Spectrum Asset Management
U.S. Treasury yields are expected to remain elevated, creating a favorable environment for income growth for hybrid securities. Investors in preferred and capital securities with high allocations to fixed-to-refixed capital securities can benefit in these conditions.
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Issuers of fixed-to-refixed securities typically face two options: allowing a security to reset at a higher rate or calling the security at par. Investors may be concerned about the outcome of either option, with some finding it counterintuitive that an issuer might call a security with a low coupon when interest rates are higher. However, in the current market rate environment, both options can offer income advantages for investors, as shown in the example below.
Citigroup’s fixed-to-refixed perpetual preferred stock, trading at a discount at $95 in early 2024, was redeemed in 2025 at par ($100). Prior to the Citigroup redemption announcement, it was expected that the dividend reset structure of +323 basis points (bps) would reset the coupon higher, boosting income due to the reset.
However, with the redemption, investors received a payout from their discounted securities at par and had the opportunity to reinvest the proceeds into a new security offering a higher yield. Further, if they purchased securities with similar reset coupon structures, they would also be rewarded with the refixed income push-up, potentially securing attractive income that can last at least another five years due to its reset off the five-year Treasury.
Source: Spectrum Asset Management, Bloomberg. As of January 27, 2025. The case study is for example and illustrative purposes only and not an indication of future results and no representation as to the returns that may be experienced by investors.
Companies are faced with an economic decision—is it more cost effective to let the coupon reset higher and pay out the higher yield to the bondholder, or is it better to redeem a security at par and issue a new security at the market rate? Both options can bode well for preferred and capital securities investors looking for income growth.
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