(Bloomberg) -- JPMorgan Chase & Co.’s big preferred shares issue this week put sales desks into top gear. Their pitch was simple: a significant coupon jump — something that’s made the junior securities one of the hottest trades in credit.
Salespeople scouting prospective buyers for the $3 billion issue touted the 6.5% coupon, also known as carry, on the preferreds. Brokers targeted owners of older securities with lower coupons, including those issued by JPMorgan, to arrange switches into the new shares, according to people familiar with the matter, who asked not to be named because discussions were private.
It worked. The issue was the most heavily-traded among US corporate bonds and preferreds this week. Market activity peaked at multiple trades per minute of the shares after the issue, based on data compiled by Bloomberg. That’s after the bank got more than $10 billion in orders for the sale, which was the biggest preferred deal by a US lender in four years.
Investors flocked to the sale because carry has become vital in credit. With risk premiums compressed near historic lows and a relatively tame interest rate-cutting cycle priced in, coupons have become the only reliable source of returns. That’s made US bank preferreds and Europe’s AT1 bonds increasingly popular. The securities help banks meet regulatory requirements and are able to offer big coupons because they’re the first in line for losses when a bank gets into trouble.
“The real story in the preferred market is the continual growth of coupon income despite a central bank easing regime,” said Manu Krishnan, deputy chief investment officer at Spectrum Asset Management. He said securities issued during times of lower interest rates will either get called or extended at much higher coupons, putting the asset class in “the unique position” of being able to boost coupons.
While this is also the case for corporate bond refinancings, the extra coupon for borrowers is typically a lot smaller than in these preferreds.
For banks, replacing older preferreds with new issues is a way to manage the cost of their capital stack. JPMorgan’s $3 billion sale came just after it announced that it would repay an older $3 billion security with a 4.6% coupon. Preferreds often have periods where their dividends are fixed, which then reset to floating rates. Those resets will usually be to higher yields now, boosting the bank’s borrowing costs more than if they chose to call the securities and sell new ones.
In the case of JPMorgan, had the previous security been extended, it would have had a higher initial floating coupon of about 7.4%. A representative at JPMorgan declined to comment on the new issue.
Other banks have also ended up boosting coupons.
When Citigroup Inc. sold a new $1.5 billion preferred in late November, the coupon stood at 6.75%. The $1.5 billion note that it repaid on Thursday had a coupon about 2 percentage points lower. Goldman Sachs Group Inc. paid a 6.85% coupon in its latest issue in January. Even though it left the call option on three older issues expire, the coupons on those jumped as they reset into payments that reflect higher underlying risk-free rates compared to the time of issuance.
“Things are coming together in ways that enable the redemption and reissue dynamic to work as it is working now,” said Spencer Phua, senior desk analyst at Piper Sandler Credit Trading.
This is driven by “some stabilization in rates expectations, better clarity on what they are expected to hold in capital and the already-longish delays for some of these high floating-dividend preferreds” that have been repayment candidates for a while, Phua said.
Still, banks may not need or want to replace all of their preferred shares. They spent years increasing this regulatory capital in anticipation of an update in post-financial crisis rules, but have recently been trimming it after indications that the final rules — known as Basel Endgame — will be less onerous than expected.
So even if replacement mathematics makes sense, some banks may just decide to further reduce their preferred capital layer by repaying notes without issuing new ones.
Any lenders that do decide to issue new preferreds are likely to get an eager reception from investors looking to boost coupons, because it’s an almost-guaranteed source of income if a borrower doesn’t default.
US investors aren’t generally interested in lower-coupon issues, according to Jackie Ineke, chief investment officer at Swiss fixed income boutique Spring Investments. They “are looking for income. Typically high coupons.”