The investor appetite for bank-issued debt is experiencing a resurgence, coinciding with an impending rise in interest rates on an estimated $120 billion worth of preferred securities. Banks have been leveraging these risky instruments, which resemble stocks, to bolster their regulatory capital. Although preferred securities typically lack a maturity date, they can be redeemed or called within five or ten years, with the interest rate resetting to either a fixed or floating rate if not called.
In the years 2020 and 2021, preferreds experienced significant issuance, totaling over $160 billion when interest rates were low. However, as the Federal Reserve raised interest rates, the volume dipped to $70 billion from the previous year. Furthermore, the market faced challenges in March due to the U.S. regional banking crisis and the collapse of Credit Suisse, which led to a complete write-down of the Swiss lender's European preferreds in the sale to UBS Group.
Nonetheless, the market has rebounded since then. Recently, Wells Fargo & Co. released a new Preferred Stock (PPS) earlier this month, which received an overwhelming response from investors, surpassing supply expectations. This event positively influenced investor sentiment towards bank-issued debt.
Industry experts predict that U.S. banks will pursue more preferred securities deals as they hold billions of dollars in preferreds that require redemption. This restoration of the market is crucial ahead of new capital requirements recently unveiled by U.S. regulators. The proposed capital rule reform is set to mandate banks to set aside larger reserves for risk.
Investors have grown more confident in preferred structures due to a better understanding of the risks following the Credit Suisse collapse and subsequent regional bank failures. Consequently, there have been purchasing opportunities at prices below long-term averages, attracting major investors like Cohen & Steers.
Despite the optimistic outlook, some challenges remain. Uncertainty surrounding the Federal Reserve's interest rate policy and investor prudence may restrict new supply in the market. As a result, it is unlikely that the issuance levels of 2020 and 2021 will be reached. Additionally, new regulations, once approved, will take time to become effective.
Experts anticipate that any new issuance in the market will likely focus on refinancing more expensive floating-rate securities within their call windows. Net new issuance is expected to be limited, as the need for such securities may not be pressing.
As the market continues to evolve, banks and investors must adapt to ensure stability and growth in this important sector of the financial market.
