Banking Stress and Preferred Securities: Now What?

Banks and financial institutions are big issuers of preferred securities, so the recent banking industry volatility has had an impact. Our guidance on preferreds is unchanged but with some caveats.

The preferred security market has been hit hard lately. With banks and other financial institutions being the most common issuers of preferreds, the recent banking sector turmoil has resulted in more volatility and lower prices.

Our guidance is unchanged but with some caveats. We continue to suggest a neutral allocation to preferreds, meaning investors can consider them if an investment in preferred securities is in line with their risk tolerance and investing time horizon. Volatility is likely to remain elevated, however, and additional price declines are possible. While the entry point appears attractive for long-term investors, some caution is warranted over the short run.

Most importantly, and as we'll discuss below, security selection is important in the current environment. Preferred securities issued by the large, highly rated banks have generally held up better than preferred issued by small and midsize banks, and we expect that trend to continue.

Preferred security prices remain near their cyclical lows. Closing at $85.7 on May 16th, the average price of the ICE BofA Fixed Rate Preferred Securities Index is still near its lowest level in more than 12 years. Volatility remains elevated, as the right side of the chart below suggests, with prices rising and falling sharply over the past year. Prices initially fell last year as bond yields surged. As hybrid investments with characteristics of both stocks and bonds, preferred securities' long maturities (or no maturities at all) make them very sensitive to interest rate changes. Prices plunged last year as the 10-year Treasury yield rose more than two percentage points.