In this monthly article, I review all the baby bonds, listed on a national exchange, sorted into several categories. There are 193 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 $23.5B 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% of PFF’s holdings are preferred stocks, which occupy 60% of the market capitalization of the fund and also 68% of PGX’s holdings are preferred stocks with a market capitalization of 71%. Still, with more than $5.2B in baby bonds, in general, these two are the most representative for this kind of fixed income securities.
Now that these products have our attention, we are continuously monitoring all baby bonds by several groups and will reinstate our monthly review, publishing a recap of the groups of interest. First, let’s take a look at the main indicators that we follow and their behavior during the last month.
TNX – CBOE 10-Year Treasury Note Yield Index ($TNX)
iShares Preferred and Income Securities ETF
Invesco Preferred Portfolio ETF
SPDR S&P 500 Trust ETF (SPY)
The most significant indicator for all fixed-income investors, the 10-year Treasury Note Yield (TNX), is currently ranging between the rate of 1.80% and 1.90% after it has declined from the 1.90% level for the third time since it has fallen below the 2% threshold in August. For the last 5 months, TNX seems to be in an uptrend after it hit its lowest rate at the start of September but failed to break through the resistance at 1.90%. Of course, this would not come without the help of escalated tensions with Iran that sent the bond market into a rally. The fixed-income securities, in turn, started the first day of December with tangible selling that turned into a sharp buying afterward. As you can see in the second and the third chart, PFF and PGX are in a very stable uptrend, reaching 2-year and 2.5-year high, respectively. As for the equity markets, the S&P 500 continues to make a new all-time high almost every day since November, amid strong global economic data and a solid start to the earnings season.
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 of 5 to 84 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 15% 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 in 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. We can even see four securities that become callable after more than a year and already carry a call risk – EBAYL, LMHA, GMTA, and GL-C.
Currently, a total of 47 of all baby bonds that are listed on a National Exchange bear a negative Yield-to-Call (for reference, it is an increase with 11 securities from the last month’s article.). In other words, 30% of all examined securities carry a call risk.
1.1 Long Time No Call
1.2 Short Time No Call
2. Baby bonds below PAR, YTM < 10%, yield curve:
Here is the full list:
With the securities in the next paragraph, we have an aggregate of only 19(!) baby bonds trading below their par value (12 less since December’s article) or in other words 10% from the whole majority. As you can see, only 2 are rated from the S&P, none of which an investment-grade to be trading at a price lower than $25. These are PBI-B and JSM. The main reason to trade below PAR is the increased credit risk for its holders. Medley Capital (MCC), Maiden Holdings (MHLD), Pitney Bowes (PBI), Arlington Asset Investment (AI), Conifer Holdings (CNFR), and JMP Group LLC (JMP) have charts of their common stock which unfortunately do not show much confidence for their creditors. The Ladenburg Thalmann’s (LTS) baby bonds also take a part. Ladenburg Thalmann agreed to sell itself to Advisor Group (private company) and its baby bonds (LTSL, LTSF, LTSK, and LTSH) have shifted their yields to the yield of the private company yields, which currently sit at 9.60%.
3. Baby bonds YTM > 10%. Be careful with these babies:
Source: Author’s database
This is the most speculative group of baby bonds. It is now consisted only of the Medley Management (MDLY) “babies,” MDLQ and MDLX that continue to take part in this group due to concerns about the upcoming merger of Medley Capital (MCC), MDLY, and Sierra Income Corp.
Here is the full list:
4. Baby bonds > Par, yield curve by Yield-to-Worst and Years-to-Call:
Now, only the rated ones. For a better idea, I’ve excluded the Telephone and Data Systems’s (TDS) and Brightsphere Investment Group’s (BSIG) notes, TDA and BSA, which are the only two callable ones, for us to have a clearer look over the yield curve.
The next step is to exclude the non-investment grade ones and to observe the yield curve of all investment-grade baby bonds:
The investment-grade baby bond with the highest Yield-to-Worst again is the QVC’s QVCC with YTC of 5.88%, along with the other baby bonds issued by the company, QVCD, with YTC of 5.58%. Ford Motor Company’s F-C is the third-yielding baby bond with YTC of 5.22%. All other issues are trading below the 5% Yield-to-Worst threshold. For reference, the average Yield-to-Worst is sitting at 3.01%. (0.65% lower from the last month’s article).
- By Years-to-Maturity and Yield-to-Maturity
Since after the call date, they all change their nominal yield, this chart may be misleading. That’s why the best way to compare the group is by their Yield-to-Worst (equal to their Yield-to-Call). This is a much more plausible yield curve.
- By Years-to-Call and Yield-to-Call:
The situation is almost constant every month. INBKZ is located at the top of the chart, meaning it has the best Yield-to-Worst from the group. However, together with INBKL, they 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 2.72%. (Almost 1% lower since December).
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.
- By Years-to-Maturity and Yield-to-Maturity:
- By Years-to-Call and Yield-to-Call
For this chart, I’ll leave only those securities that are not callable yet, trade above par, and have a positive YTC. Let’s examine the yield curve of all BDCs’ baby bonds.
7. Ex-Dividend Dates until the end of February:
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.
The ex-dividend dates are very useful for every fixed income investor who practices the dividend capture strategy.
8. A Look at the Most Recent Redemptions
There are 4 securities called for December 2019:
9. A Look at the Most Recent IPO:
There are also 4 baby bonds, issued since the beginning of December:
10. How do they move?
Here is the general idea of how the baby bonds have moved since the start of the month:
This is what our small world of baby bonds looks like three weeks after New Year. After a slight correction at the beginning of December, the fixed-income securities quickly returned to the path of buying with PFF and PGX trading at their 2 and above 2 years high. When looking at pricing today, after the most recent rally in the fixed-income, it seems a very slow year impends for the buy-and-hold fixed-income investors. I don’t see any Alpha in holding the average fixed income portfolio. Just look at the call risk issues, 30% of all can take the unpleasant surprise of an instant capital loss, even an issue that becomes callable after a year and a half! And it’s not hypothetical. More and more issues are getting redeemed and new around 5% come out. Even we are seeing the first baby bond in more than 3 years to be issued below the 5% threshold. If we take a look at the Yield curve, a shift of around 1% for a month stands out. Currently, only 10% of all issues are trading below their PAR, 2 of which only rated by S&P. From the bonds with a price above PAR, the best Yield-to-Worst security with an investment-grade rating, again, is the QVC’s QVCC, with its 5.88% Yield-to-Call, followed by the other QVC’s bond, QVCD, and its 5.58% YTC. A total of only 3 issues are yielding above 5%, as the third issue is Ford’s F-C. All other issues are trading at an average YTC of 3%. My strategy in such times is not to use my entire buying power so that I take short positions if needed.
Note: This article was originally published for our subscribers on 01/20/2020 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.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.