Talking Markets Podcast Series (Preferreds) with Bob Giangregorio (Spectrum) & Frank Sileo (UBS CIO)

Hi everyone, Dan Cassidy here. Welcome back to the Talking Markets podcast series on the UBS Market Moves podcast channel. Today's episode will provide you an update on the preferred securities market.

We are joined today from the UBS Chief Investment Office by Senior Fixed Income Strategist for the Americas, Frank Sileo. And Frank is joined today by Bob Jean Gregorio, Senior Vice President and Portfolio Manager at Spectrum Asset Management. So with that, Frank, Bob, thank you for spending some time with our listeners today on Talking Markets.

Frank, I'll now turn it over to you. So, Bob, it's great to have you here. It's always great speaking with you about the preferred securities market and you and all the folks at Spectrum have just been great partners with us here at UBS and UBS Chief Investment Office.

And I just want to start, Bob, with a quick review and outlook on the preferred securities sector from our perspective here at UBS Chief Investment Office. And then I'd love to get your take. So we came into the year with similar sector return expectations to that of last year, which is to say mid-single-digit type returns.

In 2025, preferreds returned around 6 percent. And so given that average yield typically have been around 6 to 6.5 percent or so over the past several months or so, it was a coupon clipping year last year, and we're expecting another coupon clipping year this year. The backdrop is generally constructive, but unremarkable, I would say.

So sort of a glass half-full, glass half-empty type of proposition. I mentioned yields are around 6 to 6.5 percent. They've generally moved higher this year in lockstep with Treasury rates.

So from a yield premium perspective, relative value has really just been range-bound. We started 2026 with those yield spreads over Treasuries that were in line with or maybe slightly below the historical mean, and as absolute yields in the preferred space trended higher, they've generally moved proportionally with Treasury rates. So those yield premiums really haven't materially expanded or contracted either way.

So that's been the valuation story this year. On the rate side, meanwhile, Treasury rates have been whipsawed by shifting expectations for inflation and growth. Inflation is still somewhat elevated, primarily attributable to higher oil prices related to the supply disruption in the Middle East.

And with the economy consistently beating forecasts, whether it's jobs or retail sales or corporate earnings, expectations have shifted to more neutral monetary policy trends from here rather than any near-term Fed rate cuts. So on the one hand, relative value is just generally in line with or maybe slightly tighter than historical averages, depending upon which subsector you look at and depending upon which historical range we use, whether it's trailing 5-year or 10-year historical range. And the interest rate backdrop this year has been challenging, to say the least, definitely not a tailwind.

But on the other hand, the value proposition is similar in the preferred space, as it is for most spread product, and it's similar for most credit markets. Yield demand remains very high, that's keeping yield premiums and credit spreads pretty tight. But absolute nominal yields are also relatively high, historically speaking.

And those higher nominal yields can provide a better cushion for positive returns, even if significant spread compression looks less likely from here. So it is a good time to lock in those yields. But given the potential headwinds, be it from potential tariff policy issues or geopolitics, oil prices and inflation risks or Fed policy uncertainty, we should expect continued volatility in the months ahead.

So Bob, that's how I see things here at the UBS CIO. With that set up, what's your perspective? How does it compare and contrast to our views here, and what's your take on the backdrop of the outlook for preferred?

I agree with what you said completely. I want to point out that the good thing is that the credits themselves are doing well. There's been upgrades in banking and insurance by the rating agencies, and earnings have been good.

And those that weren't good were very good. The current administration is merger-friendly, and we'll see more mergers occurring. An example was Fifth Third and Comerica, NextEra and Dominion.

And in general, we view these as positive and potentially could lead to more issuance as smaller banks merge and become bigger and issue more preferreds. With regards to spreads, I agree with you. They haven't moved very much, neither has senior debt or high yield year-to-date, but obviously rates have moved a lot since the Iran war.

It's not something we could have predicted going into the year, and it certainly is going to be important as to what happens with rates as the year progresses. But coupons haven't been this high in the institutional, the $1,000 PARs, in eight years. So 70% of returns is due to income, and coupons have risen.

So I feel that that's defensive. And the $25 PARs, just because of their long duration, they have a 6.8% current yield presently, and a lot of those issues are QDI eligible, so they're going to be tax advantaged. So from that perspective, we find some positive things, even though spreads have moved in lockstep or pretty close to lockstep as treasuries have moved.

The yields are higher, and certainly income is going to be higher. So we like that perspective. Yeah.

Yeah, and one of the messages here at CIO is we're advising clients to consider locking in yields now, because eventually we think that the Fed will begin to start cutting rates, lowering rates, and so cash rates on money markets, cash deposit rates will begin to trend down. So it's an opportune time now at this point to lock in those higher market yields that are historically high on an absolute basis, even if yield premiums and credit spreads are on the tighter end of the range. But so I agree with you there 100%.

Shifting gears a little bit, I think when we talk about preferreds, we really do need to talk about the technical cross-currents taking place in the preferred securities market today, those shifting supply and demand trends. Banks remain the predominant sector in terms of preferred market issuer composition, but there's a shrinking supply, or at least a constrained supply, of bank-preferred stocks out there, as many banks are generally redeeming more preferreds than they're issuing. And at the same time, there's been a significant resurgence in the supply of hybrid.

Those are those junior subordinated notes that share many characteristics with preferred stocks, some differences, but they're captured under the broader preferred securities umbrella, and sometimes they're referred to as hybrid preferreds. There's been a deluge of hybrid issuers, especially from utilities. You mentioned the administration being friendly from a regulatory standpoint, and they're being active, some activity in the M&A space.

You mentioned some smaller bank mergers, but also some mergers in the utility space, too. Hybrid issuance has surged, particularly from the utility sector. So I'm just putting some numbers around this.

Last year, there were only net redemptions of bank-preferred stocks to the tune of about $4.5 billion net. There was $23.5 billion issued, but $19 billion redeemed. Meanwhile, utilities issued $22 billion net, so four or five times, close to five times or six times the issuance on a net basis of the banks.

And this year, utilities are sort of on track to trend towards that number again in terms of total or net issuance, somewhere around that same level. Meanwhile, banks, so far this year, are kind of trending back and forth, pivoting, toggling back and forth between marginal net redemptions or marginal net issuance. So as we look at this, as we look at this booming issuance trend from utilities in the hybrid-preferred space, but the more limited expansion of bank-preferred, what are the implications of those trends from an investor standpoint, in your view?

Yeah. The bank-preferreds have been redeeming, but they haven't been redeeming a huge amount, at least in comparison to how much issuance has been in the corporate hybrid space by the utilities. They just have huge amounts of capital expenditures coming along with AI and data centers that they have so much to issue in senior debt, as well as this junior subordinated debt.

So the issuance of the utilities has been predominantly in the $1,000 par institutional space, but they've issued into $25 pars, and I expect them to continue to issue in $25 pars. We like that the utilities are issuing, they tend to be a sleep well at night segment of the marketplace, but I would point out that they are not GDI eligible, whereas the U.S. banks who have been net redeemers, but not hugely so, but it's a mature market just similar to the European banks. They refinance when a call comes up, but they don't net issue or redeem.

But the U.S. banks definitely have redeemed to a certain extent. Yeah. Yeah.

And my sense is that, you know, there are some positive, you know, I think there's also some cross-currents there. You know, you mentioned on the one hand, while the bank preferred stocks have tax advantages in that they pay coupons that are considered qualified dividend income, so they're taxed at an advantageous rate. The utilities, on the other hand, typically are issuing hybrids that make interest payments taxed at ordinary income rates.

On the other hand, it does provide the sector overall with a different issuing sector. It's still predominantly banks, but the mix has shifted and the share, the market share of the bank issue of composition has declined as utilities become more dominant. And I think that's sort of interesting for investors.

And I also think that it's broadened out not only the investment opportunity set from that regard, but it's also broadened out the investor base and it's led to higher demand because there are some, my sense is there are some investors, institutional investors out there that are not permitted, whether they're pensions or endowment funds or insurance companies, by mandate, they're not necessarily permitted to invest in potentially securities like perpetual bank preferred, but they are permitted to invest in these junior subordinated hybrids that the utilities have been issuing. And so it's not only increasing the investor opportunity set, but also widening and broadening out the investor base to this segment of the market. So generally some interesting trends there that are supportive overall.

But, you know, you mentioned a few times already, you've alluded to the differences not only between the types of securities issued, be it QDI eligible, perpetual bank preferred or junior subordinated hybrid, but you've also alluded to the different subsectors based on, excuse me, based on par value, the $25 par retail preferred, typically exchange traded versus the $1,000 par, sometimes called institutional preferred, that are typically OTC traded, although they're accessible to, all of which are accessible to retail investors is just what they're referenced as in the marketplace. But the one thing I wanted to ask you about is it seems to me that one of the fascinating developments over the past few years is the degree to which the character of the $25 par market has really changed over the past five years. The low interest rates, the low rate environment of 2020 and 2021 led to a refinancing boom among those fixed rate, fixed or live $25 par preferred.

All of the previously issued higher coupons were redeemed and replaced with coupons set at record lows, and that changed the character of the $25 par sector, in my view. It's a very different sector than it was five years ago. It's a highly rate sensitive sector today.

It also has a greater correlation to the stock market. So to a certain extent, those $25 par preferred can really amp up the beta, so to speak, in a fixed income portfolio. So what do you think the implications are, in your view, of this fully duration extended retail preferred sector and what role could it play in fixed income portfolios?

There's no question about that. The segments between $25 par and $1,000 par have very different coupon structures. The $1,000 par institutional space is 95% of it is composed of variable coupons.

Only 11% of the $25 par segment has variable coupons. So there's no question that the $25 par segment has longer duration. It's 12 years modified duration.

It's been more volatile, unquestionably, and it's underperformed for the last two years. And part of the underperformance can be explained by looking at what the yield curve had done. Certainly, the Fed had both times in 2025 and 2024, they started cutting rates in September, but people expected them to cut the Fed funds rate.

And the institutional preferreds, they live in that like five to four year duration range. They're shorter duration instruments where it's these deep discounted $25 pars with fixed coupons. And the ones that came after COVID, they were roughly around 4%.

But we have an awful lot of convexity now. Just looking at the index, the average price is $84 and a quarter. So in the past, a fixed income instrument that's long dated will have interest rate sensitivity when rates went up, but they didn't have the upside potential because they were callable at par and trading near par.

Now they're trading at a deep discount. So you have the upside and the downside with them. So the 6.8% current yield, that's what you're going to clip.

You still have more volatility, and it's a function of what your expectations are for longer rates, the 10 year or 30 year long bond. But if you can stomach it, the volatility, that is, they look quite attractive to us. And from our perspective and certain of our products that can buy anything in the junior subordinated space, we are adding to the $25 par segment.

Yeah, I agree. I think there's certainly a place for them in fixed income portfolios, particularly as a potential mitigant in, well, first of all, if your view is for the longer term rate picture to be lower trending, that's an environment that would be conducive for the $25 par, you know, these long duration vehicles. And it could be a mitigating component of a portfolio to the extent we see some sort of risk off, tail risk type scenario where maybe spreads flow out.

But there's a flight to quality and we see rates decline. Of course, that type of scenario, all securities and markets would be under pressure. But given the long duration nature of the $25 par retail sector, plus the high quality bias, it's under that scenario where I would expect them to perform a little better than maybe other sectors like high yield, for example, under a sort of recessionary type environment.

So, yeah, I think there's definitely a place for them as part of a holistic approach to a fixed income portfolio building. One more question I wanted to ask you, Bob, because I know at Spectrum you are you're all looking at the preferred security sector, preferred stock, hybrid preferred, subordinated notes across the spectrum and not just in the U.S., but globally. Here at the UBS CIO, we exclusively focus on the U.S. preferred sector.

But at Spectrum, you also invest particularly in the European bank security. So how do those securities, how does that market compare and contrast with the U.S. market in terms of structure, fundamentals and that sort of thing? Sure, I'm happy to discuss that.

The European bank capital, they're called contingent capital or COCOs. They're GDI eligible. Most of them at least are.

Some are not issued to U.S. investors. So the prospectus doesn't say so. So maybe they are, maybe they aren't.

But the coupon structure is all that fixed rate reset or fixed to fixed to refixed coupon structure. It would be good if they standardized the name, but they haven't. But that's the main the main structure issued by U.S. institutional preferreds.

That's it was invented in the European Yankee bank space. And in general, the spreads there are wider. So if you're comparing the European banks, the high quality European banks versus U.S. banks, there's about 75 basis points of additional yield.

That's that's not for no reason. It's always yielded more because they're just not as profitable as U.S. banks and the nations in Europe, they're like the size of a big state in the United States. But from a liquidity perspective, this is the most liquid part of the market.

And there's been a little bit talk about back bank capital simplification, and that's considering potentially altering the structure of the Cocos. And that's caused a higher demand for the existing Cocos because they view it as even less chance that there is extension risk. In general, the Cocos are called at the first call date, but there's no reason that they have to other than moral hazard.

And in general, the spreads are wider in euro currency than in U.S. dollar. For example, Verizon and NextEra issued corporate hybrids in U.S. dollar. They also issued them in euro currency.

And the spread is wider in the euro currency, but the absolute yield is lower to smaller coupon. And structurally speaking, the European corporate hybrids don't have a coupon floor. So the corporate hybrids issued by utilities in the United States, if they're not called at their first call date, the coupon would reach at all for a five year treasury and the initial spread or the initial coupon, whichever one's bigger.

That's the structure in the United States. In Europe, they have a coupon step up. And they do it so that equity credit from the rating agencies drops off at the first call date.

But in both cases, their issuance is to improve rating agencies' outlook on these companies relative to their peers. Gotcha. And I know that rating agency policy changed not too long ago, I think it was Moody's that changed their policies and framework for assigning credit ratings to these instruments.

I think it was back in 24 at this point. And that's what's led to this deluge of issuance, too. Yeah, it certainly has in the thousand dollar par space, in twenty five dollar par, the retail space, banks make up 43 percent of the market.

But in the thousand dollar par space, corporate hybrids make up 35 percent, more so than banks. They've surpassed it, which is an exciting thing. Yeah.

And I think that just points to the the evolution that has taken place in the preferred space. I call it a presolution. It's my own term I'm coined.

I'm trying to see if I can trademark that. Just kidding. It makes the segment very exciting and very fun to talk about.

And that's why I love having guests like you and experts in the field like you on the podcast to talk about all the latest exciting developments in the preferred space. But Bob, that's all the time we have. Thank you so much for joining me today.

Bob, GM Gregorio, portfolio manager and senior vice president of Spectrum Asset Management. And thank you for your time today and look forward to having you back again on the podcast. Thank you very much, Frank.

I appreciate the opportunity. Thank you for tuning in, be sure to visit UBS dot com slash studios to view the entire UBS studios suite of podcast channels, along with our video offerings such as UBS Trending. You can also follow us on Instagram for content highlights at UBS Trending.

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