Baby Bonds Complete Review

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Includes: AFSI, BC.PB, INSW.PA, MHLA, NSS, PBB, PBC, PBY, PSEC
by: Arbitrage Trader
Summary

A review of baby bonds.

All the baby bonds sorted in categories.

What has changed during the past month?

In this article, I'll review all the baby bonds, listed on a National Exchange, sorted into several categories. There are 163 issues in our database that trade on primary exchanges. Since there is no common ETF for baby bonds only, I'll examine the two biggest fixed-income ETFs with a market capitalization of $20B in general, iShares U.S. Preferred Stock ETF (PFF) and Invesco Preferred Portfolio ETF (PGX). As we can see in the charts below, 88% of PFF's holdings are preferred stocks, which occupies more than 81% of the market capitalization of the fund, and 69% of PGX's holdings are preferred stocks with market capitalization of 74%. Still, with more than $2.2B in baby bonds in general, these two are the most representative for this kind of fixed-income securities.

PFF

Source: Author's spreadsheet

PGX

Source: Author's spreadsheet

Now that these products have our attention, we are continuously monitoring all baby bonds by several groups and will reinstate our monthly review, publishing a recap of the groups of interest. First, let's take a look at the main indicators that we follow and their behavior during the last month.

TNX - CBOE 10-Year Treasury Note Yield Index ($TNX)

Source: Tradingview.com

iShares U.S. Preferred Stock ETF

Source: Tradingview.com

PGX - Invesco Preferred Portfolio ETF

Source: Tradingview.com

SPDR S&P 500 ETF (SPY)

Source: Tradingview.com

The most essential thing for fixed-income investors for the past month is the TNX has fallen below the 3% yield mark amid projections of slowing economic growth and weaker inflation. Although this was also supported by the apparent dovish speech on November 28, during which the Fed Chair Powell announced that central bank's policy rate is now "just below" estimates of a level that neither brakes nor boosts a healthy U.S. economy, comments that many investors read as signaling the Fed's three-year tightening cycle is drawing to a close, the fixed-income securities, as we can see in the second and the third chart, continue to sink lower and lower. As for the equity markets, traders have a number of reasons for the selling, including an adverse ruling in a Chinese court against Apple (AAPL), a flattening yield curve, and a delayed Brexit vote in the United Kingdom.

The Review

These baby bonds resemble the preferred stock securities in their basic features. They are debt securities that are generally issued in $25 denominations and have maturity dates of 5 to almost 90 years (in our database, AGO-F is the security with the longest maturity, 7/15/2103). Baby bonds are normally redeemable at the issuer's option on or after five years from the date of issue at par. Most of these debt securities pay quarterly interest distributions. In payment of interest and upon liquidation, the exchange-traded debt securities rank junior to the company's secured debt, equal to other unsecured debt, and senior to the company's preferred and common stock. An important note is that all baby bonds are not eligible for the 15% tax rate on dividends as there are U.S. securities that pay interest, not dividends.

1. Call Risk Baby Bonds YTC < 0

The lower the bond, the higher the risk.

Source: Author's database

Be careful not to get surprised in these ones if you are tempted by the higher yield. In fact, the higher the yield, the most likely the redemption.

Here is the full list:

Source: Author's database

2. Baby bonds below PAR, YTM < 10%, Yield Curve:

Source: Author's database

The investment grades only:

Source: Author's database

Again (as in our previous reviews), the Qwest's baby bonds (CTAA, CTV, CTDD, CTZ, CTBB, CTY) seem to be quite undervalued, as there is a spread of 2% between them and the other investment grade babies with the same maturity.

Other baby bonds that can be a good addition to one's portfolio are the Prospect Capital's (PSEC) babies, PBB, PBY, and PBC. With a Yield-to-Worst of 7% for 5 years and 7.40% for 10 years, they are one of the best options at the moment. BrightSphere Investment Group plc 5.125% Notes due 2031 (BSA) may also join them but it must take into account the longer maturity of this bond.

3. Baby bonds YTM > 10%. Be careful with these babies:

Source: Author's database

Keep in mind that they have to bring extra risk because there is no free lunch. The S&P rating of INSW-A speaks enough for itself. The AFSI bondholders are now additions to this group as their Yield-to-Worst has increased because of the company going private, which increased risk of abuse.

Take a look at the full list:

Source: Author's database

4. Baby bonds > Par, Yield curve by Yield-to-Worst and Years-to-Call:

Source: Author's database

Only the rated ones:

Source: Author's database

Here is a table with some more information about all issues:

Source: Author's database

5. Fixed-to-Floatings:

  • By Years-to-Call and Yield-to-Call:

Source: Author's database

  • By Years-to-Maturity and Yield-to-Maturity

Source: Author's database

  • The Full List

Source: Author's database

6. Baby Bonds issued by a BDC

Under the 1940 Act, BDCs must generally meet certain levels of asset coverage with respect to their outstanding "senior securities," which typically consist of outstanding borrowings under credit facilities and other debt instruments, including publicly and privately offered notes. "Asset coverage," as defined under the 1940 Act, generally refers to the ratio of a BDC's total assets compared to its aggregate amount of outstanding senior securities, which allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

  • By Years-to-Maturity and Yield-to-Maturity:

Source: Author's database

Take a closer look at the main group:

Source: Author's database

  • By Yield-to-Call and Yield-to-Maturity

Source: Author's database

Again, a closer look at the main group:

Source: Author's database

7. Ex-Dividend Dates:

Which baby bonds are ex-dividend for the next 45 days? The date given is predicted on the base of the previous ones and may vary by a few days.

Source: Author's database

The ex-dividend dates are very useful for every fixed-income investor that practices the dividend capture strategy.

8. A Look at the Most Recent Redemption

There is 1 issue that its call for redemption was announced since the last article in November: Hercules Capital 6.25% Notes due 7/30/2024 (HTGX):

Source: Author's spreadsheet

An interesting fact about this redemption is that it will occur through two redemption dates - January 14, 2019, and February 4, 2019.

9. A Look at the Most Recent IPOs:

The baby fond family has increased with 2 securities since the last article in November:

  • Brunswick Corporation 6.625% Notes due 2049 (BC.PB)

Source: Author's spreadsheet

  • Prospect Capital Corp 6.875% Notes due 6/15/2029 (PBC)

Source: Author's spreadsheet

10. How do they move?

Here is the general idea of how the baby bonds have moved since the start of the month:

Source: Author's database

As it can be expected, almost all baby bonds are down for another month, despite the declining TNX, the rising LIBOR, and the dovish Fed, and it seems almost discouraging for the fixed-income investors.

  • Top Gainers:

Source: Author's database

  • Top Losers:

Source: Author's database

The uncertainty of the preference of the AFSI preferred stockholders is gradually being transferred to a disastrous month for the bondholders as well.

Conclusion

This is how our small world of baby bonds looks just before the end of 2018.

In this rising rate environment, fears of a trade war, and slowing global economy, it is normal for the whole fixed income securities to get affected, and those who follow our monthly reviews know that all stocks are in a strong bear market. Also, I want to remind you that the last FOMC Funds Rate decision will be announced during the two-day meeting this Wednesday, and I recommend waiting before you to make any investment decisions.

Note: This article was originally published on Dec. 17, 2018, and some figures and charts may not be entirely up to date.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PBC, PBY, PBB, CTBB, CTY, CTAA, CTZ, CTV,CTDD,CTZ over the next 72 hours. 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.