Today we saw interest rates tumble apparently on concerns over a new covid variant.
The 10 year treasury closed the day at 1.48% which was a full 16 basis points below the Wednesday close. On the other hand it was just 5 basis points below the close last Friday.
Seems to me that the supposed react to the new covid variant was over the top–an over reaction. Honestly I think the equity tumble was simply because investors were looking for a reason to sell and the new covid variant gave them an excuse.
Preferreds and baby bonds took a bit of a whack this week with the average $25/share issue off just under 1% while the average investment grade fell by just over 1%. Certainly this caused some pain, but all in all it is something we can live with – do we have a choice?
Some preferred issues seem to be offering us a bit of a bargain with recent losses. 1 such issue is the Ready Capital (RC) 6.50% perpetual preferred (RC-E) which is now trading at $24.42–down from a recent high in the $25.60. RC has had stellar financials in the past year and now is at a current yield of 6.7%. Of course with potential for further rising rates we could see this one continue to tumble. Buys in this environment of perpetual issues are dicey and one should leg into positions (buy small positions multiple times).
The Urstadt Biddle (UBP) 6.25% perpetual preferred (UBP-H) is down about 4% in the last 10 days or so. This is a decent quality issue and at $25.25 maybe there is opportunity–but again a ‘leg in’ is the only way to play it.
Lastly the Prospect Capital (PSEC) 5.35% perpetual (PSEC-A) has been one of the worst performers of all perpetual preferreds – closing today at $21.63. There is no fundamental reason for this to be occurring. Yes the company is selling 5.50% monthly paying preferreds in a continuous $1 billion offering in the private market, but this is not a sufficient reason for the ‘A’ issue to tumble so hard. These private market shares do have a conversion option, but again this is not sufficient reason to send these shares lower. A current yield of 6.11% for an issue just under investment grade (2 notches) is a juicy offering.
Note I hold shares in the PSEC-A issue and bought a few more today (Friday).
I am not recommending the above shares–as I expect them to move lower IF rates move higher. I am simply pointing out some issues that may ‘work’ for immediate income investors.
SN
Have not received my CRLKP dividend payment yet.
Monday and Tuesday may bring more buying opportunities for us as Barrons / Market Watch has an article titled Markets Never Bottom on a Friday.
FWIW, I’ve been nibbling and purchased and added to positions in:
Travel stocks — CAE (simulation for pilots) and SP (they manage parking lots) and the preferreds of NRZ-D
Looking to begin a position in Granite Point (GPMTP) and add to RLJ lodging (RLJ-A) and Central Parking (CRLKP).
Greg, since you own already Im sure you know patience will have to be your friend with the SP debt CRLKP. A roached out float of 44,000 shares and thats really closer to 42k after you back out mine. Some were for sale at $24.99 I saw, but thats a bit too high for me.
That 2028 maturity is fast approaching 2WR’s wheelhouse, ha.
Do fries come with that CRLKP 2028 maturity, Grid???? I may have to supersize….. I know you’ve talked about this issue before but honestly, I’ve never really paid close enough attention… I know it’s payor has changed a few times over the years, and do I remember correctly that KKR was involved at one time?…. I’m betting I probably should know or want to know more…. Same with this new Atlanticus issue….. I read it, but didn’t jump in…… I know the Atlanticus issue has a whole lot of secured debt in front of it, but didn’t read far enough to figure out what the secured debt was for. But it sure looked as though there was so much secured that truly nothing could possibly be left over for this unsecured issue or for shareholders in a worst case scenario.
Greg Gilbert, did you happen to notice if CRLKP had paid its Jan. 1, 2022 dividend?
SN
Unfortunately, I have not yet received my dividend payment from CRLKP.
Hypothetical Question:
Let’s assume that there are a number of perpetual preferred stocks from the same issuer — some trade slightly below $25, and some others have a lower coupon and trade further below $25. If the current yields were identical, I would think that the more discounted preferred stocks would be much more attractive due to potential profit associated with a possible call. Is there any type of formula or calculation that suggests exactly how much current yield you should sacrifice relative to the discount?
The Yield-to-Call calculation may help you in comparing.
AF asked: ” Is there any type of formula or calculation that suggests exactly how much current yield you should sacrifice relative to the discount?”
AF, I am not sure the scenario you outlined is the most likely. Let’s make a simple example for a company with only two issues outstanding. Pulling numbers out of the air:
XYZ-A has a 6% coupon and is trading at 24.5, immediately callable
XYZ-B has a 4% coupon and is trading at 20.5, immediately callable
Your assumption was that the -B might be the better buy since it would have a larger capital gain if it was called. The issue is that it would likely NOT be called first. Calling the A issue would save the company more money and likely would be called first, all else being equal.
If for some reason, the “market” thought that the B issue was going to be called first, it would be priced accordingly, i.e. it would NOT fall all the way down to 20.5 in this example. Maybe it trades at 23.5 instead of 20.5.
At the end of the day, the only calculations your have are coupon yield and yield to first call. Beyond that you have to use a crystal ball to guess on corporate Baa interest rates and the likelihood of any particular issue being called.
af – IMHO, the mentality you are describing comes from a world like today where it seems like clockwork that preferreds and baby bonds all seemingly get called at or near their first call dates no matter what….. But consider a world where interest rates have continuously gone up, not down, for numerous years. It’s because of the general direction of interest rates recently that the call dates have become so important in choosing what to own, but consider an alternate universe where interest rates have gone up continuously and convention is telling you they’ll be staying where they are.. In that environment, call dates become relatively meaningless…. In the old days, when such was the case, you would every now and then see a bond/preferred called when it was trading at a discount, but normally that would happen for some extraneous reason such as the company wanting to get our from under a covenant within the prospectus of the specific issue. In this day and age of covenant light issuance, even that will become a relatively unlikely reason for a bond/preferred that was issued in historically lower interest rate times to be called in a higher interest rate environment. So IMHO, I don’t give much credence to the premise you’ve asked about in your hypothetical. Would love to hear alternate opinions..
BTW, I hadn’t seen Tex’s post before posting this one… I think we’re on the same wavelength.
From the same issuer, I would still much rather own a 4% perpetual preferred trading at $20 than a 5% perpetual preferred priced at $25. Both would have the same current yield of 5%. Is there any scenario in which that would be a mistake?
af – can’t think of any off the top of my head……. What would make that even more favorable for the $20 issue is that for the same 25k money invested, you could could buy 1250 of the 4% issue vs 1000 of the 5%. That, more than the possible benefit if it were to be called when that’s not really likely, should make the 4% the better choice.
AF asked: “Both would have the same current yield of 5%. Is there any scenario in which that would be a mistake?”
AF, I built a model for the exact situation you have described with a 4% @ 20 and 5% @ 25. Under the assumption that neither will be called, therefore they have become “perpetuals” never to be redeemed, they behave exactly the same.
If interest rates rise 1%, both will fall ~ 17%. If interest rates fall 1%, both will rise 25%. The bond math is like having the 4% issued with a $20 par and the 5% issued with a $25 par.
So your belief is correct if you are making new buys today under the assumption neither will be called, there is no advantage for one issue over the other. 2WR and I both agree that it is most likely the 5% coupon would be called first, but if for some reason the 4% was called first, it would be the winner.
There is one major assumption in this analysis which might not be true in the real world for all issues: the interest rate spread for each issue over the corporate Baa rate. So every investor should get real numbers to fine tune their model of how issues “should” respond to changes interest rates.
If they are both callable at $25 (which differs from Tex’s assumption) , I think you’re always better off with the 4% trading at 20. If yields stay the same or go up, they should behave pretty much the same. If yields go down, the 4% issue will be less constrained by the call price and should appreciate more. In theory, the market should adjust to recognize this, so that the current yield on the 4% issue becomes slightly less than on the 5% issue.
No precise formula because the variables are always changing. What are the odds of a call, how much interest rate risk, and how much is the price upside worth? So use your judgement. I generally lean toward the higher yield it has less downside risk.
I closely monitor the price difference between them. You might expect them to move in tandem. When there is a divergence with one issue moving more than the others there may be a price imbalance to take advantage of, before the prices adjust back. One of my best tactics,
You peeling back any Martin, or is it full steam ahead? I usually am, but pulled back cash some recently and will do a bit more. There are a few Im trying to snag but for specific reasons. I got a few but need more.
Full steam ahead. I’m not convinced the smart money will let Omicron nonsense crash the market. And if it does, rapid declines are so wild they offer more and bigger arbitrage opportunities. I made profitable trades in March 2020. Didn’t keep up with the falling prices but on the rebound my profits started showing up. I aint afraid of no crash. Bring it on!
Only problem is I’m going on vacation Monday and won’t be trading full time. Bad timing?
We have to remember that broadly speaking, most preferreds and baby bonds track corporate Baa bond rates more closely than US Treasury rates. On days like today, where the UST 10 year rate fell, the corporate Baa rate rose. If your model is based on the UST 10 year, it would predict that preferred prices would rise today. If you base your model on Baa’s, it would predict that prices would fall, which is what happened today.
The explanation for this is that the default risk of corporate bonds and even more so preferreds increase in recessions, whereas US treasuries having no default risk become the safe haven.
When everything is going great in the economy, the perceived default risk of corporates/preferreds goes down. So all it took was for investors to perceive that the new Covid variant “nu” increased the risk of an economic slowdown/recession. And that rippled into corporates and our preferreds. Seen it a hundred times before, so it is “same old song, just play it again.”
As to whether “nu” really causes more shutdowns, it is unknowable at this point. Also important for newbies to understand that lower coupon issues will fall more than higher coupon issues in these situations. If the panic continues, some of the ~4% coupon new issues are going to be very ugly.
More great info, Tex.
Sounds like the variant is being named omicron, not nu. https://www.bbc.com/news/world-59438723 says, “The WHO have also given it a name and ended days of speculation that we would end up in the slightly ridiculous position of calling the new variant the “Nu variant”. / There have even been arguments about the correct pronunciation of the Greek letter Nu (it’s technically a “Nee”). / Instead, you can guarantee we’ll be talking a lot about Omicron in the weeks to come.”
Darn, I was waiting for endless “who’s on first” jokes…
Greek students would also notice that after the last real variant named Mu came Nu, rejected for “who’s on first” jokes, but next came Xi and not Omicron. As in, “more deaths attributable to Xi”, “Xi is the worst yet”, etc. the WHO’s bosses in Beijing cooked up this ridiculous naming scheme to prevent covid from being called the Wuhan flu (or maybe the Wuhan coronavirus) like it would have under any sensible virology naming scheme, and they sure wouldn’t allow Xi to be associated with what came out of his labs…
Speaking of newbies, something never experienced by anyone who’s only been involved with fixed income issues in the last 5 years or so is the mathematics of bonds trading at discounts instead of a premium and the positive impact of owning bonds with stated maturities (shorter maturities in particular) when the discount is caused by higher rates, not weakening credit strength of a particular issue. The time comes when the discounted price acts similarly to today’s “pinned to par” effect because of 2 factors, a normally positively sloped yield curve and the future appreciation to par over time. For example, if you were to be able to buy a solid credit 4.75% issue due 12/1/2028 today at 22, it would yield 6.93%, ignoring accrued. That same bond, being a year closer to maturity but still being priced at 22 would be yielding 7.23%, or 30 basis more…. At the same time, in a normal world, a 2027 maturity would yield less than the same credit bond due in 2028 by let’s say 10 basis. So in an identical interest rate environment 1 year later, the 2027 should be worth 6.83% vs the 2028’s 6.93%. Assuming interest rates stood still from the day you bot your 2028 maturity at 22 until one year later, your 2028 bond OUGHT TO BE worth 22.45 to yield 6.73% instead of your original purchase at 6.83% (not 7.23% as it would were it at the same original dollar price) and that would be after having received your year’s worth of 4.75% coupon…. WOW! I bet I’ve just helped a lot of people fall asleep quickly tonight with this kind of gibberish! LOL…. Point is that once bonds with stated maturities, particularly those with short to midterm maturities, have fallen to a substantial discount because of increased interest rates, there becomes a built in cushioning effect to price change that to some degrees affords protection from even greater increases in rates……. YAWN….Zzzzzzzzzzzzzzzzzzzzzz, I’ve done it to myself as well.. G’nite.
As your alluding to Tex, everything can be all tied into equity markets also when things become chaotic. When things are smooth, the focus can be on yield spreads. But common market upheaval invariably gets involved.
December 2018 is a recent example of your explanation. Treasury yields plummeted, at same time credit spreads widened, all while stock market was sinking. And most preferreds followed like penguins.
This is why investors skeptical of preferreds label them the worst of investments. They act like stocks when market sinks, and act like bonds when they are dropping.
Tex, I was thinking about your last paragraph. I think that falls more into the “it depends” category. Also possibly the sectors too. In a general rising rate period and sound economy that is certainly true about the 4% ers being pounded. But in a market crisis scenario like March 2020, that didnt appear to be the case. All but the illiquids got pounded, but most higher yielders got pounded more. Couple examples. EP-C par $50 4.75% bottomed out at 38.95 on 3/19 for a then 6.19% yield. 5.9% par SR-A bottomed at $16.30 3/19 for a then 9.04% yield… CEQP- bottomed out 3/18 at 1.96 which was a 43% then yield . SB-C and 8% par bottom 3/19 at $9.25 which was a 21% yield. CDR-B a 7.25% par cratered to $6.85 for a 26% yield.
So for the March 2020 plague rout, nothing but illiquids escaped the carnage, but the higher yielders got crushed harder than the quality lower yielding issues.
Grid – Though I do not disagree with your premise, to be fair, you must take into account YTM (vs current yield) on EP-C in your comparison and while EP-C at 38.95 does have a current yield of only 6.19%, on or about 3/19/20 it’s yield to its 2028 maturity at 38.95 was 8.60% I think…. So what saved it from dropping further in dollar price was its midrange maturity, probably moreso than its higher quality when compared to lower grade perpetuals.
And as far as the real illiquids, I’ll ask a rhetorical question – did they really hold up better or did they just not see an increase in trading? Could someone who wanted to actually liquidate a decent sized position been able to do so at a price not reflective of what has happening elsewhere? Just asking. I have no clue….
That is how I made my big coin last year despite being fully invested. Selling my illiquids and buying the trashed out liquids.
As far as EP-C goes, I used it as an MLP example with low yield. How about this one, ALP-Q… 5% par.. Bottomed out at $20.51 which is a 6.09%. I can use any high quality issue for 2020 as an example. They didnt get torched like the high yielders. Go check the Mreits and see it as bad or worse than MLPs. The high yielders got destroyed while the high quality issues just got torched. They got hit too, but it just wasnt even in same ballbark…
There just wasnt no 20% ute preferred in 2020…But history rhymes… In 08-09 bank preferreds got torched. A sector problem there also was problem.
Like I said, Grid – totally onboard with your premise….ALP-Q is a better apples to apples comparison to the other issues you used to prove the point….
I use TNX to track the 10 year rate.
Is there a symbol for The Baa bond rate that I could easily use?
Thanks.
I watch HYG and JNK for lower quality issues — both dropped on Friday. You can also watch LQD for higher quality issues — up on Friday.
Greg, here is AA bond credit spread. Notice it is up, but still below early August so hardly a great move yet.
https://fred.stlouisfed.org/series/BAMLC0A2CAA
Tex2:
You make a great point. Anytime I have tried to partially “hedge” my income portfolio (comprised of baby bonds, preferreds, REITs, CEFs, dividend paying stocks), I usually don’t buy put options on Treasury related ETFs like TLT (20-year Treasuries) and IEF (7-10 year Treasuries) for notional exposure.
I instead look towards purchasing put options on the the junk bond ETFs like HYG and JNK. They almost always seem to be a better match. Of course, it could be different this time with inflation raging for the first time in decades.
I’m in the lower rates for longer camp as higher rates would hurt the govt. and corporations and eventually create a recession. The fed is no longer independent if it ever was and takes orders from the WH. IMHO and they want lower rates. As far as the market is concerned, I’m a buyer on VIX spikes. The VIX stays below 30 – 92% of the time. ATB
The newer FRC preferreds seem to be getting killed….might get some under $20 if this keeps up.
DaddyDollars–will have to look at it. When we see the 10 year at 2% (which is still extremely low historically) we can see many of the low coupon issues down at 20. If we ever get to 3 or 4% we will be buying investment grade issues at $15.
DaddyDollars–took a look–you’re sure right on that–pretty classic reaction to higher rates.
So where is the Fed dot plot now?
We’ve been saying the Fed is fighting the Fed for 10 years now. ….and the story continues. Some extremely deep pocket were asking me about where rates were going. Jim Grant is of the opinion that if you want to forecast rates do so in the shower where no one can hear you!
If you Prefer–yes trying to forecast rates is a fools errand for sure. I don’t think this changes the Fed at all–they will taper 15 billion now and continue monthly (until they don’t). The market has those expectations and Powell would be a fool to change directions–maybe it brings a tantrum–let them throw a tantrum. Rates need to go higher so the Fed can lower them in the future when we have a ‘real’ need for a cut.