In this monthly article, I 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 $24.3B 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, 67% of PFF's holdings are preferred stocks, which occupy 61% of the market capitalization of the fund, and also 68% of PGX's holdings are preferred stocks with a market capitalization of 72%. Still, with more than $5.4B in baby bonds, in general, these two are the most representative for this kind of fixed income securities.
Now that these products have our attention, we are continuously monitoring all baby bonds by several groups and will reinstate our monthly review, publishing a recap of the groups of interest. First, let's take a look at the main indicators that we follow and their behavior during the last month.
TNX - CBOE 10-Year Treasury Note Yield Index ($TNX)
iShares Preferred and Income Securities ETF (PFF)
Invesco Preferred Portfolio ETF (PGX)
SPDR S&P 500 Trust ETF (SPY)
The most significant indicator for all fixed-income investors, the 10-year Treasury Note Yield (TNX), still holds at the rate of 1.55% after it had previously declined from the 1.90% level at the start of the year. As it seemed last year it will break through the 1.90% resistance, it is now at its level of three and a half years ago. The fixed-income securities, in turn, continue their sharp rally, started at the beginning of December 2019. As you can see in the second and the third chart, PFF and PGX are in a very stable uptrend, reaching 2-year and 3.5-year high, respectively. As for the equity markets, the S&P 500 hit a new all-time high again, after it was previously had entered into a slight correction, against the background of rising new cases of the coronavirus. As of Feb. 17, China’s National Health Commission has said that, currently, there had been a total of 72,346 confirmed cases and 1,868 deaths.
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. We can even see four securities that become callable after more than a year and already carry a call risk - SHCNL, GATX (GMTA), and Entergy Mississippi (EMP).
Currently, a total of 58 of all baby bonds that are listed on a National Exchange bear a negative Yield-to-Call (for reference, it is an increase with 11 securities from the last month's article). In other words, 1/3(!) of all examined securities carry a call risk.
1.1 Long Time No Call
1.2 Short Time No Call
2. Baby bonds below PAR, YTM < 10%, yield curve:
Here is the full list:
With the securities in the next paragraph, we have an aggregate of only 19(!) baby bonds trading below their par value (no change since January's article) or in other words 10% from the whole majority. Curiously, there is an investment-grade issue in this group, Qwest Corp.'s CTY. However, it is actually trading above its PAR, but its stripped price is below $25, at $24.99. As you can see, only 2 more are rated from the S&P, none investment-grade, to be trading at a price lower than $25. These are PBI-B and Navient (JSM). The main reason to trade below PAR is the increased credit risk for its holders. Medley Capital (MCC), Maiden Holdings (MHLD), Pitney Bowes (PBI), Arlington Asset Investment (AI), Conifer Holdings (CNFR), 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:
The Ladenburg Thalmann's (LTS) baby bonds again take apart in the most speculative group, due to the company's acquisition by Advisor Group (private company). LTS has now successfully completed the merger with Advisor Group and also announced its intention to delist all of its baby bonds (OTC:LTSL, OTC:LTSF, OTC:LTSK, and OTC:LTSH), together with its preferred stock (LTS.PA)
So, practically, the highest yielding exchange-traded baby bonds are only the Medley Management (MDLY) "babies," MDLQ and MDLX. They continue to take part in this group due to concerns about the upcoming merger of Medley Capital, MDLY, and Sierra Income Corp.
Here is the full list:
4. Baby bonds > Par, yield curve by Yield-to-Worst and Years-to-Call:
Now, only the rated ones.
The next step is to exclude the non-investment grade ones and to observe the yield curve of all investment-grade baby bonds:
The investment-grade baby bond with the highest Yield-to-Worst traditionally is the QVC's QVCC, with YTC of 5.87%, along with the other baby bonds issued by the company, QVCD, with YTC of 5.17%. Ford Motor Company's F-C is the third-yielding baby bond with YTC of 5.16%, while all other issues are trading below the 5% Yield-to-Worst threshold. For reference, the average Yield-to-Worst is sitting at 2.75%. (0.26% lower from the last month's article).
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.
The situation is almost constant every month. First Internet Bancorp (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 2.41%. (0.31% lower since January).
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.
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.
7. Ex-Dividend Dates until the end of March:
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.
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
Currently, there are 3 securities called for 2020:
9. A Look at the Most Recent IPO:
There are also 2 baby bonds, issued since New Year:
10. How Do they Move?
Here is the general idea of how the baby bonds have moved for the past 30 days:
This is what our small world of baby bonds looks like at the mid of February. The fixed-income securities quickly continue their upward movement, with PFF and PGX trading at their 2 and above 3.5 years high. Baby bonds with a call risk continue to increase and are now 1/3 of all exchange-traded ones. If we take a look at the Yield Curve, yields continue to lower and lower, as the investment-grade baby bonds and the fixed-to-floating ones have their Yield-to-Call deep below 3%. Currently, only 10% of all issues are trading below their PAR, 3 of which only rated by S&P. From the bonds with a price above PAR, the best Yield-to-Worst security with an investment-grade rating, continue to be QVCC, with its 5.87% Yield-to-Call, followed by the other QVC's bond, QVCD, and its 5.17% YTC. A total of only 3 issues are yielding above 5%, as the third issue is Ford's F-C. All other issues are trading at an average YTC of 2.75%.
Note: This article was originally published for our subscribers on 02/18/2020 and some figures and charts may not be entirely up to date.
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
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.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.