OXLCZ - Preferreds Weekly Review: Drop In Rates Drives New Issuance

2024-01-21 09:40:10 ET

Summary

• We take a look at the action in preferreds and baby bonds through the second week of January and highlight some of the key themes we are watching.
• All preferreds sectors were up for the week, buoyed by lower Treasury yields.
• Preferreds credit spreads have fully retraced the bank mini-crisis spread blow-up and have only been tighter in 2021.
• Investment companies are taking advantage of the drop in yields to issue a backlog of securities.

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 the 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 second week of January.

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

All preferreds sectors were up on the week, benefiting from the drop in Treasury yields. Month-to-date, only the REIT preferreds sector is in the red.

Preferreds credit spreads have fully retraced the bank mini-crisis spread blow-up and have only been tighter in 2021 in the last 3 years though yields remain significantly higher since then.

Market Themes

Credit yields, as proxied by high-yield corporate bonds, have fallen nearly 2% from their peak late last year. One outcome of this yield collapse has been a spate of bond issuance from various investment companies such as BDCs, mortgage REITs and CEFs.

Issuers are taking advantage of this sharp drop in yields to issue a backlog of securities they may have wanted to sell for some time.

One obvious question which we got on the service is why would borrowers want to issue bonds now if the market expects further deflation (accompanied by presumably lower rates) over the medium term?

They are doing it for several reasons. For some issuers their other bonds are coming due now so they need to be refinanced anyway and borrowing more via a floating-rate credit facility may not be as attractive. This is due to the very inverted yield curve as well as the additional covenants that credit facilities require over unsecured bonds.

Secondly, a huge amount of disinflation / lower rates is already priced in which also explains why the yield curve is so inverted. So there is no need to wait for actual disinflation to happen unless the borrower thinks longer-term rates will fall more than what's priced in now, perhaps because they think a recession is on the cards.

New issuance that has crossed our screen in the last couple of weeks includes the following:

• BDC MAIN priced a 2029 bond at 6.95%.
• BDC TSLX priced a 2029 bond at 6.125%
• mortgage REIT MFA priced a 2029 bond at 8.875% (MFAN)
• CLO Equity CEF ECC priced a 2029 8% preferred (ECCF)

Unfortunately, only the last two securities will be listed on the exchange - the others will be over-the-counter making them a little more difficult to buy.

The rough rule of thumb is that investment-grade issuers will tend to use the institutional / over-the-counter (OTC) market while sub-investment grade issuers will tend to issue in the retail / exchange-traded market. though there are many exceptions.

Stance And Takeaways

Although the issuance of new securities is very welcome, the sub-7% yields we are seeing across many new issues is less so. At the same time, we don't recommend a pro-cyclical investment approach where investors stretch for yield by moving into lower-quality securities when yields fall and valuations become expensive as they are now.

Rather, a middle-of-the-road approach makes sense where investors can pick up decent quality securities with yields north of 8% without resorting to dumpster diving. This includes a bank preferred we recently added such as the USB Series A ( USB.PR.A ) as well as a number of BDC and CEF bonds such as ( PFXNZ ), ( WHFCL ), ( OXLCZ ) and others.

For further details see: