Floating-rate Preferreds... Still Make Sense - July 7:
Similar to fixed-rate preferreds, floating-rate preferreds have come under pressure since the beginning of the year. In fact, floating-rate preferreds are down about 4.0% since January more than that of fixed-rate preferreds. In the view of UBS, in the current issue of its Preferred Stock Strategist, the recent widening of credit spreads has played an important role in the sell-off of floating-rate preferreds. Credit spreads have widened 25 basis points since the beginning of the quarter. Also, a sharp acceleration in originations has pressured floating-rate preferreds: since last November, the floating-rate preferred market has grown to roughly $7.8 billion from $2.3 billion. Changes in expectations for short-term interest rates have also affected the market.
UBS continues to recommend floating-rate preferreds as a viable strategy in a rising interest rate environment. These securities show a low interest rate risk due to the frequent coupon resets that helps to mitigate the price response in a rising rate environment. Floating-rate preferreds offer the potential for higher coupon income as Fed rate increases occur. Since the majority of floating-rate preferreds are tied to short term interest rates, additional Fed tightening will likely lead to higher income distributions. Finally, many floating-rate preferreds distribute income that is eligible for the reduced dividend tax rate.
Sources: UBS Preferred Stock Strategist; PreferredsOnline.
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