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Welcome to the latest edition of our Preferred Stock Market Weekly Review, where we provide a bottom-up look at specific news and events, as well as a top-down overview of the overall market, to determine how the preferred stock and baby bond markets are performing. We also provide historical context and themes that we believe are driving the market and that investors should take note of. This update covers the period up to the last week of June.
For a look at the broader revenue space, be sure to check out our other weekly updates covering the Business Development Company (BDC) and Closed-End Fund (CEF) markets.
Market trend
Preferred stocks were flat throughout the week as rising Treasury yields were offset by narrowing credit spreads.
Spreads have begun to narrow and continue to trade at historically low levels.
Market Themes
A few weeks ago, agency mortgage REIT Dynex Capital (DX) offered 10.5 million shares in a greenshoe offering of 1.575 million shares, a roughly 19% increase over its total shares outstanding. We see these types of offerings by mortgage REITs from time to time, and they're a good outcome for preferred stockholders (and not so good for common stockholders, due to the potential for dilution).
This is one of the reasons we like agency mortgage REIT preferred stock, i.e. preferred stock issued by AGNC, NLY, DX, etc. These companies have been happy to issue additional common stock over the past few years. This additional issuance boosts their total asset and capital levels, which largely offsets the decline in book value due to wider agency spreads. Agency mREIT book values have been more resilient than hybrid mortgage REITs during periods of credit stress like the COVID shock. Margin issues related to mark-to-market have only arisen in the hybrid mREIT sector.
The net result for preferred holders is that their equity coverage will rise as the amount of their equity increases and the liquidation value of their preferreds remains the same. DX already boasts the highest equity/preferred coverage ratio across the sector, but this will rise to nearly 10x, a very strong figure and nearly three times the pre-COVID figure.
The following chart shows the steady increase in equity. This upward trend more than offsets the decline in book value. This also steadily reduces the risk of preferred stock. There are few other factors that management can regularly rely on to reduce preferred stock risk. This issuance serves management in two ways: it provides capital for new market opportunities and it expands the overall portfolio.
DX.PR.C continues to be one of the most attractive securities in the income space. It's currently a win-win for shareholders. When it matures on the first call date in 2025, it will have a call yield of 10.4%, but if you switch to a floating rate, it will yield 10.7% (which assumes several rate cuts already and may decline over time as the Fed cuts rates). The yield, based on expectations that Fed rates will remain stable over the long term, is also just above 10%.
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