HTFC - Preferreds Weekly Review: Chimera Investment Steps Back From The Libor Brink

2023-10-09 08:58:28 ET

Summary

• We take a look at the action in preferreds and baby bonds through the last week of September and highlight some of the key themes we are watching.
• Preferreds finished September on a weak note, under pressure from rising Treasury yields.
• CIM finally announced a transition to SOFR for its Libor-based preferreds.
• The Horizon Tech baby bonds offer a decent lower-beta, higher-quality option for income investors.

Welcome to another installment of our Preferreds Market Weekly Review, where we discuss preferred stock and baby bond market activity from both the bottom-up, highlighting individual news and events, as well as top-down, providing an overview of the broader market. We also try to add some historical context as well as relevant themes that look to be driving markets or that investors ought to be mindful of. This update covers the period through the last week of September.

Be sure to check out our other weekly updates covering the business development company ("BDC") as well as the closed-end fund ("CEF") markets for perspectives across the broader income space.

Market Action

Preferreds finished September on a weak note, under pressure from rising longer-term Treasury yields - the second down month in a row. That said, the sector is down only around 2% since the end of July, even as Treasury yields have marched sharply higher.

The supporting factor has been stable credit spreads.

Preferreds remain attractive assets in the current environment given their relatively high quality and the sector yield trading not far from its 5-year peak.

Market Themes

This week brought good news from the mortgage REIT Chimera Investment ( CIM ). The company announced that its Libor-based preferreds will transition to SOFR rather than remaining fixed for life as we saw with PennyMac.

Recall that our view, as discussed in the most recent CIM article, was that this wasn’t really up for debate given the Calculation Agent language in the prospectus. It is this method the preferreds would use to determine a successor rate to Libor. And given the Libor Act specifically created safe harbor for calculation agents to pick SOFR as just that successor rate, there was little chance for any other outcome.

In any case, there was a nice jump in [[CIM.PR.B]], a stock we had just rotated into in our High Income Portfolio from [[CIM.PR.D]]. B has now outperformed D by around 7% since our switch to it a week ago. This gives our rotation strategy in the CIM preferreds suite, since our initial allocation in early 2021, the best result across the individual preferreds.

The relative value gap with D has nearly closed, and B remains only slightly more attractive now than D.

Market Commentary

This week, we added the 2027 BDC Horizon Tech baby bond ( HTFC ) to our Baby Bond Tool. The 2026 sister bond HTFB is in our Defensive Income Portfolio and both bonds are trading at a yield of around 7.4%.

The bonds look OK across some of the key metrics. Leverage is below the average BDC level, while the percentage of secured loans is above the average. Furthermore, over the last 5 years the NAV has been stable and the amount of recourse credit facilities ahead of non-recourse secured ABS debt or unsecured debt is fairly low.

Overall, the bonds are a decent lower-beta, higher-quality option at the moment.

Stance And Takeaways

The preferreds sector remains an attractive option for income investors in the current environment of fairly expensive credit valuations amid a clearly slowing macro picture. At the moment, both floating-rate and longer-duration stocks remain attractive, however that will likely shift if the Fed has to take the policy rate down for any reason.

At that point we would expect a significant relative value repricing across the sector, just like we saw in 2020 and in 2022 when there was a sharp move in short-term rates. This development is one to watch out for as it is what will drive significant divergence in performance across the preferreds space.

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