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The Preferred Stock Selloff

The rise in the 10 year Treasury Bond from 1.5% to 2.5% has been quick and quite startling. In percentage terms that is a two thirds increase in rate and a coincident two thirds drop in value. What is really eye opening was the drop in preferred stock values from the ranges of $25 to $28, premiums to the standard $25 IPO prices, to the discounted $21 to $25 range. Yields on investment grade preferred from BBB- to AA have stepped up from the 5-6% range to the 5.75-7% range.

Most of the preferred IPO proceeds over the last few years have gone toward calling back 5 year old and older preferred issues that came public at 6-9%, allowing the banks, the insurance companies, the REITS, the utilities and a few other industrials, to refinance this component of their cost of capital at significantly lower rates.

Is the refinancing over?

I have not seen a rush to continue this refinancing of preferred as the market has stepped up its yield curve over the past couple of months. Does this mean the sellers are waiting for a retracement of some of this abrupt, interest rate, step function or are they scurrying to accelerate their IPOs with their investment bankers in the wings, in fear that rates may push even higher making refinancing less worthwhile or even negative?

The same can be said of those home owners looking to refinance their mortgages. Do they wait for a little interest relief or do they jam the mortgage companies with an overwhelming load of new refinancings? And does the extra cash in their pockets they thought they might gain with a refinancing wipe out their plans for that new car?

Whether rates go up or down from here, we can expect a lull in spending at best. On the downside, big ticket items, durable goods, residential construction and perhaps even commercial construction can expect flat to down numbers for the foreseeable future.

Who benefits from the preferred interest rate uptick?

Those seeking additional income, namely retired folks, who fear the stock market can only get very low returns from CDs and money market funds. They will get a raise when they decide rates are high enough to risk investing some capital in a preferred stock, somewhat less risky than dividend yielding stocks and a little more aggressive than putting it into lower paying bonds.

The individual investor has the choice between purchasing preferred stock through ETFs and mutual funds or buying individual issues of preferred. As with bond funds and bond ETFs, there is an awful lot of interest rate risk transferred from ETF/mutual fund managers to individual investors. Individuals, who invest in individual issues of preferred can elect to hold to term and not risk capital losses, where as fund managers are buying and selling all the time, incurring losses and gains often. The fund/ETF investor can only watch from the sidelines passively. They can, of course, sell the Fund/ETF at any time, but the control over the capital gains and losses is buried in the everyday transactions the managers are making. I would recommend that an individual investor choose to buy individual preferred stocks and keep control of the interest rate risk in his or her hands.