Interest Rates Spook the Markets

I have just been sitting back watching the markets–interest rates as much as any stock market, given that I own no common stocks.

With the 10 year treasury sitting around the 2.22% area one has to believe that a recession is coming into expectations. We know that global funds are moving strongly into US Treasurys, but even with this being the case the supply gets larger and larger as the government spends like crazy and the Fed balance sheet continues to runoff – so no demand from the Fed.

I just looked at the average price of a $25 baby bond or preferred stock and they have barely budged this week–I expected to find them down a few cents as the ‘baby was tossed with the bath water’ sellers emerged–they didn’t emerge.

With the spectre of a potential recession later in the year or early in 2020 income investors should begin to watch a few of their holdings for weakness in issuer finances. For instance we would be sceptical of some lodging REIT preferreds to hold up during a recession–for instance Ashford Hospitality (NYSE:AHT) has not done well during this long growth period so how are they going to hold up during a recession? Baby bonds and preferred stocks from all of the BDC (business development company) are ones I am highly suspect of performance during a recession. It is true that none went broke 10-15 years ago as we had the global economic crisis–but most of them are newer companies (less than 20 years old) and have not been truly proven during a recession–and they are more highly leveraged now than they were previously.

Whether we have a recession is yet to be determined–but considering that the Atlanta Fed GDP Now shows a forecast of 1.3% growth for the 2nd quarter it is likely we are seeing a slowing–beyond that it is anyone’s guess.

41 thoughts on “Interest Rates Spook the Markets”

  1. Picked up some Friday at par. My first convertible. I have been reading that they have a “floor”. If so, what is that for CNP-B and how is it calculated? Thanks in advance.

    1. The key portion (in my mind) from QOL, is this “The conversion settlement rate will be 1.5291 shares per unit if the then current market price is equal to or greater than $32.70 and 1.8349 shares per unit if the market price is equal to or less than $27.25”.

      To each his own, but I read this as it having a ‘floor’ of $50.00 a share, pretty much regardless of what the common stock price is – if that common stock price is below $27.25 per share. For example, if the common stock price is $20.00 per share at the time of conversion, you’re still going to get $50 worth of CNP common stock, or a recouperation of your initial investment (if CNP is bought at $50.00 share). Your floor is, essentially, the par value of the CNP-B security… Unless CNP goes into serious financial trouble.

      You may also look at it this way, which is how many view ‘fixed income’ investing… You’re giving up the possibility of big cap gains and losses on common stocks, for the ‘assurance’ that you’ll get a fixed rate of return on your preferreds and baby bonds. Of course, nothing is guaranteed and to me, ALL investments have the possibility of crapping out and leaving you with none of your original investment. But staying on the fixed side of things give you more of a guaranteed paycheck versus working off of bonuses or commissions, if you get my drift. As I age, I want to take the ‘guaranteed’ rate of return chance, versus, the dartboard cap gain game approach. A couple of years ago, my common/fixed mix of securities was about 99%/2%. Now, I’m at about 66% common/34% fixed and I am continuing to move over to the fixed side with each passing month.

      1. A4I, I am not suggesting this is abad investment, but you are not guaranteed $50 of conversion value. If for exaggerated purposes only if common stock was worth $1, you will only get $1.83 in conversion value, not $50. This is in prospectus below.
        You will bear the risk of a decline in the market price of our common stock between the pricing date for our depositary shares and the mandatory conversion date.
        The number of shares of our common stock that you would receive upon mandatory conversion of our Series B Preferred Stock (and the related conversion of our depositary shares) is not fixed, but instead will depend on the applicable market value, which is the average VWAP per share of our common stock over the final averaging period, which is the 20 consecutive trading day period beginning on, and including, the 21st scheduled trading day immediately preceding September 1, 2021. The aggregate market value of the shares of our common stock that you would receive upon mandatory conversion may be less than the aggregate liquidation preference of our Series B Preferred Stock represented by your depositary shares. Specifically, if the applicable market value of our common stock is less than the initial price of approximately $27.25 (which is approximately equal to the per share public offering price of our common stock in the Concurrent Offering), subject to certain anti-dilution adjustments, the market value of the shares of our common stock that you would receive upon mandatory conversion of each share of our Series B Preferred Stock will be less than the $1,000 liquidation preference per share of our Series B Preferred Stock (and, accordingly the market value of shares of our common stock that you would receive upon mandatory conversion of each depositary share will be less than the $50 liquidation preference per depositary share), and an investment in our depositary shares would result in a loss. Accordingly, you will bear the entire risk of a decline in the market price of our common stock. Any such decline could be substantial.

        1. Grid, I agree with your thoughts, which is why I stated: “Unless CNP goes into serious financial trouble.”, and “Of course, nothing is guaranteed and to me, ALL investments have the possibility of crapping out and leaving you with none of your original investment.”

          Knowing that you’re a big ute fan as well, we likely agree that investing in utes is about as good as it gets in the fixed income world, unless one has true full faith and credit in the US gov w/buying treasuries and such. I’ll take my chances with the utes. It’s all good brother. Thanks for chiming in.

          I believe that CNP is stonger today and better positioned for future success than it has ever been. My fav ute still remains NEE and I see none bigger, better, nor stronger than Next Era. SO, D, and DUK would be the next fav’s.

          1. A4I, I think you know this, but just making sure, I certainly wasnt meaning to be critical of the investment pick at all. I was just wanting to clarify that there was no floor on value at conversion. Par doesnt have any real meaning now unless liquidation of company occurred. One will get conversion value on conversion date which could be well above $50 or well below $50 depending on what the stock price does.
            This is a mandatory convertible preferred. A little different beast than a fixed perpetual, or term dated issue. Usually these are issued by a company who has acquired another company. They dont want to take on the “earnings hit to common stock” at acquisition. They want a little breathing room time to get earnings from acquisition flowing before share dilution occurs at conversion. The temporary higher yield of the convertible is the carrot to induce purchase at underwriting.

  2. I had a GTC order for 1000 EBBNF Enbridge Series L @ 19.10 that was filled today. It’s my first purchase of Canadian resets so we will see how it goes. I wanted the QDI so i took a 1/2 position.

      1. Leslie,
        It’s my first purchase, so I’m absolutely sure. I’m basing that on comments from Gridbird and others. What I need to figure out is how hard it is to deal with the taxes once I exceed $600 in taxes withheld.

        1. Mrinprophet, unless you load up late, you will miss the problem this year assuming by $600 that you are married filing jointly. The Enbridge series issues only have 2 more dividends this year. Filling out your 2000 share position wont endanger you this year to file the form 1116.

      2. First: My personal experience with TDAM brokerage is that they designate QDI on the Account Transactions tab and that should translate over to end of year statement under all QDI accounting.
        The SECOND issue is CN withholding on divs to Americans (foreigners). Holding in an IRA seems to NOT trigger that tax for legal reasoning, but it seems to be documented and credited that way.
        QDI and CN withholding are separate issues.
        Many people have worked over brokerages to keep them from withholding the second item from IRA and other tax sheltered securities to good success for us all. Many people have reported there experiences here with different brokerage policies.
        Portfolio positioning is ANOTHER variable in the decision making process. My conclusion is POUND your IRAs/SEP/ 401k til you bleed and go ROTH!

        1. Joel, that was my biggest mistake I ever made was blowing off my Roth contribution most years. Having a very generous pension further compounded the issue being I am ensconced in a higher retirement tax bracket. So what do I do? Since retirement the past 9 years I have worked enough to fully fund yearly my Roth (earned income is needed). To add to your thought, dont be afraid to pound an HSA contribution yearly and roll it into an HSA brokerage account. An HSA is the only true triple tax break available…if done correctly.

          1. I’m 46 so still in the accumulation phase. I’m maxing out the HSA and 401k, along with backdoor Roth for my wife. I have a small pension that kicks in at 65. The problem.i have is that I want to retire early and can’t touch all of that until 60. All current taxable savings are now going toward income generating assets to use between 55 and 60, then beyond. My youngest should be off to college at 54 and then I’d like the option to hang it up then.

            I’ve spent 20+ years on the institutional buy side so I’m really intrigued by investments that are focused on HNW.

  3. CNP-B selling at par. QDI… Any interest from the fellow ute investors?

    Morningstar and S&P put the fair stock value @ $28.11/share on the common stock, right about where it is now.

    Yield is 7.0% at par with more than 2yrs before call/maturity.

    1. It could be interesting however I’m not well versed in the mandatory convertible space which makes the analysis of the preferred issue harder (at least harder for me).

      I’d be interested in hearing what others think about this issue.

      1. @Tim.Moore
        Essentially, if an investor owns the issue on 9/1/2021, your preferred shares will be converted to common stock, with the number of shares dependent on the share prices during the preceeding 20 day period; also, a preferred share holder has the right to convert his/her preferred shares at any time to a specific number of common shares. There are additional variables. Best I can summarize and hope it helps you.

    2. Affinity,

      Read the quantumonline description. What happened with the Vectren Merger? Any effect on your investment thesis?

      1. Is this rhetorical?

        The VVC merger was completed months ago, prior to the deadline of April 2019. They are a Fortune 500 company with a presence in almost 40 states. Personally, I have no concerns about the viability of CNP moving forward. On the common side, I own NEE, SRE, D, DUK, SO, etc. On the fixed side, I own AQNA, AQNB, CNP-B, CMSD, PPX, AILLL, CNLPL, IPWLK, CTGSP, DUK-A, GLIBP, NI-B, etc.

        I stay versed in the ute space.

        1. My apologies. I meant “I” read the quantumonline description, not that you needed to. I appreciate your insights and your willingness to share. I picked up AQNB a couple of days ago fyi.

          1. AQNA has been a great performer and I expect much the same from AQNB. Keeping both tax sheltered so more $ can compound faster, rather than ( 15% foreign tax ) be kept by the Feds and doing me no good.

            1. A4I, I cant say with certainty, but Im pretty sure there is no special withholding on this debt issue. Enbridge has a baby bond on big board and no withholding occurs I have been told. But for me its irrelevant as I put debt issues in a tax sheltered account for tax reasons, so I cant offer personal experience here.

              1. AQNA/AQNB would be subject to the foreign tax of 15% if heId outside of an IRA, IMO, but I also cannot say for sure with either of these because I won’t hold them outside of an IRA. Everything I’ve ever owned that was HQ’d in Canada, was subject to the 15% witholding outside of an IRA.

                1. Unfortunately for me, I have had opposite occur. Foreign withholding of dividend inside tax free account. One issue got corrected (Emera) and the other (Altagas) didnt so I flipped out as it jumped a buck anyways.

            2. AQNB is trading with small volume about 46 minutes after market open with bid just jumped to $25.47 1,000 shares (hidden of course) ASK $25.49. A few minutes ago, it was bid 25.42

              1. Picked up 200 shares of TRSXL yesterday at $25.55. TRSXL has changed to its permanent symbol as TSCBP. I placed a order for 200 shares at $25.50 good till cancelled.

    3. I have been watching this for a few days since you mentioned it. I have never dealt with a convertible issue before so want to tread lightly. Seems to be quite a bit “out of the money” currently. Wondering if the play is to buy and then see prior to forced conversion?

      1. Exactly, Proto… Collecting the divvy while waiting. Low interest rates are a plus for ute’s, and it looks like low rates are here to stay for the near future. It will trade in near lock step with the common most likely since it’s so tied to it. For me, it’s really a way to ‘own’ CNP but get a juicier payment for holding it. I used to own the common stock but sold to buy this. No need, IMO, to hold the common and ‘hope’ for cap appreciation while collecting a smaller divvy. I’d rather have the stated payment of the convertible in this environment of turmoil. Plus, it’s QDI, so I get even more juice in my cup versus holding the common – but mileage varies with each person and for how long you hold, etc.

  4. I noticed some weakness in TGP preferreds. Inclined to buy some more Series B but I might get some A in case it drops to par. I favor fixed coupons and I’m attracted also by GMLPP that lost $1 from the highs.

    1. Everything is relative. Perhaps my risk tolerance is higher. I believe that TGP is not so risky as compared to TNP Preferreds. Yes, TGP has a very long history of anomaly, i.e. the B share always show “un-justified” weakness as compared to the A share (I have both). From Earnings Call transcripts, I believe TNP, despite its long history seem to be riskier. No plan for the 2020 European environmental control, scrubbers. The CEO insists that he will make the charter price competitive and let the company hiring the charter to pay for the scrubbers. He intends to buy more new ships instead of paying down the debt. Then, I intend to hold. Worst is the DLNG-B, bought without DD following Richard Lejeune. Ditto for TOO-E., BTW, GMLPP is safer, very bad for commons, GMLP. Large cap shipper. I suspect they issue more common share of GMLP to finance their new ship. Who knows. The partnership GLNG, paying just 1% dividend for its limited partners, could be issuing more GMLPP too. Sorry for my cynicism. LOL.

      1. Johnkcal…what are your thoughts on the upcoming deadline for the TNP B-shares? Do they get redeemed on schedule or does Tsakos pay the 25% coupon rate penalty?

        1. I sold mine taking profit. Dumb mistake on my part. You will need to read the QOL and the original SEC offering document which can be assessed via I intend to hold on TNP, QDI and hate to take a net loss. I did manage to sell some of my AHT-I and H’s. Cap loss offset by dividends received. In one case, actually took small cap gain. Very choppy market from the continued trade war. I bet on EPR eREIT with debts rated IG. That is decent trade. BEP is also decent renewable owned by Brookfield. I thought I should get UTG, a respectable utility loaded fund. Bad move, WRONG timing for sure.

        2. I will bet big bucks that TNP-B gets redeemed. I would be shocked if it didn’t. This is also Richard’s (LeJeune) opinion as people in his chat have joked about hoping that they “forget” to redeem.

          I own TNP-B and C. Richard frequently discusses their large amount of debt but he doesn’t seem to be worried about either the B or the C being redeemed. I’m not worried about B and I hope he’s right about C.

        3. I’m overweight with TNP-B myself and fairly confident it will be redeemed before the deadline in July. TNP reports earnings on Thursday June 6th and there should be some more discussion around whether they redeem the B-shares or not.

  5. Tim, It’s seems likely the rate of redemptions will be picking up pace now and past call issues increasingly in jeopardy. Sold my last past-call holding today of AGO-E. The replacement options are slim and as you say, the pfds are not moving much. Cash has notched up a bit as a viable option.

    1. General question. I’ve noticed more and more comments lately regarding past call issues possibly being in jeopardy of call. Is there some criteria that places a preferred more at risk of this — i.e, spread amounts, number of outstanding issues, ratings, etc. For instance I own BBT.D which has a coupon of 5.85. Even though it is past due, I don’t see it being that large of a coupon to merit a call. Would love to hear others thoughts.

      1. Hey Bob…I’d say take a look at all of the BBT outstanding preferred shares as well as any long term debt in order to get a more complete picture. How the company has treated past due preferred shares in the past may also provide some clues.

      2. AZBob, The most significant call risk is associated with the issuer’s ability to get better terms via a new IPO and to simultaneously redeem (refinance) the existing past-call issue. Though as Citadel points out – check your moat position in the company’s outstanding issues.

        BBT has four outstanding pfds with coupons ranging from 5.25% to your past-call BBT-D at 5.85%. If BBT were going to redeem/replace, your BBT-D would certainly be a target – though as a lower-rated (BBB-) IG issue, one would think the 5.85% “appears” safe for now. Take comfort also in the current price of BBT-D staying close to par reducing capital exposure to a call. As of today you’ve got an embedded .16/share in divvys in BBT-D (assuming a 30-day call notice), so at today’s close of $25.54 you’ve only got a .38 premium to call.

        If rates continue the current trajectory there will certainly be some surprise redemptions. I’ve been off-loading issues with that exposure and hedging with a balance of FTF, resets, noncallables and longer duration issues such as KTBA, NRUC and the recent FMTP.

  6. Tim said: “BDC. . .It is true that none went broke 10-15 years ago as we had the global economic crisis.” Tim, I think you are technically correct, but Allied Capital (ALD) essentially went bankrupt in the GFC. There was a fire sale to Ares Capiral IIRC. David Einhorm wrote a book about ALD. IIRC, the suspended their dividend when they were crashing down.

    1. In addition to the ALD meltdown in the GFC, ACAS cut their dividend to zero and muddled through until they recently sold themselves. Didn’t go bankrupt but holders of the common lost that juicy dividend forever, along with a corresponding huge price meltdown. On the other hand, I am not as concerned with the BDC preferreds and baby bonds. They are subject to leverage rules that are similar to the closed end fund leverage rules, and liquidations of assets and issueance of dilutive common stock to cure leverage violations is likely to happen before the BDC preferreds and baby bonds get vaporized. However, there is always the risk that the assets of a BDC could melt down so quick that the preferred and baby bonds can’t be saved before a bankruptcy wipes them out. Could happen, but unlikely. I can’t wait to go shopping for distressed BDC baby bonds during the next downturn – right now they trade for pretty low coupons due the aforementioned leverage rules, and I would sure like a little market drama to produce some bargins in these babies. I wouldn’t touch BDC common shares with a 10 foot pole this late in the cycle though – although the best ones will survive, the marginal ones will get slaughtered and the best one may be in for a pretty wild ride.

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