Watch Out For Lower Reset Yields In Preferreds

Apr. 29, 2020 4:56 PM ETMS.PA, MS.PE, MS.PF, MS.PI, MS.PK, MS.PL, NLY.PD, NLY.PF, NLY.PG, NLY.PI10 Comments


  • Lower reset yields add to a long list of concerns for preferred stock investors.
  • Market expectations of lower reset yields are a result of sharply lower short-term rates.
  • Investors should focus on the available relative value opportunities depending on their view of short-term rates and likelihood of calls.
  • This idea was discussed in more depth with members of my private investing community, Systematic Income. Get started today »

As if preferred investors had nothing to worry about in the current market environment. A debacle in the energy markets, sharp unwinds in mortgage REIT collateral, depressed earnings in hospitality REITs and the list goes on and on. In this article, we take a look at another concern - the issue of lower reset yields - or the expected drop in yield of fixed-to-float preferred stocks once the stock moves past its first call date. We calculate that at current market expectations, the average fixed-to-float stock will see its yield drop by about 2%, potentially taking away a big chunk of the existing distribution.

Our main takeaway is that investors should take a closer look at relative value opportunities on offer within the different series of the same issuer depending on their view of short-term rates and likelihood of calls.

Why Worry About Reset Yields?

The drop in expected coupons and the lower likelihood of calls are the chief reasons why investors should worry about reset yields. Preferred stock prices are still relatively depressed despite a sharp rally from the drawdown trough last month. With the median clean price trading around 23 from above 25 prior to the drawdown, the market is sending a message that preferred stocks, by and large, are unlikely to refinance existing issues. This means that once a fixed-to-float stock moves past its first call date, the coupon will switch to a floating rate.

Source: Systematic Income Service

This coupon switch to a floating rate would not be a serious problem in a normal market environment. The trouble is we are not living in a normal market environment. Short-term rates, which are the base rates for preferred stock floating-rate coupons, have collapsed. This means that on average a fixed-to-float stock will see its yield drop about 2% based on current Libor forwards. Of

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This article was written by

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Income investing across BDCs, CEFs, ETFs, preferreds, baby bonds and more.

At Systematic Income our aim is to build robust Income Portfolios with mid-to-high single digit yields and provide investors with unique Interactive Tools to cut through the wealth of different investment options across BDCs, CEFs, ETFs, mutual funds, preferred stocks and more. Join us on our Marketplace service Systematic Income.

Our background is in research and trading at several bulge-bracket global investment banks along with technical savvy which helps to round out our service. 

Disclosure: I am/we are long NLY.PD, MS.PA. 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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