July 17 (IFR) - US banks are likely to lock in record-low funding costs for Tier 1 capital securities in the weeks ahead, if the feeding frenzy around Kimco Realty’s preferred stock issue is any indication of demand for high-yield securities.
Kimco, a real estate investment trust, or REIT, was able to price a US$225m cumulative perpetual preferred non-call five-year transaction on Monday at just 5.5%, 25bp tighter than the wider level of its guidance, to set what is believed to be the lowest coupon ever for any such security.
Its success is reflective of the huge gap between supply and demand in the US$25 par preferred stock market, not only because low rates are driving retail investors toward the higher yield securities, but also because US banks have announced more than US$26bn of redemptions in Trust Preferred Securities (TruPS) in the last few weeks.
“We are just seeing an enormous imbalance between supply and demand,” said one banker. “Whatever you put out there is absorbed very quickly”.
That augurs well for what is understood to be a slew of other preferred issues preparing to launch as soon as earnings are out.
“We see a very active calendar well into August, driven by REITs refinancing outstanding high-coupon preferreds, financials refinancing TruPS for regulatory purposes, as well as non-financials raising capital for ratings and other purposes,” said Paul Spivack, head of US debt syndicate at Morgan Stanley.
Preferreds are sold to bond investors because they usually have calls at around five or 10 years, but offer more yield because they are perpetual and therefore have no maturity if they aren’t called.
The fact they pay coupons or dividends has made them a big favorite among retail investors, who can buy US$25 bonds at par.
That demand, already high simply because of the need for yield, has become red-hot in recent weeks, as US banks announce plans to call TruPS, which lose their Tier 1 capital status beginning January 2013.
“Investors are looking for different ways to enhance return in their portfolio,” said Andrew Karp, head of US investment grade debt syndicate at Bank of America Merrill Lynch, which led the Kimco deal along with Morgan Stanley, UBS and Wells Fargo Securities.
“So moving down the capital structure is one solution, and that is a trend that will benefit all issuers of preferreds,” Karp told IFR.
Announcements of TruPS redemptions have come thick and fast in recent weeks, as money center and regional US banks use the Fed’s Notice of Proposed Rulemaking on Basel III guidelines, unveiled in mid-June, as the ‘capital event’ needed to trigger an immediate calling of the TruPS.
The huge demand for new product has already caused yields on outstanding US banks to tighten substantially in recent weeks from new issue yields that were already considered rich.
Regional bank BB&T’s 5.85% preferreds are trading at 5.56%, US Bancorp’s 6% preferreds at 5.46% and PNC Financial’s 6.125% preferred at 5.6%.
“We are expecting a robust calendar post-earnings of new preferred issues, particularly from US regional banks,” said Saurabh Monga, a director in debt capital markets at Deutsche Bank.
“I think people will look at secondary yields and set pricing accordingly,” Monga said.
Retail investors, however, will probably just be used as leverage for pricing. The typical structure banks have used for these deals are US$25 par structures that are predominantly sold to institutional investors.
Often only a few hundred million dollars worth of bonds are sold to retail investors, who typically take preferreds at much lower yields than institutional investors.
The biggest banks that have announced TruPS redemptions in recent weeks include JP Morgan, which is taking out US$8.9bn, Citigroup (US$5.2bn), SunTrust Bank (US$1.2bn), BB&T (US$3.07bn) and Bank of America Merrill Lynch (US$3.8bn).
More than US$80bn of perpetual preferreds are expected to be issued by the top 25 banks between now and the beginning of 2016, bringing the total size of the perpetual preferred market in the US to around US$134.1bn.
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