Reviewing a Few of Our Favorite High-Yield Holdings
By Tim McPartland
The new year is a good time to share some of our favorite high-yield holdings that we personally have enjoyed holding in the last year or so.
As regular readers know, we have modest goals for our portfolios, typically in the 7-8% area. While we have had these goals for years, they have become more and more difficult to attain as preferred stock and baby bond issuers continue to redeem some of the higher coupons from the marketplace through “refinancing” transactions.
Despite these redemptions, we have been able to attain our goals by identifying numerous high-yield issues that have been extremely helpful in garnering yields that would be considered “high yield” in the current environment. Currently, we consider anything over 6.5% as high yield. Of course, the definition of high yield is one which shifts — depending upon the individual investor. Some investors may consider 4% high yield, while others may consider issues over 8% as high yield — there is no valid, firm definition.
Below, we list a few issues that we currently own and which we have held for the last year.
Arbor Realty Trust 7.375% Senior Notes (NYSE: ABRN). This issue closed at $25.71/share recently after trading as low as $25.25 in the last 70 days. As you might have guessed, the shares traded at this low price on the ex-dividend date and, since that date, have steadily climbed around .75 cents per day. At the currently price, it likely will not move much, if any, higher as it goes ex-dividend on Jan. 31. On the ex-date, it will fall back to the $25.20-$25.30 range and then will very likely again begin the ascent back to the $25.70 area.
The reason we like this issue are numerous. First, Arbor Realty (NYSE: ABR) is a commercial mortgage REIT which has performed fairly well during the last year or so and we would expect this to continue if the general economy remains strong. Second, the baby bonds became callable on May 15, 2017. This means that there is a chance these bonds could be called at any time. The benefit to us with this first call date is the share price should stay above $25/share while remaining below $25.75. The reason it likely won’t fall below $25 is that there is a chance it could be called, and it is unlikely that investors will let an issue with a potential call fall below the call price. The share price won’t rise much above the $25.75 area because investors are aware of the call potential and there is a risk of a minor capital loss at any price above $25.46 (the quarterly interest payment is 46.09/cents per share). Plus, the issue has a maturity date of 5/15/2021, which means that even if interest rates shot much higher, the short maturity date will help maintain share-price stability.
This issue has traded in the $25.20-$25.80 range since July 2016. We have held it through this entire period to garner a solid yield. It is cautioned that if interest rates were to maintain at current levels or even move lower, this issue could be called, and the holder would incur a modest capital loss if it is trading above $25.46.
Newtek Business Services 7% Notes (NASDAQ: NEWTL). This baby bond issue closed recently at $25.41 after rebounding from $25.30. Like the Arbor Realty issue, the recent low was on the ex-dividend date. Shares have traded in the $25.30-$25.80 range during the last year as the baby bonds became callable on 4/22/2017. That means the share price should remain in the $25.30-$25.80 range in the coming months, although there is always a possibility of a call in which case a small capital loss could be incurred. These shares mature in 2021, which means the share price should trade with low volatility.
Newtek also has a 7.50% baby bond outstanding, but because of the first call date being in September 2018, the bonds are trading at $26.67 as investors have foolishly bid the price higher based upon the high coupon. It seemed certain that shortly after the ex-dividend date in June, the share price will fall by $1/share as investors realize the bonds could well be called in September.
Lastly, we like, and own NuStar Logistics LP 7.625% Fixed-to-Floating Rate Subordinated Notes (NYSE: NSS). The notes have traded as low as $24.95 on the ex-dividend date, which was 12/28/2017, and now have started to climb and closed today at $25.25. It is likely that the notes will climb to the $25.50-$25.70 area in the next 60 days as the next ex-dividend date approaches.
The NuStar notes carry somewhat more risk than the two previous issues, but seem to have settled into a nice trading pattern as the first call date approaches on Jan. 15. The reason we say that these baby bonds carry more risk than the two previous issues is because they do not have a maturity date until 2043. That means they carry more interest rate risk than the shorter dated maturities. Additionally, while NuStar is a large energy partnership, it has committed a number of missteps lately in its business to cause some short-term indigestion. Of course, the energy sector always presents a chance of higher volatility.
We would expect that the NuStar notes will continue to trade in the $25-$25.75 range for the months ahead. While the notes carry more interest rate risk, the floating rate feature of the notes will serve to temper large downward share-price moves. Investors should understand that the higher the risk, the higher the reward, and 7.625% is a fairly good reward in the current interest rate environment.
We have owned the above issues in larger than normal quantities over the course of the last year simply to garner the 7-7.625% yields.
By now, you can see the common theme of the above issues. They are all baby bonds and each of them is either past their first call date or, in the case of the NuStar issue, very close to the first call date. Two of the three issues mature in the next three years and the one with the longer-dated maturity has a floating rate feature which helps to minimize interest rate risk. Additionally, each of them provides a nice reward and trades with minimum volatility. We are very willing to risk 20-30 cents per share to hold these issues after the first call date, as one only needs to collect one interest payment to ensure a break even, if an issue is called.
As always none of the above is guaranteed to the investor and maybe this technique for trying to garner good yields doesn’t fit your needs, but it is a very attractive method to us and we plan to hold these issues for the foreseeable future.