Uncategorized
Signs of fatigue from perpetual preferred investors
admin | September 21, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The domestic preferred securities market has “matured” in the last few years as banks have generally filled that funding need as recommended by the Fed. The Collins Amendment in the Dodd-Frank legislation put an end to the use of hybrid securities in banks’ equity capital ratios. The phase-out of bank trust preferreds (TruPS) and other hybrids left a bit of a gap in the capital structure, which left perpetual preferred equity as the sole alternative. The Fed has recommended that banks target 1.5% of risk-weighted assets be funded with these perpetual preferred securities, though that is only a target and not a minimum requirement.
The credit cycle is now long-enough in the tooth that many of the preferred notes issued shortly after the financial crisis have been called due to the high coupons and high floating resets. We have discussed this economic decision and attractive short-term relative value in prior publications, but in short the notes with an “economic call” that remain outstanding should be valued with the expectation that the notes will be called in short-order, but that any price with a positive yield to call is a good price.
Demand for preferreds in the last 10 years has been very strong, which has pushed accepted yields down, and hence the floating reset levels, which in turn elevates the risk of extension when the notes are callable. The elevated risk of extension creates a less stable pricing dynamic for these kinds of securities, which has been evident each time there is a market scare or view of higher rates looming.
This week two perpetual callable preferred securities were issued that – almost as soon as they priced – traded below par, in large part because of the poor reset levels. Early in the week, GM issued a PerpNC10 at 6.50% with a reset of 3mL+ 343.6 bp, and now trades down 1.5 points. On Thursday, State Street issued a fully investment grade PerpNC5 at 5.625% with a reset of 3mL+253.9 bp and then traded back a half point on the break. This kind of pricing dynamic begs the question of “when will investors demand more for their risk?” We expect that if and when the time comes, it will bring more pricing downside to these low-reset notes.
admin
john.killian@santander.us
1 (646) 776-7714
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
