Preferreds Weekly Review: Tight Spreads Drive New Baby Bond Issuance

The preferred stock market recently demonstrated strong performance, with credit spreads tightening to their lowest levels since February and yields declining, which has led some fixed-rate preferreds to trade above par due to their higher coupons relative to prevailing market yields. Amidst this environment, Chimera (CIM) issued an 8.875% baby bond while strategically repositioning its portfolio towards Agency MBS and Mortgage Servicing Rights (MSRs) for duration risk management. Concurrently, Great Elm (GECC) is refinancing higher-coupon debt with a new 7.75% bond, capitalizing on current low yields, and New York Mortgage REIT rebranded to ADAM, better reflecting its predominantly Agency-focused portfolio.

Analysis

The preferred stock market is currently exhibiting strength, with credit spreads contracting to their tightest levels since February, driven by falling Treasury yields. This has resulted in yield compression across the sector, causing fixed-rate preferreds with long non-call periods to trade at significant premiums, often near $26, as their prices adjust to align high coupons with lower prevailing market yields. In this environment, several mortgage REITs and BDCs are making strategic capital and portfolio adjustments. Chimera (CIM) issued an 8.875% baby bond while simultaneously repositioning its portfolio by increasing its Agency holdings to circa 20%, a strategy intended to be complemented by a significant expansion of its mortgage servicing rights (MSR) allocation to manage duration risk. Conversely, Great Elm (GECC) is refinancing an 8.75% note with a new 7.75% bond, a move that captures interest savings but at a coupon 1.5% above the BDC average, reflecting the company's noted history of credit issues and NAV erosion. Separately, New York Mortgage Trust's (NYMT) rebranding to ADAM is a logical move to better reflect its portfolio's heavy concentration in Agency securities rather than New York-specific assets, with its existing securities noted as remaining attractive.

Key Decisions for Investors

• Given that preferred credit spreads are at multi-month tights and prices are elevated, investors should exercise caution and be mindful of duration risk, as a reversal in interest rates could lead to capital losses on securities trading well above par.
• Differentiate between new issuers by scrutinizing their underlying fundamentals; Chimera's (CIM) strategic shift towards a duration-hedged Agency and MSR portfolio may offer a more favorable risk-reward balance than Great Elm's (GECC) refinancing, which comes with a higher yield that compensates for its history of credit issues.
• The rebranding of NYMT to ADAM clarifies its agency-focused strategy, and with its securities noted as attractive, investors may find opportunities in the company's preferred and bond issues.
• When evaluating preferreds trading above $25, distinguish between fixed-rate issues with long-term call protection, whose premium reflects a yield-to-call adjustment, and quarterly-callable issues which have inherently limited price upside.