Fed’s dual mandate is “price stability” which they equate with “inflation”. Even though many economists would argue that we should be watching money supply, and not prices, to track inflation, unfortunately, those economists do not work at the Fed. Walmart mentioned this morning that prices will be increasing even with the reduced tariffs currently in effect. People at Walmart (and the Fed) are not watching money supply, just prices. Prices at Walmart and other stores feed into CPI as well, so CPI should increase. So by that definition, tariffs are “inflationary” even if that’s the wrong way to look at it.
Dan , margins at some businesses are up but as you said prices are higher. All the car manufacturers have already said new vehicles will be going up by several thousands of dollars so if course there will be less sales. Here in California we have always enjoyed cheap prices on vegetables from Mexico and I have noticed tomatoes have went up. Farmed salmon is up 1 to 2 dollars over last year. Yes I probably will be buying less but spending the same.
I think there’s different ways to measure inflation.
Tim
I share your indecision and marvel that the common market can justify price levels now that approach those of the previous highs before the volatility and economic gloom have now set in.
I have attached the BLS revisions to the 2nd and 3rd quarter job reports for 2024. The 600,000 new jobs from private employers have disappeared in corrections. Government jobs were the only sources of job growth for those two quarters. Close to the same corrections occurred last year.
Until a month ago, I was okay with buying good yields at a discount but now I favor higher yield at par with a reset based on the 5 year like the recent Wintrust. Maybe FTAIM at $26? I want more of a hedge on higher inflation or continued higher rates to offset the bulk of my fixed rate pfd’s.
Potter,
BLS has been a poor source of info in its initial announcements for more than a year (I can’t look right now for longer history). They are usually WAY off, then revise hugely (usually down).
Last year, I thought it was a political thing. may still be, but I am beginning to think they have just lost the thread and need to adjust their methodology significantly (BLS adjusts its methodologies for a bunch of things every quarter – and documents them publicly.).
FWIW, the only job growth we have seen in California for quite a while (several years?) has been from our government. Our tax dollars at waste…