Talking Markets Podcast Series (Preferreds) with Derek Pines (Bramshill) & Frank Sileo (UBS CIO)

Derek Pines · Bramshill Investments

After the selloff, nominal yields across preferreds, IG, munis and high yield look attractive.

With core CPI at 2.4%, nominal yields look attractive. Fixed-for-life preferreds are around 7.25%, investment grade corporates 6% to 7% depending on the curve, munis above 5% and high yield above 8%. Pines says a fully taxable investor gets a taxable-equivalent yield above 9% on fixed-for-life preferreds, which he calls a decent starting point not seen in a long time.

“preferreds are in the 7.25% area, investment grade corporates are in the, you know, 6% to 7% area, depending where you want to be on the curve. Muni is north of 5%, high yield north of 8%.”at 6:03

Frank Sileo · UBS Chief Investment Office

$25 par preferreds have become more rate-sensitive, with duration above nine years after refinancing-era coupons.

The 2020–2021 refinancing boom let preferred issuers lock in historically low coupons on fixed-rate perpetual preferreds. The $25 par retail market now has an average duration of more than nine years, versus about four years for the $1,000 par variable-rate segment. Sileo says the sector has therefore become more rate-sensitive and longer duration than five years ago.

“And as a result, the $25 par retail market really looks much different today than it did just five years ago. It's become a more rate sensitive sector, it's become a longer duration sector... [$]25 par preferreds as a sector now have an average duration of more than nine years.”at 11:19

Derek Pines · Bramshill Investments

Preferred ETF returns diverge widely; a 30% mandatory-convertible ETF fell only 1% while plain indices fell about 6%.

Fixed-for-life $25 par ETFs fell about 5.5% to 6% in the quarter, but another $25 par ETF fell only 1%. The difference is structure. That ETF holds about 30% mandatory convertible preferreds, which act like equities and rose 10% to 15% this year, buffering the other 70%. Pines says many buyers do not appreciate how much these nuanced differences matter.

“you had another $25 par ETF that was only down 1%... And that's because you have ETFs even within the $25 space that just have massively different characteristics than some of the traditional indices.”at 13:02

Derek Pines · Bramshill Investments

Preferreds with very low back-end resets face large extension risk if rates fall.

Preferreds with very low back-end resets seem fine in a rising-rate environment. But if rates fall, those bonds would reset at much lower coupons and extend past their first call, creating large extension risk. Pines flags this as a risk to watch rather than a reason to avoid rising-rate beneficiaries.

“those right now seem like they're fine in a rising rate environment. But if you go into an environment where... rates happen to go the other way... those all of a sudden have huge extension risk.”at 16:04

Derek Pines · Bramshill Investments

Junior subordinated issuance near $100B is positive, drawing institutional buyers, not a supply overhang.

A major rating agency gave corporations at least 50% equity credit for junior subordinated debt, making it efficient capital that protects senior ratings at low tax cost. Junior subordinated issuance is close to $100 billion this year, in a sub-asset class that barely existed 24 months ago. Pines acknowledges fears of an overhang but argues that heavy issuance draws more attention and more institutional investors into the space, which is a positive.

“And while there's a fear of having too much issuance and an overhang in the space, the reality of it is in our view, is for a new space, when you get this issuance, really, what you're just doing is you're drawing more eyes on it... And that's a positive.”at 17:07

Frank Sileo · UBS Chief Investment Office

Retail $25 par preferreds yield over 7%, giving a head start to attractive twelve-month total returns.

Retail preferreds now yield about 7.3% on average. Sileo argues that this coupon carry is a significant head start toward attractive total return over the next twelve months. He adds that the sector's sharp volatility and heavy underperformance this year could set up a rebound.

“retail preferreds now yield over 7%. I think on average, we're looking at yields of about seven thirty or so. And that level of income or coupon carry represents a significant head start towards generating attractive total return from here over the next twelve months.”at 20:02

Frank Sileo · UBS Chief Investment Office

Variable-rate $1,000 par preferreds offer near-retail yields with half the rate sensitivity.

Institutional $1,000 par variable-rate preferreds yield just slightly less than $25 par and retail preferreds. Because of their variable-rate coupons they have about half the interest rate sensitivity of the retail segment. Sileo says that combination of high yield and lower duration adds resiliency to a fixed income portfolio.

“they offer yields that are just slightly lower than the $25 par, slightly lower than the retail preferreds, but they have half the interest rate sensitivity because of those variable rate coupons. So that means less volatility while still offering attractive income.”at 21:14

Derek Pines · Bramshill Investments

Index spreads are tight; he wants more cushion before buying long-duration preferreds, with selective bank exceptions.

Spreads are fairly tight at the index level for most asset classes, even after recent cheapening. Pines therefore looks for sub-asset-class pockets where spreads are not too tight. He says that while he is close to buying, he would like more spread cushion before going into long-duration preferreds, though he sees one-off opportunities in higher-quality banks that could pay off over the long term.

“But at the index level, for most asset classes, they're still fairly tight... we'd love to have a little more spread cushion before going into long duration preferreds, although there's some, you know, one off opportunities on higher quality banks”at 22:26

Derek Pines · Bramshill Investments

Parity baby bonds trade 30 to 75bp wide of identical senior debt, a relative-value opportunity.

Baby bonds in the $25 par market are often mispriced because they trade on the preferred desk. Because they have fallen with the $25 par market, they can trade 30 to 75 basis points wide of the same issuer's senior unsecured debt, which trades on the institutional market. Pines says high-quality issuers' baby bonds offer opportunities to capitalize on that gap.

“these baby bonds, because they've traded down with the $25 par market, they may be anywhere from 30 to, you know, in some cases, 75 basis points wide of where that exact same debt in the cap structure trades. So those are opportunities...”at 24:14

Derek Pines · Bramshill Investments

Coupon-floored junior subordinated preferreds protect investors if rates fall; he loves these structures.

Junior subordinated utility preferreds are typically low or mid BBB, one notch below holdco debt, with 6.75% to low-7% coupons. Their back-end resets are based on wide-issue spreads, around 180 to 250 basis points over Treasuries. Without a coupon floor, a bond would reset lower in a falling-rate environment and extend. A floor keeps the coupon from falling below the initial level, which Pines says is why he loves these structures and is compensated for them.

“if there's a coupon floor built in, that bond never can go below that initial six and seven eighths coupon. So we love those structures.”at 26:48

Derek Pines · Bramshill Investments

Low-dollar bonds at 50-60 cents offer positive convexity and recovery well above price in distress.

Long-duration bonds issued years ago at par with low coupons now trade at 50 to 60 cents on the dollar. Their duration shortens as they fall and lengthens as they rise, giving positive convexity. Pines also argues the credit risk is limited because a senior unsecured bond at 55 cents should recover in the 60s or 70s even in a distress scenario.

“we really like the low dollar ones... those are trading now 50 to 60¢ on the dollar... Traditionally, that stuff will recover in the sixties or seventies.”at 28:19

Derek Pines · Bramshill Investments

Munis look cheap, with the muni-Treasury ratio near 93%, 1.5 to two standard deviations cheap.

Muni yields have blown out into the mid-5s, especially on the long end, which Pines hasn't seen in a long time. The muni-to-Treasury ratio is around 93%, which is roughly 1.5 to two standard deviations cheap over the last few years. For a fully taxable account, the taxable-equivalent yield is above 9%, so munis look attractive.

“the muni market is interesting here. You've seen yields blow out in the mid fives... The ratio to treasuries... is around 93%, which is really almost 1.5 to two standard deviations cheap over the last few years.”at 29:17

Derek Pines · Bramshill Investments

Closed-end funds with large NAV discounts, covered dividends and positive UNII are attractive entry points.

Pines looks for closed-end funds with large net asset value discounts, a fund earning its dividend, and a decent undistributed net investment income (UNII) balance. Funds that meet these metrics can be a good entry point in the current market, he argues.

“We see a lot of opportunities in the new market in closed end funds as well. And what we'll typically look for is large NAV discounts, look for a fund that's earning their dividend, but also has a decent UNII balance.”at 29:53

Frank Sileo · UBS Chief Investment Office

Preferred supply is being absorbed by new institutional buyers like pensions, endowments and insurers.

Heavy issuance of junior subordinated preferreds has been met with demand from new investors. Mandates that barred pensions, endowments and insurers from perpetual bank preferreds now allow them to buy these securities, which have 30-year, non-call 5 or non-call 10 structures and advantageous yields. Sileo argues this broadening of the buyer base is why supply has not been a problem.

“it's really broadened out the investor base that increased supply is being met with increased demand from new investors that may not have been able to purchase perpetual preferreds in the past.”at 31:08

Derek Pines · Bramshill Investments

Ten-year real yield near 3%, the highest since 2008, makes real yields very attractive.

Much of the rise in yields has been in real rates. The ten-year Treasury real yield is around 3%, which Pines says has not been seen since 2008, near 25-year highs. With core CPI at 2.4%, he argues real yields are high, not just nominal ones, and this makes fixed income attractive after the selloff.

“the real rates on the ten year treasury are at 3% right now. We haven't seen that since 2008, heading into the [credit crunch]. So we're touching on twenty five year highs.”at 5:17

Derek Pines · Bramshill Investments

A more hawkish Fed would slow the economy and push long-end yields lower.

Pines expects the Fed's effect on the curve to depend on the message. If the Fed becomes more hawkish, he thinks it will slow the economy, which would put a bid into long-end yields. The result is a self-limiting dynamic on the long end, since tighter policy tends to pull long yields down.

“right now, if the Fed gets more hawkish, we're more in the camp that that's going to cause more of a slowdown and that's going to probably put a bid into long end yields.”at 8:19

Frank Sileo · UBS Chief Investment Office

Ten-year yield unlikely to rise another 100bp by April; yields should stabilize, aiding long-duration preferreds.

The ten-year Treasury yield has already risen about 100 basis points over the last six months. Sileo argues another 100 basis points by April, or 200 basis points over twelve months, is highly unlikely, so yields are more likely to stabilize in relative terms. That would support long-duration $25 par preferreds and make the rate backdrop less of a headwind for fixed income.

“the ten year Treasury rate has risen by about 100 basis points over the last six months alone. And it's highly unlikely to rise another 100 basis points between now and April, or 200 basis points over the next twelve months.”at 20:38

Frank Sileo · UBS Chief Investment Office

Market overestimates further Fed tightening; UBS expects one December hike, then pause and easing bias.

Fed rate expectations have swung sharply this year: in April or May markets priced two cuts, but after last month's hike markets still price at least three more hikes over twelve months. Sileo thinks most of the Fed repricing is now behind us and that markets overestimate how much more tightening is needed. UBS's forecast is one more hike in December, then a pause and a likely easing bias, with rate cuts returning in the second half of 2027.

“We think that the market is actually overestimating how much more tightening the Fed will need to do from here. Our forecast calls for one more Fed rate hike in December followed by a pause and then a likely easing bias...”at 3:29

Derek Pines · Bramshill Investments

Warsh's hawkish messaging flattened the curve, with the long end rallying in those periods.

The back end of the curve rallied and flattened only twice this year, at Warsh's first meeting in May and his hawkish Jackson Hole commentary. Pines says the 3s30s spread tightened from well over 100 basis points to the 40s, then began steepening once an October hike came off the table. He concludes that when the Fed sounds more hawkish, the long end tends to act well.

“the only time this year that the back end really actually rallied and you saw that flattening was the two times that [Warsh] has spoken... And you actually saw the back end act really well in those periods.”at 7:16

Derek Pines · Bramshill Investments

AI capex borrowing has overwhelmed demand, widening spreads on high-quality tech bonds to attractive yields.

Spreads on some high-quality tech names have widened because the companies are issuing debt to fund massive AI capex, and that supply has overwhelmed the market. The result is that investors can now buy high-quality tech credit at attractive yields that were rarely available before. Pines frames this as a supply-driven widening rather than a credit deterioration.

“This is [an] oversupply, not enough demand, there's just been a massive AI CapEx spend. They're coming to market to fund this CapEx spend, and it's just overwhelmed the market.”at 27:43