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How To Find And Select Undervalued Fixed-Income Securities

Aug. 06, 2018 10:40 AM ETAxos Financial, Inc. (AX)C, KEY, PBB, PYS, PSEC, RRD, BOKF77 Comments


  • This is an educational article regarding the process of finding and selecting under-priced fixed-income securities that trade on the stock exchange.
  • It argues for using relative valuation when making a buy recommendation on a particular fixed-income security.
  • BofI Holding's 6.25% Subordinated Notes maturing on 2/28/2026 are used as a case study in using relative valuation to find a very undervalued fixed-income security.


In the world of fixed-income investing, there is no objective value, only relative value. There is no interest rate (yield) that one can say is right for a particular security. For example, preferred stocks currently sell at yields that aren't much different from yields that existed when the 10-Year Treasury yield was half of what it is now. So are preferred stocks overpriced now or were they underpriced when the 10-Year Treasury had a significantly lower yield?

My major gripe regarding some Seeking Alpha authors who promote fixed-income ideas (preferred stocks or bonds) is that they use an objective valuation approach rather than a relative valuation approach in their security selection process. They provide information about the company that issued the fixed-income security that they are promoting, and about the details of the fixed-income security that they write about (yield, price, call date), and expect that is enough to make an investment decision. However, no evidence is provided that their recommended security is a relatively better value than other similar securities issued by other similar companies. Sometimes I find the recommendations to be relatively overpriced and inferior.

Tips For Finding and Selecting Undervalued Fixed-Income Securities

1) One of the lessons I have learned from my 20 years of trading fixed-income securities is that the best values are in unrated fixed-income securities. You can generally get preferred stock and baby bond safety ratings from Moody's and S&P from QuantumOnline.com, but when checking safety ratings at QuantumOnline, you will discover that a large number of fixed-income securities are not rated. This only means that the company has decided not to pay the rating agencies to rate their fixed-income securities. But many unrated securities are extremely safe. Despite this fact, many mutual funds and other institutional investors have instructions not to buy unrated securities. Therefore, unrated securities are often underpriced

This article was written by

Preferred Stock Trader profile picture

Trading preferred stocks and fixed income securities for more than 25 years and stocks in general for 35 years.  Author of many Seeking Alpha articles and Editor's Picks articles.

Analyst’s Disclosure: I am/we are long BOFIL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (77)

JudasPriest profile picture
Hi. Great analyses here. Is there any chance of getting your article below without having to subscribe? At this point, I don't think a subscription to SA would be worth it to me but I'd love to read this piece. Thanks you. Don

Preferred Stock Trader profile picture
You should be able to see the article now.
JudasPriest profile picture
Perfect. Thanks.
PST, thanks for the article and the teaching. What would you suggest as a good sourse to learn how to evaluate companies and balance sheets?
Many thanks.
Preferred Stock Trader profile picture
I just kind of taught myself through experience. Security analysis by Ben Graham is sort of the bible for evaluating balance sheets.
tikigod18 profile picture
PST: just found you by chance. You now have a new follower. Wonderful info in uncertain times.
Gridbird profile picture
Tiki, PST, is a very good person to follow. Insightful and a person of integrity.
Preferred Stock Trader profile picture
Thank you both for your kind comments.
Looks like it was part of an ATT buy out, under T (ATT) on Finra bonds, top row, page one, with other ATT buyouts alphabetically, trading everyday. Seems to crash whenever T makes a big deal like the recent one, debt scare, but this bond has 20 years of seasoning? Can't get much info. Thanks.
Anyone have info on :
Aliant Communications on FINRA under T, Cusip 016090AA0
Seems very under radar but 20 years seasoning.
Preferred Stock Trader profile picture
I know nothing about this bond. When you say it is on FINRA under T, what do you mean? Judging from the price, it seems this company has big troubles. The common stock doesn't appear to be traded on the exchange anymore and hasn't filed a 10Q since 2015. So it is not surprising it is on nobody's radar.
Bruceski44 profile picture
Hmmm, margin buying is safer than buying bonds of a semi-reliable company well below par? That doesn't work for me.

I agree TA has a bad balance sheet, but I think that will improve. There was also a lawsuit, which made investors nervous, but that was settled in TA's favor before I bought. I'm gambling 2% of my portfolio on TANNI, and don't see a huge risk that it won't pay off before it matures in less than 10 years. Since I've already made over $1.50 per share, I could just dump them for a gain, or they could be called anytime. Maybe I don't understand as well as you, but I don't see any smoke here.
Preferred Stock Trader profile picture
What evidence do you have that the TA balance sheet will improve? The company keeps losing money so it will likely get worse. Just my opinion.
Bruceski44 profile picture
Thanks PST and Gridbird. Great lessons here to continue the article's theme. Not necessarily on relative value, but on the murky risks which may not be apparent. Choosing safe and durable fixed income securities is highly technical and I appreciate you both sharing your knowledge and experience as I learn the details.

PST, I did use your relative value thesis a while ago when picking CTDD out of all the CTL bonds and TANNI from TA. I'm getting ~8% YTW and I think I'll hold these for income. TA just had a disappointing earnings release, but I don't see them going belly up. CTL reports tomorrow after the close.
Gridbird profile picture
Bruce, I might miss out on some higher risk trades, but I havent in years been kicked in the groin either. It could be a higher risk higher reward trade, but it just doesnt work for me. I cant remember off hand the exact words but they have issued what could be interpreted as “cryptic messages” in discussing the future of the preferreds. And maybe I am just looking for something that is there, but isnt. But before I buy I look for ways I could get screwed over. And there are many when buying anything so I try to minimize it more to just duration risk and call risk for most (not all). Of course this can drag down my total preferred yield which is probably around 7%. But I also have some ultra safe issues dragging it down such as KYN-F and GGO-A and the 6% investment grade stuff too. I kind of hit all areas, short duration, perpetual, adjustable, term, high yield, relative high yield past call, etc. It just depends on what your risk allocation is and your goal and expectations are. Some online friends only want secure yeild and are not as worried over capital preservation. Others secure that through bonds and CDs, while using preferreds in high yeild higher risk and treat as dirty equity traders.
Preferred Stock Trader profile picture
I'm with Gridbird. Reaching for yield is very dangerous and you are putting money into companies that you really don't understand well and that are controversial with terrible balance sheets. TANNI traded below $20 in the last year and it certainly could do that again or worse. To achieve a higher yield, as you are trying to do, I would rather use some margin buying with lower yielding bonds/preferreds that are rock solid. I can achieve a better yield than you are getting with less risk (in my opinion). Of course, I am an active trader and can borrow for less than 2.5%.
Gridbird profile picture
They could get delisted to save on reporting costs once they go privated. I own one delisted baby bond (the old PFX) and a few delisted preferreds that trade on the pink sheets. But they are companies and people I trust. I dont feel the love from this outfit, so I stay away from them, but that is just me. I did do a quick flip trade on a few AFSI preferreds when they cratered well below this price and then sold a few weeks later on a couple buck per share gain. I wont be back though.
Bruceski44 profile picture
Thanks Grid!

Now I see they showed real weakness, even before the vote. Trying to restrain my greed now...
Gridbird profile picture
Bruce the baby bonds are trading stronger than the preferreds. This situation provides insight into “it doesnt matter until it does”. The preferreds and the subordinated debt issues largely traded together until the crap hit the fan with the company. The baby bonds have recovered more because they have debt covenant protection. The preferreds are non cumulative. If they got delisted or even suspended the preferreds are exposed and market knows this and the risk. I am not saying it will happen, but going private will not assist in playing any games with the debt as much as the preferreds.
That is why I respected the company that acquired PFX. They allowed shareholders to vote to approve a delisting to save company millions in filing fees and gave the shareholders a modest 10 cent one time bonus if they approved which they did. But they didnt have to do this and could have just delisted. I wouldnt count on this outfit doing this.
Preferred Stock Trader profile picture
The private AFSI must continue to pay the bonds unless they want to go into bankruptcy. So it makes sense that the bonds trade more strongly. The preferred stocks are non-cumulative. Therefore, AFSI can just suspend the preferred stock dividends forever and it does them no harm. I understand they look tempting but I won't buy them. You may end up with a preferred with suspended dividends even if the company is doing okay. These guys can't be trusted to do the right thing if they don't have to.
Bruceski44 profile picture
I just spent a couple of hours performing financial analysis on Amtrust Financial Services (AFSI) bonds and preferreds and got all excited to see the below-par and high YTC potential for a company which had a bad year, but is recovering nicely YTD. But then I started looking at the news items to find that shareholders voted to take the company private on 6/21, paying $14.75 per common share to do so. But I cannot find any info on what will happen to the preferreds and baby bonds. There are two bonds AFSS and AFST and five preferreds, AFSI-A through AFSI-F. Even on Amtrust's website, I cannot find any FAQs or other documents describing what will happen. Does anyone know?

Note to self: look at the latest news first next time!
Bruceski44 profile picture
too late to call Investor Relations so sent email.
07 Aug. 2018
Great article. Thanks for the very useful info. I see the earlier comments regarding BOFIL Yield to Maturity but I'm more concerned about Yield to Call. Earliest call date is 32 months away and current premium pricing is equivalent to 8 months of interest. Any thoughts regarding the likelihood of an early call?
Preferred Stock Trader profile picture
Thanks for your kind words and for reading.

To answer your question, it is too far away to know what the interest rate environment will be and to guess about a call, but the Yield to Call is around 5%. That is an excellent return for a safe 2.5 year bond. Therefore, the call date doesn't concern me. The yield on Keycorp and Citigroup's March 2021 bonds are only 3.3%. BOFIL still looks good if you are a buy and holder even if it turns into a 2.5 year bond. Hope that helps.

And remember, it goes ex-dividend next week so it is really less than 5 months of interest over par and not 8.
Great article that answers questions that I have had for a time.
Preferred Stock Trader profile picture
Glad it was helpful. I have another article you might like. It is a bit old but it is about understanding and selecting convertible preferred stocks. I am trying to make it public again but SA is having technical problems. Try to read it later. Hopefully I can make it public again. seekingalpha.com/...
I read every article from you. I don't have the expertise to make individual picks, and would love to see your buy&hold list. Following you, Gridbird, and others. Thanks so much.
Preferred Stock Trader profile picture
A couple of companies with good bonds are GBLI and RILY - symbols GBLIL, GBLIZ, RILYZ, RILYH, RILYG. RILYL is very good but could be called in a few weeks, but I still hold a large position there. Nice yielders with little interest rate risk because they are not long bonds.
35spline profile picture
PST, I like your ideas. Do you ever publish specific trade recommendations?
Preferred Stock Trader profile picture
Yes. I have some articles you can look back to recommending underpriced preferred stocks. There are links in the article above to some of those. Look at the article - #4 under the "Tips For Finding and Selecting Undervalued Fixed-Income Securities". I don't write frequently as trading is much more profitable for me than writing and I don't have an agenda to start a subscription service. My latest article recommended preferred stocks TGP-B and GLOP-A. Both have done very well since the article was published. Here is the link :
larryjust profile picture
PST, you invest wisely and are generous in teaching others. Thank you.
Preferred Stock Trader profile picture
Thanks for stopping by, Larry.
Very nice article and education PST. I have learned lots from you. Unfortunately, i think the investors of today are looking for, "tell me what to buy, and don't tell me why." Keep the education up, as I believe in due diligence. As our portfolios increase in value as the years go by, I want to be as educated as possible.
Preferred Stock Trader profile picture
Thanks, Mr Lucky. I get frustrated when I read articles recommending a particular preferred stock when I know there are much better ones available. I also feel they are wasting my time reading these articles if they do nothing to show how their recommendation compares to securities of other similar companies. I won't name the author, but there was a particularly bad article recommending a terrible shipping preferred, called it "safe" when it is not at all safe, and did no comparison to other shipping preferreds which would have showed that the preferred chosen was the worst possible choice. That motivated me to write the article in hopes that other authors will read it and start writing useful articles.
Gridbird profile picture
“Safe” is a word thrown around in a very cavalier way on SA. It definitely has a different meaning to different people that is certain.
"Fortress Balance sheet", "Wide moat", SWAN the list of superlatives goes on. My big problem is that there are too many recommendations. Warren Buffet asked, "What are the chances that your sixth best idea is as good as your best idea"? Yet there are authors making daily recommendations and rarely suggesting selling.
Gridbird profile picture
PST, forgot to ask did you get in on the GLPRU temporary ticker trading? I usually dont go into the 9% plus range unless there is a real company with real earnings and this 75 year old LP fit the requirements despite knee shaking B rated bonds. It was shooting fish in a barrel last week at $24.80. DCP-B was another recent easy money MLP trade. That FPI-B was a recent nice quick hitter too. Bought in the 18s and sold in the 22s, theee days later thanks to that bogus fraud article in SA about them. Overall flipping preferreds has been very good the past three months.
Preferred Stock Trader profile picture
Unfortunately, I have been pretty busy and not checked the IPOs much lately, which often provide great opportunities. Congrats on buying those. The last one I bought was ESGRP. Regarding DCP-B, I have always disliked the MLP sector and tend to avoid them in general, so I didn't look at it. Regarding GLPRU, I've seen a lot of 9% IPOs go bankrupt so my initial tendency is to avoid those, but if I research it and it looks good, I will buy those.
PST, I have a long position in BOFI but found this article very educational. Thank you for that, and for taking time and space to explain your thesis. Well done!
Preferred Stock Trader profile picture
Thanks, broker555. Appreciate the kind words.
Bruceski44 profile picture
When considering interest rate risk with preferreds or baby bonds, I prefer the BB, because they usually have a maturity date. Most preferreds do not have a maturity date, and if not called, would be a perpetual issue. If the price drops due to rising interest rates (discussions today that Jaime Dimon thinks the 10-yr Treasury could go to 5%), then you might be facing a large capital loss when trying to unload them. In that scenario, at least the BB maturity would provide some closure when redeemed at par. Even if the maturity date is 2095 or so... Can you refute any of this?

Thanks for the article and your thoughts..
Gridbird profile picture
Bruce there are many variables that come into play with your question that can change the outcome. One being credit quality of issuing company and how higher rates affect that company specifically. Many other variables also, but some can be mitigated to a certain degree. Take on the safer end of the preferred world (and lower yielding), GGO-A. It is a perpetual with a 2021 first call date, but starting next year it goes 10 year treasury plus 200 basis points with a 5% floor and 7% ceiling off of $40 par. This will take the strain of yield risk off it to some degree in theory. Also take an issue like one of my core holdings AILLL. It was issued as a 6.625% in 1993 when 10 year was around 6%, yet today it still yields 6.2% as it is anchored near par due to long time call risk (since 1998) unable to trade to its true market yield. This will support its back side though if yields rise. But I in general share your concern. I mitigate as much as I can by owning term dated, adjustables, higher yielders, and trust debts with first call dates long gone by and final maturites in the 2030’s.
Preferred Stock Trader profile picture
Baby Bonds (BB) certainly provide much better interest rate protection than most preferrred stocks, however there are some preferred stocks that do provide fairly good interest rate risk. Those are "term preferred" stocks which are similar to bonds, preferred stocks with a failure to redeem clause (where the interest rate on the preferred stock will rise if it is not called by a specific date), and some preferreds that have very high yields due to the fact that they are callable so investors are afraid to buy them, even with relatively high yields, because they could lose some money if called. A good example is DS-B which I have owned for years, pays a huge qualified dividend, but never gets called.
Preferred Stock Trader profile picture
DS-B is unlikely to be affected by interest rates and is a bargain relative to DS-C or DS-D, but it could be affected by failure of the common stock DS to perform well, so here we primarily have credit risk and little interest rate risk (similar to a bond).
Preferred Stock Trader profile picture
Thanks for posting that Greg. However, your link doesn't seem to work.
I will try to post it: innovativeincomeinvestor.com/... Mine doesn't work either. Readers can just go to innovativeincomeinvestor dot com and click on "list of baby bonds". I do see that some baby bonds on the list have already matured or have a symbol change, so this list is not perfect, but it can be useful for those who prefer it to quantumonline's list.
Greg_Maryland profile picture

Nice article. Long PYS.

FYI, there is a site that looks at Baby Bonds that might be of interest.
Preferred Stock Trader profile picture
Greg, being straight long PYS is risky. I believe the mispricing is on the 2029 bond that trades on the bond market and not PYS. If you look at the 2031 RRD Bond, it yields 10% which doesn't make PYS look good on a relative basis. Long PYS without a hedge could work, but I wouldn't be in that trade.
Really good article. I've had BOFIL on my watch screen for sometime. If the liquidity were greater I might have purchased.
Preferred Stock Trader profile picture
Thanks for reading and replying, Melvin.
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