Talking Markets Podcast Series (Preferreds) with Doug Baker (Nuveen) & Frank Sileo (UBS CIO)
The desk interprets the commentary from UBS and Nuveen as indicative of a challenging landscape for preferred securities, coupled with broader fixed income dynamics. Per the full note source, Doug Baker and Frank Sileo emphasize the difficulty of navigating market volatility amidst historically tight credit spreads. With spread compression limiting investor comfort, the potential for heightened risk remains a concern going into the latter half of 2026.
What the desk is arguing
The overarching narrative suggests that the preferred securities sector is entering a period of turbulence, as articulated by Baker and Sileo. They point out that the first half of 2026 was characterized by credit spreads near historical lows, which has left little room for error in an era marked by volatility.
Positioning in the fixed income space appears precarious, with investment-grade and high-yield credit reflecting this tight spread environment. The commentary highlighted that these fundamental factors may compel investors to reassess the risk-reward matrix in preferreds as market conditions shift.
Where it sits in our coverage
Although recent data doesn't present a clear consensus target for preferred securities, it's worth noting that jpmorgan has set a target of 1.10 for Mar-26, while bofa anticipates a more cautious outlook at 1.04 for the same tenor.
This divergence illustrates that while some firms remain bullish, others highlight caution driven by current market conditions, suggesting a divided sentiment on the future trajectory of the preferred sector.
How other firms see it
Firms like jpmorgan lean toward an optimistic outlook for preferred securities, whereas bofa presents a counter-narrative, reflecting underlying concerns regarding spread tightness. Traders should consider how these views influence positions as they navigate upcoming market adjustments.
For context, the spread behavior in the preferred securities market might closely align with the movements in broader fixed income assets, particularly the dynamics surrounding recent Federal Reserve policies and treasury yields.
01Preferred securities face heightened risk amid historically low credit spreads.
02Market volatility has limited investor comfort in navigating these securities.
03Divergent targets among major banks indicate varying sentiment on the preferred securities market.
04Monitoring Fed policy changes will be critical for future directional plays.
Market implications
Watch for further developments in credit spreads as a key indicator of shifting risk appetite among investors. Any positive movement beyond 1.10 could signal a recovery trend, while a dip below 1.04 may reinforce bearish positioning.
Risks to this view
The primary risk to this outlook stems from a sudden shift in monetary policy by the Federal Reserve. A hawkish pivot could exacerbate credit spread widening, thereby challenging the performance of preferred securities.
ubs
Welcome back to the Talkie Markets podcast series here on the UBS Market Moves podcast channel. For today, we will be focusing back in on the preferred securities market. Joining us for today's conversation, glad to welcome back from the UBS Chief Investment Office Senior Fixed Income Strategist for the Americas, Frank Saleo.
Frank is joined today by Doug Baker from Nuveen. Doug is a Portfolio Manager for Nuveen's Global Fixed Income team and heads the Preferred Securities Sector team. Doug is also a Portfolio Manager for the firm's Preferred Security Strategies, as well as a Co-Portfolio Manager for the firm's Multi-Sector Strategies.
And Doug is also a member of the Investment Committee, which establishes investment policy for all Global Fixed Income products at Nuveen. So Doug, Frank, thank you both for dropping by the podcast. And now, Frank, let me turn it over to you to lead today's conversation with Doug.
Thank you so much, Dan. And Doug, thanks for being here. It's always great to chat with you about the Preferred Securities Sector.
You and Nuveen have been great partners to us here at UBS CIO, and I'm looking forward to our conversation today. Well, I really appreciate the invitation, and I'm looking forward to the dialogue as well. Thanks.
So, as we enter into the second half of the 2026 year, I just want to start things off by reviewing the first half and then giving an outlook on the Preferred Securities Sector from our perspective here at UBS Chief Investment Office. And then I'd love to get your take on things. But from my perspective so far, 2026 has been a bit of a bumpy ride for Preferred and for Fixed Income more broadly.
The credit markets, whether it's investment grade corporates or high yield, began the year with credit spread near historical lows and near historically tight levels. And the same can be said of yield premiums for Preferred. And so we haven't had much cushion to absorb the market volatility that we've had this year.
Now, I came into the year expecting mid-single digit returns for Preferred in 2026, sort of a coupon-clipping type of return. So far, $1,000 PAR Preferreds are up by roughly 2.5% or so year-to-date, while the retail $25 PARs are more flattish. So blending these together, we may undershoot that return target, but it all comes down to the rate backdrop in the second half.
Economic growth has been surprisingly resilient this year, and treasure rates have been affected by those more surprising economic trends. But in more recent weeks, treasure rates really have just been whipsawed by elevated inflation expectations, primarily attributable to higher oil prices, which, of course, has been related to the oil supply disruption in the Middle East. Now, against this backdrop, most fixed income sectors have actually held up pretty well.
We actually saw investment grade and high yield credit spreads resume a pretty significant tightening in the second quarter. Overall, these factors will be the key drivers in the second half, basically inflation expectations and the impact on benchmark treasury rates. But taking a longer-term view, at CIO, we're expecting moderating growth trends, moderating inflation trends over the next 12 months, and that should support lower benchmark treasury rates.
Meanwhile, looking at Preferreds, nominal yields in the Preferred space are relatively high right now, around 6.5% or so, give or take. And these higher nominal yields are accompanied by improved valuations relative to other sectors where we've seen more significant spread tightening, as I just mentioned a few moments ago. So this could make it a good time to consider locking in attractive yields in the Preferred space for the long run.
So Doug, with that setup, what is your perspective at Nuveen, and how does it compare and contrast to our views here? Actually, our views are quite similar. You know, we, broadly speaking, are looking for areas within fixed income where investors can capitalize on a higher carry, higher yield.
We across the platform really like the story in Preferreds because with the uncertainty out there, whether it's economic, whether it's geopolitical, the underlying theme in Preferreds is that this is a high-quality investment solution. You're typically a subordinate investor in what is, on average, a single A-rated issuer, oftentimes highly regulated, and we like that risk profile in this market to generate yield. And then yield will give you some cushion from a total return perspective if we do get a slight widening and spreads at some point down the road.
Now, we're not calling for that, and especially not in the Preferred market, because we think the fundamentals and the technicals are very supportive of where valuations are today. I mean, you know, we're going through bank earnings now. It's our largest sector.
Banks are doing incredibly well. We also had results from the annual stress test back in June demonstrated once again that bank balance sheets are quite resilient. Our second-largest sector, insurance, we're anticipating another strong quarter out of that space as well.
So you have this strong fundamental story, and then we'll probably touch on this a little bit later, but the technicals between supply and demand we think are very different in the Preferred market versus other areas of taxable fixed income like, say, investment grade, where we're seeing a tremendous amount of supply. We actually expect supply to be relatively modest in our space, and yet demand for income, high-quality income, and income that's tax-efficient, we just don't think that that's going to abate anytime soon. So while people will look at spreads and say, well, you know, they're at the tighter end of the range, we think with those factors I just mentioned, which we can dig into more, really do support current levels.
So we're constructive on the Preferred space, and I would say for some of the other portfolio managers here at Nuveen that have the ability to allocate across sectors, and I'm on one of those strategies, a lot of those strategies are at their recent highs in allocating to Preferred for this story that I just highly outlined. That's a great point, Doug. You know, when it comes to value, there are so many ways to look at it, to look at relative value, and it is important for investors to take a holistic approach to what value and where value may be currently, and you raise an excellent point there about maybe spreads or relative yield spreads on the one hand relative to history, but then also where relative value is today in comparison to other sectors.
Great point. And also, of course, the technical story. Let's dive into that a little bit more.
A major story in Preferred securities land over the past year or two has been the technical story, those supply-demand dynamics that can impact returns. Of course, as you mentioned, banks remain the predominant sector in terms of Preferred market issuer composition, but there's a shrinking supply of bank Preferred stocks out there as banks are generally redeeming more Preferreds than they're issuing. As of mid-year, give or take, banks had issued about $12.5 billion in new perpetual Preferred stocks here in the U.S.
This is the U.S. market I'm referring to. While they've issued $12.5 billion, they've redeemed $15 billion, so we're kind of on the net redemption side of the equilibrium mark there in banks. At the same time, there's been significant resurgence in the supply of hybrid Preferreds.
These are the long maturity junior support and notes that share many characteristics of Preferred stocks and are captured under the Preferred securities umbrella. Last year, utilities issued $22 billion of hybrid Preferreds, and at mid-year this year, they've already issued another $13 billion. In your view, what are the implications of these trends from these two important regulated industry sectors?
Yeah, absolutely. I would say that had somebody told me we were going to have that much supply out of the utility space, and obviously a lot of that is driven by the AI narrative and the utilities needing to expand or enhance existing infrastructure, I would have been concerned about the impact on spreads, on valuations with that supply. But what we've found is that with those hybrid securities, so these utilities are typically issuing dated maturity hybrid structures, which are different than the perpetuals issued by banks, those securities are typically, the utility issued securities, are typically index eligible as well for either investment grade bond indices and or high yield bond indices, not just preferred indices.
The investor base has been broad, it's been deep, and this is also going to be typically a segment within those areas that are higher yielding compared to the rest of the index on average. As a result, for portfolio managers like me, we have looked at fixed income recently as going to be heavily a carry type of trade. You want to allocate to those securities in your index, these hybrids.
We've seen a very good appetite for that supply and seen very little, so far, impact on valuations in the secondary market. Now, Frank, I know we've chatted about this in the past, I've had a slight kind of adjustment in my outlook potentially for issuance out of the U.S. bank space. We have seen net redemptions for a while now, and that's been supportive of valuations and also frustrating for folks that are trying to put money to work, but it's possible with the most recent capital proposals that are part of the Basel III endgame, as well as us watching bank balance sheets grow, that we might see some positive supply, net supply, over the coming quarters, maybe over the coming year or so, and it's going to be twofold.
From an optimization standpoint, now that the banks have an understanding of what the final capital proposals are going to be, in advance of that, the banks have been holding excess common equity, what we call CET1, or common equity, which tends to be a more expensive form of Tier 1 capital than preferreds, and as they held that extra common equity capital waiting for these final capital rules, they didn't need as much preferreds. Now that they know, they'll probably return some of that common equity capital in the form of buybacks or dividends to the common shareholder, and then replace that, maybe, with some preferred exposure to really optimize the cost of their capital structure. We also may see some more preferred issuance of bank balance sheets continue to grow, as we've seen this quarter, but at the end of the day, we're talking about, our outlook is right now, maybe over the next 12 to 18 months, maybe $10 billion to $15 billion of net positive issuance out of the U.S. bank sector.
Sometimes, that's just one day of new issue flow in the investment-grade market. I want to put some context around that, that while we're expecting some positive supply maybe on the horizon, it's unlikely it's going to be a significant amount, but also, this paper, we also believe, is going to be well-received, and why is that? They're issued by large banks that have been performing incredibly well, that have great brand name recognition with the investor base, and then these are also structures that tend to pay individual investors qualified dividend income, so distribution that can be tax-advantaged for certain investors, and we think that that backdrop is going to be supportive of that new issue supply, if we see it, so we're hopeful, we'd like to see some new issue, just to give us some opportunities, but again, even if that doesn't happen, the liquidity in the secondary market today in preferred land is quite good, but we have our fingers crossed that we might see some new issue supply out of our banks over the next year to year and a half.
Gotcha, yeah. Makes a lot of sense. I mean, it'll be definitely something to watch out for.
All indications are that demand is still very, very strong in this space, so even the supply that you're forecasting or suggesting we may be seeing, I'm sure will be very well-received, because like I said, it's been kind of slim pickings over the past year and a half, so I'm sure any new bank supply would be well-received, because the demand is there, and as you mentioned earlier, on the demand side, the utilities, the hybrids that we're seeing, is actually broadening the investor base, so that's being met with very strong demand as well, as that investor base is being widened and more people are sort of being welcomed into the preferred securities tent, so to speak, and it's been kind of a nice trend to watch and an interesting balancing act. I've been calling it the evolution of the preferred space, or the prefolution. I'm still going with that.
Moving a little bit to segmenting the market in a different way, within the preferred space, there are two sub-segments. I alluded to this earlier. You have the $25 par retail preferreds and the $1,000 par institutional preferreds.
Another predominant theme I've been focusing on over the past year or so is the changed character of the $25 par preferreds. It's a very different sector than it was five years ago in the wake of the refinancing boom of 2020 and 2021, and also given the surge in utility hybrids that's predominantly taking place in the $1,000 par space, and not in the $25 par space, so that's also creating greater differentiation between the two spaces in terms of issuer composition. $25 pars are a highly rate-sensitive sector today. They also have greater correlation to the stock market.
They could really amp up the beta in a fixed-income portfolio, so to speak. What is your view on the $25 par preferred space as it relates to the $1,000 pars and its place in portfolios and how we should be looking at that? Yeah, absolutely.
Speaking at a high level, looking at averages, we're drawn a little bit more to the opportunity and even on a risk-adjusted basis to the $1,000 par side of the market versus the $25 par side of the market today. On the $1,000 par side of the market, looking at the largest index, the average duration as of month-end June was just over four years, about 4.3 years. To compare that to the $25 par equivalent index, that duration was just under nine years, so about 8.9 years.
There's a big difference there in interest rate sensitivity on average between the two sides of the market. Then, ironically, even though $25 par returns have lagged year-to-date $1,000 par, you can still pick up a little bit more credit spread in $1,000 par than in $25 par. We say, on average, maybe you're picking up an extra 15 or 20 basis points.
To put that into context, recently, over the past couple years, that difference has been much more meaningful. $25 par's credit spreads have been much further below that of $1,000 par. If you look at that on an absolute basis and compare the two, it looks like $1,000 par is cheap, but if you look at what that difference has been historically, this is not as tight as it's been in a while. Maybe $25 par is getting to a point from a credit spread basis where folks can feel more comfortable allocating.
Now, why has that happened? Why have we had that credit spread relationship? I think a lot of it is simply the $25 par market has shrunk over time.
When I first started managing preferred in 2006, when I look back at index data, the $25 par market was roughly two-thirds of the domestic preferred market. Today, using those same indices, it's down to just about 30%. I think what that's done is it's created a smaller pool of securities for investors that have gravitated towards that area of the market, and that demand has pushed valuations to levels that we see today, which, again, are cheaper than where they have been, but still quite low.
We don't think that that dynamic is going to reverse itself out any time soon. It seems like the $1,000 par side of the market from the big issuers is still, no pun intended, the preferred route today, but it's just an interesting evolution between the two sides of the market over time and the impact it's had on valuations and opportunities. Absolutely.
Another way to segment preferred market is by geographic region. Here at UBS CIO, we exclusively focus on the U.S. preferred sector, but I know at Nuveen, you also invest in European bank securities. How do they compare and contrast with the U.S. market in terms of structure, fundamentals, and things like that?
I know you were just over in Europe not long ago meeting with bank issuers of preferred or preferred-like securities. What are the takeaways from that? A couple things.
The security structure that most of those European banks are issuing today to meet their It looks like a preferred stock. You may have heard of these. They're called contingent capital securities.
Some people call them COCOs for short. These securities are very, very similar in structure to the perpetual preferreds that are issued by our U.S. banks, except for one mechanical feature, and that is a contingency feature, which is a hard trigger that is part of the security based upon the issuing bank's level of capital. If the bank's level of capital were to fall down to this particular threshold, something would happen to the investor in these COCO securities.
Maybe they would have a temporary write-down of the value of the security, a permanent write-down, or maybe they're exchanged into common equity. But here's the reality. These COCO securities, really, that market came into its own.
It first began on the heels of the GFC, the Great Financial Crisis, and these trigger levels were set according to kind of where bank capital was back then. But since the GFC, Western European banks in particular have raised a tremendous amount of capital, so the capital they hold above these trigger levels is so far above that the likelihood of having one of these securities actually triggered is very low. Now, you still have the risk in those securities, like you do in U.S. preferreds, that a regulator steps in and says, hey, a bank is failing or struggling and we need to take over.
And when things like that happen, then typically the common equity investor, a preferred investor, a COCO investor, will feel some sort of loss. And that's the real risk. Not so much today from the structure itself.
So we do really look at those more as like perpetual preferreds. Another growing area of the market that we participate in is the Canadian bank preferred market. They have a structure called a limited recourse capital note.
Essentially, it's like a U.S. preferred, except it has a maturity date on it. Otherwise, everything else is the same. And what's nice for U.S. investors is that for a lot of those COCO securities issued by Western European banks, for those limited recourse capital notes issued by Canadian banks, those distributions to U.S. investors are oftentimes considered qualified dividend income.
So tax advantage as well. Now, from our recent trip over there, we were in Spain. We were in Paris.
Where else were we? Italy and London. The biggest concern over there from the folks that we spoke to wasn't so much the political backdrop.
We have elections that are coming up in the U.K., in France that we've been paying a lot of attention to here in the U.S. But really their biggest concern isn't so much that. They're actually kind of comfortable that the likelihood of an extreme election happening is unlikely.
Their biggest concern really is the volatility in interest rates and not just what that means for fixed income, but what it means for the economy. So we thought that that was a very interesting takeaway because from the topics that we focus on here, when we look at those markets, oftentimes it's focusing on political events that are around the corner. But after talking to these individuals across a handful of countries, they're not as concerned.
And it's really more interest rates and the impact that that can have on the economy that really is what's on their radar as the key risk today. So we thought that was an interesting takeaway, and I'm happy to be able to share that with folks that are listening to this call today. Great.
Thinking about just listening to what you were saying and thinking about the progress made by the European banks, and you also mentioned the Canadian banks, and earlier in our conversation about the utilities issuing hybrids, the resurgence there and differences in $25 parts and $1,000 parts, it's just fascinating to see the change and the evolution that has taken place in so many areas in the preferred space. There's always something interesting and exciting for us to dig into, Doug. But I want to thank you today.
That's all the time we have. But, Doug, I do want to thank you so much for being here and chatting with us and our listeners today. It's been a great conversation, so thank you.
Thank you very much, Frank. Much appreciated. Thank you.
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