Outlook 2023: Preferred stock dividends high, issuance low; attractive 2023 entry point eyed

Chicago, Dec. 30 – The preferred stock new issue market dramatically retracted in 2022 to hit an 11-year low, marked at $14.63 billion.

For contrast, the year before, 2021, marked an all-time high – almost $70 billion.

The S&P U.S. Preferred Stock index, a benchmark, was more than 20% lower year to date.

Sector-wise, the index is comprised of financials at 73% and real estate at 7.7%, with no other sector representing more than 3.5% of the index.

Financials also made up the bulk of new issuance in 2022.

The paltry $14.63 billion number that did price would have been significantly lower if Bank of America Corp. as an issuer had sat on the sidelines in 2022. The bank accounted for $4.45 billion of the annual total.

PNC Financial Services Group Inc. was the issuer on another $2.25 billion.

A third bank, Societe Generale, issued $1.4 billion, meaning that just three issuers together accounted for more than half of the new issuance for the entire year.

In Citi’s Wealth Outlook 2023 alternatively titled “Roadmap to recovery: Portfolios to anticipate opportunities,” a note is given that “historically, issuers have always refinanced preferreds when interest rates were falling rather than rising.”

Interest rates were clearly rising throughout the year.

Bank of America, a test case for other issuers that could have been in the wings, started the year with a 4.375% dividend in January. A few weeks later, BofA sold another $700 million of preferred stock with a 4.75% dividend. However, by April pricing had increased to 6.125% for a $2 billion offering.

Performance

Bank of America’s second preferred issue of 2022, series SS with a 4.75% dividend, shifted steadily downward in terms of its trading price from a debut in January that had it hovering in the $25-par range for about a month before it started a long decline, leveling out above $19.00 per share in November.

PNC Financial Services Group’s series V perpetual preferreds were trading just above par in December after spending most of September, all of October and all of November below. The all-time low for the new issue came on Oct. 25 when the price hit 94.15.

The October trading prices are partially explained by the market getting spooked before Halloween with a rumor that Credit Suisse was on the brink of bankruptcy, a rumor the Swiss bank has currently battled its way back from.

“Preferred securities appear attractive for investors who have long investing horizons and can ride out some potential volatility,” Charles Schwab analyst Collin Martin said, an analyst who has been tracking this market for a long period of time.

He also said that Schwab doesn’t “expect prices to rise much in the near term, however.”

Martin also pointed out that “The average yield-to-maturity of the ICE BofA Fixed Rate Preferred Securities index is above 7% for the first time in more than a decade, and average prices have rarely been lower.”

In terms of potential upcoming calls, looking ahead, “Average coupon rates remain low at roughly 5%, so most issuers don't have much incentive to [call] their preferreds,” he continued.

This fact, that average dividends are roughly 5%, and issuers could expect to pay more than that currently for new issuance, should be a harbinger for the state of the new issue market for 2023, at least for the first half of the year.

“The gap between market yields and coupon rates suggest that most preferreds will not be called any time soon,” according to Martin.

Asset allocation

In terms of a recommendation for portfolio allocation, preferreds are generally out of the limelight.

Banks find themselves freshly excited about straight bond debt, as yields in junk bonds are routinely back in the double-digits and strong investment-grade credits are issuing bonds with attractive coupons.

Because of the ranking of preferred stock in the debt stack, bonds, even unsecured bonds, from a well-known issuer produce a good yield right now without what Citi deems the “additional risk” inherent in preferred stock.

State Street’s outlook for 2023 pushes back against this, though.

The asset manager notes that preferred yields are over 6% for the first time since 2013.

“Even with higher rates around the world, there is no sector, credit quality, or rating band in the Bloomberg Global Aggregate Bond index that has a yield over 6%,” State Street notes.

The asset manager maintains that preferreds currently offer a “deeply discounted investment-grade yield opportunity.”

State Street concludes that “The attractive entry point serves as a bit of a backstop and balances the risk that the Fed’s policy pivot doesn’t come soon or isn’t as benevolent as many expect.”

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