Market Commentary | July 15, 2023


Segueing to Higher Dividend Income and a Return to Par

The Labor Department on Wednesday reported that its index of consumer prices rose just 0.2% in June from a month earlier. Market watchers breathed a sigh of relief, but the Fed quickly warned that its battle with inflation is not yet done and at least three Fed Governors indicated we would see two more 25 basis point rate hikes this year. As this information evolved, we felt the need to review one of our investment themes in this inflationary environment.

A little more than a year ago we described that we had identified several $ Billion of discounted REIT preferred issues that carried a particularly attractive feature of dividend coupon rates that would convert from fixed to floating interest rates at specified dates in the near future. Upon conversion to floating rate, they would then pay dividends at 3-month London Interbank Offer Rate (LIBOR) plus 350 to 600 basis points. At the time, the Fed had just started its rate hiking campaign and LIBOR stood at about 1.60%; on June 30th, LIBOR had hit 5.53%. Two additional rate hikes this year, and we will be looking at LIBOR (or its new equivalent SOFR) indexing our floating rate preferreds at 6% +350 to 650 basis points.

Segueing to Higher Dividend Income and a Return to Par

Prior to the start of rising interest rates, these preferreds traded around or slightly above their $25 par value. When interest rates rise, bond prices fall and that is exactly what happened with these preferreds, with many of them seeing their market prices fall as much as 25%. Upon conversion to floating rate, however, the three issues that have thus far converted almost immediately resumed trading around par. Surprisingly, the issues that have not yet converted, but soon will, are still available at steep discounts.

The accelerated opportunity we see here is that the passage of time has moved more issues closer to conversion while rates have risen much higher than anyone anticipated they would. At present, we have ten issues currently trading at 10 to 20% discounts to par that will convert from interest coupons of 6.50% to 8.0% to floating rate coupons of 10.5% to 12.5% over the next 12months. In buying at discounted prices now, we stand to lock in high, rising dividends and a short wait to capture capital gains as prices return to par. If we are watchful and quick, we might be able to accomplish the result in succession.

Over the coming periods we will shuffle portfolio positions to free up capital to take advantage of this situation. If you are enthusiastic about this prospect, send more money; the opportunity exceeds our current capital.

Notes and Disclosure

Articles are provided for informational purposes only. They are not recommendations to buy or sell any security and are strictly the opinion of the writer. The information contained in these articles is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person.

Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. The reader must determine whether any investment is suitable and accepts responsibility for their investment decisions.

Commentary may contain forward-looking statements that are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC and its affiliates cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts, and findings in this article.

Past performance does not guarantee future results. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. Historical returns should not be used as the primary basis for investment decisions. Although the statements of fact and data in this report have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors.

We routinely own and trade the same securities purchased or sold for advisory clients of 2MCAC. This circumstance is communicated to clients on an ongoing basis. As fiduciaries, we prioritize our clients’ interests above those of our corporate and personal accounts to avoid conflict and adverse selection in trading these commonly held interests.

Hypertext links to other sites are provided strictly as a courtesy. When you link to any of the sites provided on our website, you are leaving this website. We make no representation as to the completeness or accuracy of information provided on these websites. Nor is the company liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, websites, information, and programs made available through this website. When you access one of these websites, you are leaving our website and assume total responsibility and risk for your use of the websites to which you are linking.

Share This