The following is a summary of a report prepared by UBS Financial Services Inc.
* Prices well supported:
* Fixed-rate preferreds responded to the supportive interest rate
environment during the month of July and prices moved higher by
roughly 2.2%. Preferreds also rebounded on a spread basis due to
steady credit conditions and investor willingness to extend out the
curve.
* Market outlook:
In our view, the total return outlook for preferred securities
appears more favorable than it has in quite some time. A supportive
interest rate forecast is balanced with expectations for stable to
modestly wider credit spreads. However, with credit weakness expected
to be concentrated among lower-rated securities, high-quality
preferreds should continue to perform well, in our view.
* Upgrade six fully-taxable preferreds to Buy:
Given our constructive market outlook, we upgrade six fully-taxable
issues to Buy from Neutral that represent a good mix of credit
stability, coupon income, and the ability for further price
appreciation, in our view. The securities include BAC B, LEH L, MWG,
MWR, USB G, and WNA.
* Additional ratings changes:
This month we initiate coverage on LNC G and USB I with Neutral
ratings. We reclassify EQR C, FBF L, PSA R, and SPG F to Refinanceable
from Neutral now that their first call dates are approaching. We also
reclassify C Z and WSF to Uncertain Refi from Neutral.
Preferred securities were well supported during the month of July as
market participants became more convinced that the Fed would pause at
the August 8 FOMC meeting. Consequently, prices of fixed-rate preferreds
in our coverage universe responded to the supportive interest rate
environment and moved higher by roughly 2.2%. Furthermore, preferreds
have continued to perform well so far in August as weak payroll data and
a Fed tightening pause have lent further support to bond prices.
Preferreds also rebounded on a spread basis. Spread levels in our
option-adjusted spread (OAS) index narrowed by roughly 20 bps during
July and finished July at 80 bps versus Treasuries. We would attribute
the spread narrowing primarily to investor willingness to extend out on
the yield curve as expectations for the end of the tightening cycle
moved closer. Also, stable credit conditions and a contraction in the
average duration of the preferred market also contributed to firmer
spreads.
In our view, the total return outlook for preferred securities appears
more favorable than it has in quite some time. With a pause at the
August 8 FOMC meeting, WMR economics look for the tightening cycle to
now be complete. It is therefore likely that Treasury yields may have
already peaked near the 5.25% level, and a supportive interest rate
environment going forward would allow preferreds to continue to perform
well. Balancing this supportive interest rate environment, however, is a
more cautious outlook for corporate credit conditions. However, based on
historical precedent, lower quality securities are likely to be impacted
the most by a slowing economy. We therefore feel comfortable about the
return prospects for high quality preferreds and maintain a market
weight allocation.
Given our constructive market outlook, we upgrade the following
fully-taxable preferreds to Buy from Neutral: BAC B, LEH L, MWG, MWR,
USB G, and WNA. Each issue has a stable credit profile, a high OAS
relative to its peers, and offers a balanced mix of current coupon
income and the ability for further price appreciation, in our view. We
initiate coverage on LNC G and USB I with Neutral Ratings. With spread
levels in line with sector peers, we expect these preferred to perform
in line with their respective peer groups. We reclassify EQR C, FBF L,
PSA R, and SPG F to Refinanceable from Neutral now that their first call
dates are approaching. We also reclassify C Z and WSF to Uncertain Refi
from Neutral.
In addition, we reiterate our overall recommend themes for preferreds
which include: 1) Favoring higher quality issues in the bank and
securities sectors since we expect a slowing economy to impact
lower-rated securities the most; 2) Tax-advantaged preferreds offer
value for clients in the 35% tax bracket. Within this segment, we favor
foreign QDI issues such as Buy rated HBC A. 3) Fixed-rate preferreds are
likely to outperform floating-rate preferreds as WMR economists look for
the tightening cycle to now be complete.
This report has been prepared by UBS Financial Services Inc.
UBS does and seeks to do business with companies covered in its research
reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making
their investment decision.
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