Baby Bonds Complete Review

Dec. 18, 2019 2:26 PM ETAAIC, AQNA, AQNB, BC.PA, CNFRL, LRFC, CTBB, CTDD, CTV, F, INBKL, INBKZ, CFG, LTS, LTSF, LTSH, LTSK, LTSL, PFX, MDLQ, MDLX, MDLY, MGR, MHLD, NRUC, OFSSL, PBB, PBI, PBY, PFF, PGX, QVCD, RILYH, TDA10 Comments9 Likes

Summary

  • A review of all baby bonds.
  • All the baby bonds sorted in categories.
  • What has changed during the past month?
  • I do much more than just articles at Trade With Beta: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

In this article, I'll review all the baby bonds, listed on a national exchange, sorted into several categories. There are 192 issues in our database that trade on primary exchanges. Since there is no common ETF for baby bonds only, I'll examine the two largest primary exchange-traded fixed-income ETFs with a market capitalization of over $22.5B in general, the iShares Preferred and Income Securities ETF (PFF) and the Invesco Preferred Portfolio ETF (PGX). As we can see in the charts below, 68% of PFF's holdings are preferred stocks, which occupy 70% of the market capitalization of the fund and also 69% of PGX's holdings are preferred stocks with a market capitalization of 66%. Still, with more than $5.4B 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 Preferred and Income Securities ETF

Source: Tradingview.com

Invesco Preferred Portfolio ETF

Source: Tradingview.com

SPDR S&P 500 Trust ETF (SPY)

Source: Tradingview.com

The most significant indicator for all fixed-income investors, the 10-year Treasury Note Yield (TNX), has bounced again at the current rate of 1.86% from a rate of 1.70% on the first trading day of December, mainly due to the stronger than expected jobs report on the first Friday. The last month's non-farm payrolls up 266,000 versus 186,000 expected and the unemployment rate decline of 3.5% moved the U.S. treasuries lower. It is also essential that the US and China will sign a "phase one" trade deal in January, moving all equity markets higher, as a risk-on, to a new all-time high, and put extra pressure on the U.S. Treasuries. The fixed-income securities, in turn, started the first day of the month with tangible selling, before bouncing back driven by the bullish equity markets, with PFF and PGX having a 2% gain for several days and again moving close to their 1-year and 2-year high, respectively.

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 84 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. Be careful not to get surprised in these ones if you are tempted by the higher yield. In simple terms, these securities are trading above their par value and can be subject to redemption at any time. The immediate capital loss leads to negative returns.

Currently, a total of 47 of all baby bonds that are listed on a National Exchange bear a negative Yield-to-Call. In other words, 25% of all examined securities carry a call risk.

1.1 Long Time No Call

Source: Author's database

1.2 Short Time No Call

Source: Author's database

2. Baby bonds below PAR, YTM < 10%, yield curve:

Source: Author's database

The rated ones only:

Source: Author's database

Here is the full list (with the not rated ones):

Source: Author's database

With the securities in the next paragraph, we have an aggregate of only 31 baby bonds trading below their par value or in other words 16% from the whole majority. As you can see, only 6 are rated from the S&P, 3 of which are investment-grade "babies" that are trading at a price lower than $25. In fact, they fall into the "below-par" baby bonds, mainly because their stripped is below $25. Telephone and Data Systems (TDS) is trading almost at par ($24.98) and BrightSphere Investment Group's (BSIG) last price is even above ($25.10). An interesting thing about the rated issues is they all are trading post their call date, meaning they are anytime callable now.

As for the rest, the main reason to trade below PAR is the increased credit risk for its holders. Medley Capital (MCC), Maiden Holdings (MHLD), Pitney Bowes (PBI), Capitala Finance (CPTA), Arlington Asset Investment (AI), and JMP Group LLC (JMP) have charts of their common stock which unfortunately do not show much confidence for their creditors.

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

Source: Author's database

This is the most speculative group of baby bonds. Lately, the Ladenburg Thalmann's (LTS) baby bonds also take apart. Ladenburg Thalmann agreed to sell itself to Advisor Group (private company) and its baby bonds (OTC:LTSL, OTC:LTSF, OTC:LTSK, and OTC:LTSH) have shifted their yields to the yield of the private company yields, which currently sits at 10.94%.

As for the Medley Management (MDLY) "babies", MDLQ and MDLX continue to take part in this group due to concerns about the upcoming merger of Medley Capital, MDLY, and Sierra Income Corp.

The Conifer Holdings' (CNFR) baby bond, CNFRL, constantly rotates into both groups of baby bonds, trading below PAR, mainly due to its very low liquidity.

Here is 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

Now, only the rated ones. For a better idea, I've excluded the Qwest Corporation's (CTV) notes, which is the only callable one, for us to have a clearer look over the yield curve.

Source: Author's database

The next step is to exclude the non-investment grade ones and to observe the yield curve of all investment-grade baby bonds:

Source: Author's database

The investment-grade baby bond with the highest Yield-to-Worst currently is the QVC's QVCC with YTC of 6.14%. Qwest Corporation's CTBB and CTDD, along with QVC's QVCD are next, all yielding around 5.70%. All other issues are yielding close to or below the 5% threshold. For reference, the average Yield-to-Worst is sitting at 3.66%.

5. Fixed-to-Floatings:

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

Source: Author's database

Since after the call date, they all change their nominal yield, this chart may be misleading. That's why the best way to compare the group is by their Yield-to-Worst (equal to their Yield-to-Call). This is a much more plausible yield curve.

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

Source: Author's database

  • The Full List

Source: Author's database

The situation is almost constant every month. INBKZ is located at the top of the chart, meaning it has the best Yield-to-Worst from the group. However, together with INBKL, they are the only ones that are not rated by S&P. Except for AQNA and AQNB, the rest of the baby bonds carry an investment-grade rating. Here, we have an average Yield-to-Worst of all fixed-to-floating baby bonds at 3.69%.

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

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

For this chart, I'll leave only those securities that are not callable yet, trade above par, and have a positive YTC. Let's examine the yield curve of all BDCs' baby bonds.

Source: Author's database

Take note that except for PBB and PBY ("BBB-" by S&P), all other securities are not rated by any of the big three rating agencies.

7. Ex-Dividend Dates until the end of January 2020:

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 who practices the dividend capture strategy.

8. A Look at the Most Recent Redemptions

There are 4 securities called since October:

Source: Author's database

Here is the full list:

Source: Author's database

9. A Look at the Most Recent IPO:

There are 6 baby bonds, issued for the last month.

Source: Author's database

Again, the full list:

Source: Author's database

Three issues are currently trading over-the-counter before they open trading on the NYSE: WRB-F, CUBB, and the newly issued baby bond by Ford (F), which permanent ticker symbol is still unknown. At this point, you can check its market price in FINRA:

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

  • Top Gainers:

Source: Author's database

  • Top Losers:

Source: Author's database

Conclusion

This is what our small world of baby bonds looks like two weeks before New Year. After a slight correction at the beginning of December, the fixed-income securities quickly returned to the path of buying with PFF and PGX having a 2% gain of several days very rapidly. As expected, the Fed kept the fund's rate last week during the two-day FOMC meeting and signaled that it will interest rates steady for a while. Currently, the investment-grade issue with the best Yield-to-Worst is QVC's recently issued baby bonds, QVCC, with a YTC of 6.14% and it is the only above the 6% barrier. Excluding several issues with a return of between 5% and 6%, the rest's YTW is below the rate of 5%. Furthermore, 1/4 of all baby bonds carry a call risk, while 31 are trading below their par value, only 3 of which with an investment-grade rating (all three very close to PAR). Lastly, there are some issues we have added in our Defensive Portfolio, you might like: RILYH, OFFSL, BC.PA, MGR, and NRUC, with an average Yield-to-Worst of 5.51%.

Note: This article was originally published for our subscribers on 12/16/2019 and some figures and charts may not be entirely up to date.

Trade With Beta

The Trade With Beta team has been submerged in the universe of preferred stocks and baby bonds for almost a decade, and we decided to share our knowledge and expertise through the inception of this service. We attempt to cover all aspects of these products, from IPOs to pair trades and portfolio picks and, last but not least, issues. Additionally, once a month, we go through all different groups of fixed-income instruments to make sure that nothing has gone unnoticed.

This article was written by

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Day trader whose strategy is based on arbitrages in preferred stocks and closed-end funds. I have been trading the markets since I started my education in Finance. My professional trading career started right before the big financial crisis of 2008-2009 and I clearly understand what are the risks the average investor faces. Being a very competitive trader I have always worked hard on improving my research and knowledge. All my bets are heavily leveraged(up to 25 times) so there is very little room for mistakes. Through the years my approach has been constantly changing. I started as a pure day trader. Later I added pair trades. At the moment most of my profits come from leveraging my fixed income picks. I find myself somewhere in between a trader and an investor. I am always invested in the markets but constantly replace my normally valued constituents with undervalued ones. This approach is similar to rebalancing your portfolio and I just do this any time there is some better value in the markets. I separate my trading results from my trading/investment results. I target 40% ROE on my investment account and since inception in 2015, I am very close to this target.


My main activity is running a group of traders. Currently, I have around 40 traders on my team. We share our research and make sure not to miss anything. If there is something going on in the markets it is impossible not to participate somehow. Some of my traders are involved in writing the articles in SA. As such Ilia Iliev is writing all fixed-income IPO articles. This is part of their development as successful traders.


My thoughts about the market in general:

*If it is on the exchange it is overvalued and our job is to find the least overvalued.

*Never trust gurus - they are clueless.

*Work hard - this is the only way to convince yourself you deserve success.

*If you take the risk it is you who has to do the research.

*High yield is always too expensive.


We are running a service here on SA. It is a great community with very knowledgable people inside. Even though we are not in the spotlight as often as we would like to our articles' results are among the strongest on SA. You can always contact me to share some of our articles and best picks so far.

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Disclosure: I am/we are long RILYH, OFSSL, BC.PA, MGR, NRUC. 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.

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