In this monthly article, I review all the baby bonds, listed on a national exchange, sorted into several categories. There are 190 issues in our database that trade on primary exchanges. Since there is no common ETF for baby bonds only, I’ll examine the two largest primary exchange-traded fixed-income ETFs with a market capitalization of over $22.4 billion in general: the iShares Preferred and Income Securities ETF (PFF) and the Invesco Preferred Portfolio ETF (PGX).
As we can see in the charts below, 67.6% of PFF’s holdings are preferred stocks, which occupy 58.9% of the market capitalization of the fund, and also 69.1% of PGX’s holdings are preferred stocks with a market capitalization of 71.8%. Still, with more than $4.8 billion in baby bonds, in general, these two are the most representative of this kind of fixed-income security.
Now that these products have our attention, we are continuously monitoring all baby bonds by several groups and will reinstate our monthly review, publishing a recap of the groups of interest. First, let’s take a look at the main indicators that we follow and their behavior during the last month.
TNX – CBOE 10-Year Treasury Note Yield Index ($TNX)
iShares Preferred and Income Securities ETF
Invesco Preferred Portfolio ETF
SPDR S&P 500 Trust ETF (SPY)
In late February and early March, when was the peak of the COVID-19 fear, we saw everything being sold off literally no matter at what price. For a reference, at that time, 2000-3000 new cases were found per day, mainly in China and the world was alarmed by the onset of a global recession. Now, several months later, 200,000-300,000 new cases per day are confirmed, the U.S., EU, and the U.K. reported an unprecedented drop in the GDP, but people’s mood is just the opposite. The rally in the equity market continues every day, with S&P 500 being just below its all-time high, while the 10-year Treasury Note Yield (TNX) sits at 0.68% after it previously dropped to the rate of 0.50%. Not without significance are all the incentives by the Government and the Federal Reserve. In fact, and it’s all a matter of stimulus now. As for the fixed-income securities, despite the lowering and lowering liquidity, they’re being stable, and although they lag behind the equity market, currently, there is no force for anything to push them down.
These baby bonds resemble the preferred stock securities in their basic features. They are debt securities that are generally issued in $25 denominations and have maturity dates from 6 months (Medley Capital Corp.’s (MCX) matures on January 30) to 83 years (in our database, AGO-F is the security with the longest maturity, 7/15/2103). Baby bonds are normally redeemable at the issuer’s option on or after five years from the date of issue at par. Most of these debt securities pay quarterly interest distributions. In payment of interest and upon liquidation, the exchange-traded debt securities rank junior to the company’s secured debt, equal to other unsecured debt, and senior to the company’s preferred and common stock. An important note is that all baby bonds are not eligible for the preferential federal tax rate on dividends, as there are U.S. securities that pay interest, not dividends.
1. Call Risk Baby Bonds YTC < 0
The lower the bond, the higher the risk. Be careful not to get surprised by these ones if you are tempted by the higher yield. In simple terms, these securities are trading above their par value and can be subject to redemption at any time. The immediate capital loss leads to negative returns. Currently, 39 issues are bringing you risk of redemption, while a month ago this number was 27. We can also see 9 baby bonds that haven’t reached their call dates yet but already bring their holders a call risk.
1.1 Long Time No Call
1.2 Short Time No Call
2. Baby bonds below PAR, YTM < 10%, yield curve:
Let’s see all issues that are rated from Standard & Poor’s:
The issues that are trading below $25 with a Yield-to-Maturity of less than 10% (here we put the hypothesis that above this number we are talking about already risky units) are 59, or 1/3 of all examined securities. The highest yielding rated baby bond in this group is NuStar Logistics’ NSS, rated with ‘B’ from S&P, with a Yield-to-Worst of 9.01%. If we seek the highest yielding investment-grade issues, this is Enbridge’s (NYSE:ENB) ENBA with a Yield-to-Maturity of 6.57%. The averages look like this: 7.70% is the average YTW (equal to the YTM) of all (0.22% lower since last month’s article), while 6.92% is the average YTW of the rated ones (0.38% lower for a month), and the investment-grade issues are yielding at an average of 6.16%. Compared to one month ago, the group consists of 14 baby bonds less. Also, while in the mid of July, 11 investment-grade “babies” were trading below par, now this number is only 4.
The full list of all rated baby bonds:
3. Baby bonds YTM > 10%. Be careful with these babies.
In the highest-yielding group, while now there are a total of 12 baby bonds with a Yield-to-Worst of above the 10% threshold (10 issues less since July) with an average Yield-to-Worst (YTM) of 23.01% (3% higher since last month’s article). This is mostly due to the reduced number of issues and the extremely high yields-to-maturity of Medley Management’s MDLQ and MDLX. Note that, except for Pitney Bowes’ PBI-B, no other security is rated from any of the big three rating agencies.
The full list:
4. Baby bonds > Par, yield curve by Yield-to-Worst and Years-to-Call
Now only the issues that have an investment-grade rating from Standard & Poor’s:
Again, more and more exchange-traded debt securities are starting to trade above their par value of $25, while in the months following the coronavirus crisis, almost all issues have fallen below that threshold. Now there are 63 issues trading above par without bearing any call risk, which is 16 more since last month’s article. Except for 8 issues, which are not rated, and 7 that are rating with a “BB” and “BB+” S&P ratings, all other issues are investment-grade ones. The average Yield-to-Worst of the group, equal to their Yield-to-Call, is sitting at 3.31%, 0.12% lower than a month ago. Qwest Corp.’s (NYSE:CTY) CTBB is currently the investment-grade baby bond with the highest YTC of 6.53% and together with PSEC‘s PBC and its 6.21% are the only two investment-grade issues above the 6% threshold. Saratoga’s SAK, which does not have any rating, is the highest yielder though, having a YTW of 6.53%.
- By Years-to-Maturity and Yield-to-Maturity
Currently, 3 of the 10 fixed-to-floating baby bonds are trading below their par, and their Yield-to-Maturity is their Yield-to-Worst. As for the rest 7 issues, their Yield-to-Worst is their Yield-to-Call.
Still, after the call date, they all change their nominal yield, and that is why this chart may be a little misleading. That’s why I also compare the group by their Yield-Years-to-Call and Yield-to-Call.
- By Years-to-Call and Yield-to-Call:
First Internet Bancorp’s (NASDAQ:INBK) INBKZ and INBKL are the only ones that are not rated by S&P. Except for AQNA and AQNB, the rest of the baby bonds carry an investment-grade rating. Here, we have an average Yield-to-Worst of all fixed-to-floating baby bonds at 4.19% (0.80% lower since July).
6. Baby Bonds issued by a BDC
Under the 1940 Act, BDCs must generally meet certain levels of asset coverage with respect to their outstanding “senior securities,” which typically consist of outstanding borrowings under credit facilities and other debt instruments, including publicly and privately offered notes. “Asset coverage,” as defined under the 1940 Act, generally refers to the ratio of a BDC’s total assets compared to its aggregate amount of outstanding senior securities, which allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.
Currently, AFC and Prospect Capital Corp.’s baby bonds are the only 4 with a rating, rated a “BBB-” from Standard & Poor’s.
- By Years-to-Maturity and Yield-to-Maturity:
- By Years-to-Call and Yield-to-Call
For a clearer look, I’m excluding MCV and AFC that are anytime callable.
7. Ex-Dividend Dates until the end of September 2020
Which baby bonds are ex-dividend for the next 45 days? The date given is predicted on the base of the previous ones and may vary by a few days.
8. A Look at the Most Recent Redemptions
Currently, there are 8 securities called for 2020 with an average nominal yield of 6.67%.
9. A Look at the Most Recent IPO
There are also 9 baby bonds, issued since New Year.
10. How Do they Move?
Here is the general idea of how the baby bonds have moved for the past 30 days. On the abscissa, the movement is given in absolute value.
Almost all issues are positive for the past month. The average move of all exchange-traded baby bonds is a gain of $0.79.
These 16 issues are the only to be negative for the last 30 days.
This is what our small world of baby bonds looks like in the second half of August. As it seemed that the world would end, everything quickly returned almost at its levels before COVID-19, as the equities in the face of the S&P 500 are on the penny below their all-time high. As regards to the baby bonds, the issues that are trading above their par value continue to climb higher, lowering their Yield-to-Call (Yield-to-Worst). For the past month, only 16 issues are negative, reducing the issues trading below PAR and increasing those that trade above their par value. The securities that sit below PAR are generally the relatively higher risky ones. Now 77 of all exchange-traded baby bonds are trading below their PAR, while a month ago there were 103. These with a YTM of below 10% have an average YTM, which is their YTW, of 7.70%, while the riskiest group has an average YTM of 23%. But the 23% YTW comes mainly due to the reduced number of baby bonds and the extremely high YTM of MDLY’s baby bonds. The investment grades trading below $25, in turn, are now only 4 issues, compared to 11 thirty days ago. As regards the issues trading on the other side of the par value, they are almost entirely with an investment-grade S&P rating, and their Yield-to-Worst, which is their Yield-to-Call, is sitting at 3.31%.
Note: This article was originally published for our subscribers on 08/17/2020 and some figures and charts may not be entirely up to date.
Trade With Beta
The Trade With Beta team has been submerged in the universe of preferred stocks and baby bonds for almost a decade, and we decided to share our knowledge and expertise through the inception of this service. We attempt to cover all aspects of these products, from IPOs to pair trades and portfolio picks and, last but not least, issues. Additionally, once a month, we go through all different groups of fixed-income instruments to make sure that nothing has gone unnoticed.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.