Just as interest rates on an estimated $120 billion in such instruments are ready to reset to much higher levels, investor interest in a type of debt issued largely by US banks to increase their capital is beginning to show early signs of recovery.
Banks frequently use so-called preferred securities, one of the riskiest types of debt that also resembles stocks in certain ways, to increase their capital for regulatory requirements.
These securities typically don’t have a maturity date, but they can be redeemed or called five or ten years after they were first issued. If they are not called, a new fixed or floating rate takes effect.
In each of 2020 and 2021, when rates were low, preferreds totaled more than $160 billion. As the U.S. Federal Reserve began an interest rate hike cycle, volume decreased last year to $70 billion. Then, in March, the regional financial crisis in the United States and the bankruptcy of Credit Suisse effectively closed the market. The equivalent of preferred shares in Europe was totally written off in the sale of the Swiss lender to rival UBS Group (UBSG.S).
The market has since begun to reopen. Investor demand vastly outpaced supply this month when Wells Fargo & Co (WFC.N) issued a new public preferred security. That happened soon after the debt’s investor reputation began to improve.
Since the banking crisis’ peak in March, spreads—the difference between these securities’ rates and Treasury bonds—have contracted by 60 basis points.
Now that U.S. banks have billions of dollars worth of preferreds coming up for redemption, some bankers anticipate more deals, particularly from these institutions.
Since Credit Suisse and other recent regional banks collapse, investors have a better awareness of the risk associated with these preferred arrangements, according to Daniel Botoff, global head of debt capital markets syndicate at RBC Capital Markets. As a result, investors are expressing greater interest in these instruments.
One of the largest preferred stock investors, Cohen & Steers, according to vice president and portfolio specialist Allie Quine, saw opportunities to acquire at prices that were more appealing than their long-term averages.
Prior to new capital requirements being placed on banks, this market’s recovery is crucial. The specifics of reform of capital regulations that would require banks to set aside billions more to mitigate risk were announced by US regulators on Thursday.
To be sure, some analysts claimed that the fresh supply wouldn’t likely approach the levels predicted in 2020 and 2021 due to uncertainty regarding the Fed’s interest rate outlook and prolonged investor prudence. Additionally, it will take time for the effects of the recently adopted new regulations to be felt.
Any future issuing “will probably be targeted toward refinancing more expensive floating-rate securities within their call windows,” Quine said. According to Necessity, “Net new issuance will generally remain limited.”
