10 Year Treasuries Versus Investment Grade Perpetual Preferreds
By: Tim McPartland,
March 8, 2015
We constantly receive questions about what affect interest rates have on preferred stock prices. In a general sense we can address this question for perpetual preferreds. Even though we have read investor speculation that interest rates do not effect fixed income type securities there should be no question that there is a very pronounced relationship and for those that doubt that is the case we feel some level of pity. While the results of higher interest rates on fixed income securities likely will not match the decimation that occurred in the upstream MLP sector in the last year it can be very meaningful and one should be prepared simply so there are as few surprises as possible.
We have constructed a very simply spreadsheet below that conveys the pricing of a basket of investment grade perpetual preferred stocks against the 10 year treasury yield. The ‘basket’ we are using are all the investment grade perpetual preferred stocks we follow (floaters, fixed to floating and Term preferreds have been removed). This basket covers 122 investment grade $25/share issues–thus it is a good representation of the universe.
Additionally as we have constructed this minor spreadsheet we have reviewed and studied a paper by Cohen and Steers titled “When Interest Rates Rise” which deals with the movement of preferred stocks when there is a FED tightening cycle The report covers the last 23 years. We are unable to link directly to this study, but if you go here it is the first search result from a google search. It is the best study we have read. We have constructed our little spreadsheet below with this study in mind.
Now as you look at the tiny spreadsheet below one must understand that the spread between the 10 year treasury and investment grade perpetual preferreds can move substantially. Currently the spread is very high–more than 3%. But over the 23 year study period covered by Cohen and Steers the spread has been as low as 1.07%.
So below you can look at the chart (the 1st spreadsheet) and see that based on recent spreads, and factoring in historical studies of pricing during FED tightening periods, the 10 year treasury at a given level will result in the corresponding investment grade perpetual preferred being at a certain current yield and price.
NOTE–this chart is for $25 Investment Grade Perpetual Preferreds ONLY. It is guaranteed to change—the spread will change daily, weekly, monthly etc. Thus this spreadsheet should be considered approximate only and should be considered as a price over time–not able to capture ‘black swans’ or other random events.
Additionally it is a given that it is not simply the level of interest rates that will affect preferred prices–for any given issue the perceived business direction of the issuer etc will have an effect.