Lots of Red in Income Markets

A confluence of ex-dividend dates with relatively rapidly rising interest rates is forcing many, many preferreds and baby bonds lower by 25 or 50 cents this week–some much more.

With the 10 year treasury trading around 1.89% after being at 1.43% just 10 days ago you might expect some give back on the easy capital gains we have all garnered recently. Personally our accounts are off about $1,000 bucks this week–no big deal–mostly because we have such a high cash position.

I am personally watching certain quality issues–for instance the AllianzGI Convertible and Income Fund 5.625% preferred (NCV-A) is trading down 60-65 cents in the last 2 days (about 1/2 is due to ex dividend) bringing the current yield to 5.41%. I have more than a full position, but could add a little more.

Some of the other big losers simply are some quality issues that were getting ahead of themselves such as Digital Realty 6.35% preferred (DLR-I) which had traded up to $27 a couple of days ago and now with the combination of ex-dividend and rising interest rates have knocked it down to $25.93 It should be noted this issue has early redemption available in 11 months and many times when an issue is trading with such a large premium to a $25 redemption once it gets closer to the potential redemption is will fall on ex-dividend date and never recover.

The preferreds list showing losses can be seen here–maybe it is a shopping list?

36 thoughts on “Lots of Red in Income Markets”

  1. I have about 20 issues in my fixed income account including funds and individual stocks. ALL of them were down by a significant amount. Did someone announce an interest rate hike that I didn’t hear about?

    1. Jersey, this is a misconception that continues that many do not understand. The Fed controls the “short end” of the yield curve with raising and lowering Fed Funds Rate and Discount Rate. Perpetual fixed preferreds do not trade on the short end. They trade off the LONG end of the yield curve, loosely the 10 year bond. Unless the Fed would intervene to buy up long bonds, their “rate cut” decisions that most hear about has nothing to do with the setting rates there.
      In fact cutting short end rates could cause long end to go lower or higher based on other factors with economy. That is a book length discussion. The bottom line is Jerseyville, is the 10 year bond interest rate has jumped over 30% in less than 2 weeks (45 bps). That is huge jump in a short amount of time. This will put pressure on preferreds. And usually its the liquid most recent issues that drop harder since they were priced closer to todays lower yields.

        1. You are of course welcome, Mikeo. Its good to know the fundamental background info to understand what and why they trade like they do. Unfortunately the most important part, when and how much they move, is unknowable. Predicting interest rate directions on a daily, monthly, or yearly basis would have to be an ego crushing humbling job, lol.
          And getting caught up in all of that can constantly have one buying and selling at wrong times if they over worry. The one thing that one has to worry about is buying new issues that keep getting the yields ratcheted down through declining interest rates. Because every time a low yielder goes to market and shoots up, it incentivizes companies/underwriters to test an issue with even lower yields. Until rates start backing up and those will plummet the fastest…But next week is a new week and 6 months from now yesterday could be another peak as it drifts lower again. Who knows. That is why I keep for my sanity, a diversification of term dated, call anchored, uncallables, and adustables. They all tend to move differently at different times.

          1. “for my sanity, diversification” – so agree Grid. Though having traded a few in the last few days and looked at a few prices for opportunties, I have not bothered to look at the account balances. Diversification means I’m not really that curious.

            1. I nod in agreement. Diversification, where fixed income is concerned, certainly means the obvious, such as issuer, industry, call date, currency.

              But also how the issues behave through the rate cycle. If you have a crystal ball, and a high risk tolerance, go “all-in” on whatever rate forecast you have. If you’re right, you make out. If you’re wrong, you get a job bagging groceries at Trader Joe’s.

              If no crystal ball, spread your risk among issues that go up when rates go up, go up when rates go down, and hang tough no matter what.

              Rate movement diversification is what really leads to put money in Canadian resets. They are opposite to most preferred in that they go UP when rates go up (both dividend and price), not down. More so if the time to reset is short. Very few U.S. issues behave like that. Just witness the last week.

      1. Thanks to all for the discussion on this thread. To me, one of the interesting things about movements in the past couple months is the magnitude of the swings. As Grid points out, 10 year rates have swung 30% in 2 weeks. Have fundamentals have changed drastically? The answer is no. It just seems like every single analyst has been telling us that rates are going to continue to go down. When one thing happens that casts doubt upon that speculation, and all the bets are on the other side of the equation, the swings can be dramatic. The US economy could certainly be better. But most of us on this site recall plenty of times when it faced much more severe challenges. It’s not difficult to imagine a scenario where uncertainties about trade are reduced, or even deferred to another day, and all the experts start telling us to expect slightly higher growth and therefore rising rates. When everyone is betting on a mild slowdown, and then everyone suddenly wants to bet on mild expansion, the change in the market can be dramatic even when the change in opinions about fundamental growth outlook is not much more than a tweak.

      2. Exactly and preferred investors often move prices trying to anticipate the size of the next move. Same with new issues. Anticipate other borrowers coming to market this month.

        Besides anything with a ytc in low 3’s or lower have been begging to be sold.

  2. I have been loading up on recently IPOed issues with relatively low coupons but trading below NAV. Till this sell-off subsides, safer to buy those trading below NAV than ones much above even if coupon is more …

    e.g. COFOL (COF-I 5% Preferred IPOed 9/4)

    1. I have a contrary opinion. When prices are falling I think issues with some call risk are safer. Their price won’t fall as fast because it’s already suppressed by call risk.

      1. Yes, I agree Martin. Its really more of a math (coupon, call risk) issue than a vanilla par issue. Issues past call with relative higher than market yield anchored near par are not as exposed to repricing as new “at market” yields.

      2. I was a sometimes flipper. Goal has changed somewhat. Monday I am going to buy more of the new 5th 3rd. Way below par. Payment will be much over 5%. And, since I bought over par, possible profit if called.

        Might do COF-I as well.

        1. Bill, you stated… “Goal has changed somewhat”. Too me that is the most important concept. Understand what you are investing in, and match your purchases to your goals.
          Any ticker tossed out by me or anyone can be of no relevance to another persons goal. When my dad was alive and I had him invested in preferreds he said “I dont care if the price drops to a penny as long as I am getting my 6% divis” (of course that was when you could get IG preferreds at 6%). So for him, price movement was irrelevant. Now my step mom wanted no part of that stuff. So I got her all in longer dated 3% CDs instead, and she is happy as lark. And if CDs went to 0% she would be happy with it drawing nothing since she wont spend the money anyways.

    2. mSquare – I’m guessing here, but I suspect you mean you’re loading up on recently IPOed issues trading below PAR, not NAV, right? Par, or “liquidation preference” when used with preferred stocks, is a fixed amount, normally $25 per share when talking about preferreds or baby bonds though it could also be $10, $50, $100, or even an unsual number such as GGO-A’s $40. Most frequently when talking about bonds, not baby bonds, par = $1000. NAV = Net Asset Value and it’s a variable, moving target amount most frequently associated with mutual funds and closed end funds and exchange traded funds…https://www.investopedia.com/terms/n/nav.asp And I agree with Grid that it’s the most recently issued perpetual issues that will be most vulnerable to price declines when interest rates move up violently on the long end as they did this past week relatively detached to what the Fed does on the short end… Like he said, it’s a math thing and as a corollary to the math thing, as Martin G said, there’s some protection vs those swings when accepting issues with some call risk.

      1. 2wr–I have never brought this up much, but many (most) of the $25 liquidation preference shares are not par $25. Everyone has gotten so used to calling $25 par that I just let it pass—but many, many of them are 1 cent par.

        1. Tim – Good point…. You’re right technically speaking, and I was probably too loose with my definitions, but in the practical real world, is there an example where par vs liquidation preference made a difference to the investor??? My guess is that if there is, Grid probably knows the example… lol. My point was that I thought mSquare was confusing NAV with par, but that’s due to my bond background….

          1. 2wr–no it makes no difference – just a technicality. Just one of my pet peeves–not as egregious as when folks use preferred stock to describe baby bonds where there is a very true difference.

            1. Tim, I appreciate what you say on baby bonds…But I have know drifted to the “it really doesnt matter” most of the time camp. Even FINRA lists these as preferred stock securities anymore.
              When crap hits the fan for a company they will in essence become preferred. Of course I am referring to the subordinate debt issues. When you look at bond ratings most of these have recovery values of pennies. They in times of trouble will get deferred like a preferred, or buried under secured debt and bank secured loans…Say bye bye to the cash as others get their dough! 🙂

              1. Grid – Aren’t you putting the emphasis on the wrong syllable when you’re finding all baby bonds guilty of the potential crimes that can happen to subordinated debt issues? That differentiation is picked up most frequently if not always by the rating agencies as they rate subordinated debt of the same issuer (when they rate the issuer at all) at least one notch down from unsecured debt and essentially equal to the preferred’s rating.

                1. The problem is never the present its the future. Im just saying if a company gets into financial trouble the same thing will happen. Secured debt slapped on top of senior unsecured, then bank financing, then worst case bankruptcy financing. These all in future tense that get piled on. Of course the credit ratings would deteriorate correspondingly while this is occurring.

              2. To amplify grid’s point, the difference in liquidation preference between preferred and junior subordinated debt (many baby bonds, especially the long dated ones) is razor thin. If the preferred get wiped out there is precious little chance the junior subordinated get anything.

                So, as you chose between the two, keep that in mind, and also the different tax treatment. Baby bonds are ordinary income, always. Preferred may be QID or non, depending on the issuer and terms. 6% from a baby bond is low 5’s QID, unless it’s a qualified account.

                I am personally not fond of the long dated baby bonds. They favor the issuer too much. Long maturity and short calls. I’m being asked to take on too much risk for too little reward.

                1. Bob, to add in, my personal observation is this. The big difference ultimately typically is this. The company keeps the tax break instead of giving it to the buyer. And they do have a “higher perceived safety level” so they tend to trade a little bit stiffer when a company has some financial stress than their true preferred sisters. Yes they typically are rated a notch higher than the true sister capital preferred. But ultimately if it ends badly it will end badly most likely for the junior subordinated debt and preferreds together.
                  Some may get a bit too tax conscious over baby bonds versus a preferred. Your tax bracket could be such that the baby bond pays you more after tax than a QDI. Its a case by case individual situation though. The Trump tax cut narrowed the benefit of QDI over baby bonds and even reit preferreds.

            2. Is it also egregious to claim that you are receiving a ‘dividend’ from a baby bond? I don’t like to get dividends from my baby bonds, personally. I much prefer to get ‘interest payments’. That’s just how I roll… lol

              1. Well I guess that settles it then – I’ll just fade into the background on this one now and enjoy my baby bonds’ dividends while hoping they’re not called away from me at NAV while I’m awaiting my preferreds next interest payment……………… 😉

          2. 2WR, If I have to worry about company liquidation I aint buying, lol.. Lets take an oldie for example…UEPEP, a 4.50% par issue… Its a $100 par preferred…With a $110 redemption price, or $105.50 liquidation price…Now how do you like that variety of numbers…Im not worried about Ameren MO liquidating because if it did, I would be without power. And this issue is now over 70 years old, too. Many companies have in treasury dollar value par issues, and $0.00 or as Tim stated .01 par value.
            For my issues, its more on an accounting statement and a distinction without a difference though.

  3. I’ve sold off some very large positions over past three days. Brighthouse jpm and others. No need to fight the tape by not clipping some at all time levels.

  4. Looking at the ones that are going ex-dividend around the 18th, which ones do you think will fall the most?
    Citigroup J , VLYPP and GAB J seems to be the ones that could fall pretty far.

  5. The 10 yeat at 2% is a marginally neutral rate to the current 90-day rate. If you assume a rate cut this month – the current 10 year rate is a tad above that at 1.89%

    At 2.25% ( if you expect another rate cut this month) that would provide a reasonable cushion about the 90-day rate of close to 0.5%.

    Not a shopping list in my opinion, until 1-Fed cuts rates and 2-we normalize at least 0.5% above short term rates.

    I for one, believe we should be at a 2.25% interest rate on the 10 year, so I start off with a predetermined view

  6. I’m glad to see this… hoping for another day or two like it so I can buy PRH near par.

    My guess is the trade war will be back in full swing after the commies celebrate their 70th. Then rates should start dropping again

  7. I bought some BFALL at $24.75
    Pretty happy with that and should be safe. Will use spreadsheet and look for others. Good weekend to all!

  8. Picked up some VER.pf under $25.20 today, so not much of a premium when this month’s div is factored in

  9. Getting quite nervous about this. The only thing I did not expect was rising rates! I find myself positioned very defensively and September started with a bang for all beaten (for a reason) assets. Anyway I believe this is a false signal guided by frenzy rotation. I keep my holdings plus JPY and gold.

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