Which Preferred Shares Are Safe From The LIBOR Stunt?
Following up on PMT’s shocking announcement from Friday, we:
Reviewed commentary from another industry expert.
Evaluated terms for some bank preferred shares.
Evaluated terms for the preferred shares we cover that are not explicitly fixed-rate forever.
Note 1: This is the order of presentation, not the order used for performing research. This order goes from shortest section to longest section.
Note 2: The “Weekly Series” article we usually publish on the common shares will be delayed as my time was invested in this research instead.
By reviewing each prospectus, we were able to categorize terms based on the language present in each document. Clearly, this was not enough time to read each prospectus from start to finish (25+ pages per document). Instead, I reviewed the relevant sections and categorized them based on the most relevant terms.
Part 1: Commentary From Another Expert
One of our subscribers suggested a brief article from Spectrum Asset Management.
It’s only 3 pages, and I found it useful in tracking the banks. Following that, I proceeded to categorize the actions of the major investment banks.
The company names are linked to the relevant press release or presentation:
2/27/2023 Citigroup (C ) uses SOFR.
3/1/2023 JP Morgan (JPM) uses SOFR.
3/31/2023 Bank of America (BAC) uses SOFR.
4/28/2023 Morgan Stanley (MS) declares at least some floating rate shares will be fixed.
5/12/2023 Wells Fargo (WFC) declares at least some floating rate shares will be fixed.
May 2023: Goldman Sachs (GS) uses SOFR.
Part 2: Terms
I didn’t have time to review many of the preferred share terms for banks.
Two major investment banks decided to screw preferred shareholders: MS and WFC.
With limited time, I opted to review MS. I skipped WFC, because I have no confidence in WFC’s decisions:
To be clear, I am not accusing WFC of breaking the law in the past, present, or future. I’m merely providing my opinion on whether I would personally trust WFC.
Therefore, Morgan Stanley wins by virtue of facing off against WFC.
In reviewing the Morgan Stanley terms, I am not convinced Morgan Stanley is justified. They have at least a slightly stronger case, but still flimsy.
For instance, Morgan Stanley’s terms for the series F preferred shares end with:
“If the banks so selected by the calculation agent are not quoting as set forth above, LIBOR for that dividend determination date will be the same as LIBOR for the immediately preceding dividend period, or, if there was no such dividend period, the dividend payable will be based on the initial dividend rate”.
It’s still questionable whether Morgan Stanley can actually ignore that they should’ve replaced LIBOR, but at least some of the prospectuses included the explicit possibility that they might use the initial dividend rate in some scenario. That’s better footing than only having the “immediately preceding dividend period”.
I haven’t gone deeper into this because we don’t cover MS, and I had to prioritize.
Part 3: Terms
Most of the preferred shares are written with pretty standard terms. However, they mess it up by changing formatting, adding a word or two (sometimes for no reason), and changing which terms get capitalized. Lovely.
So what can we do?
We can search for a few terms that appear to be the most relevant and record them. I created a table referencing every share we cover that is not explicitly “fixed-rate” and scored them on several criteria. The scoring is a simple pass/fail for each criterion, which worked very well.
The categories are:
5-Year Treasury: The 5-year Treasury isn’t going away. If a share uses the 5-year Treasury, no further research is needed or performed.
SOFR: If the share’s floating rate is based on SOFR instead of based on LIBOR, then by definition it will use SOFR.
Floating: If the share is already floating, going back to the original coupon rate would be difficult. If they tried to fix it, they would need to try to fix it based on current rates.
LD IAS: References “If Libor has been discontinued” and references using either “Industry Accepted Substitute” or “Industry Accepted Successor”.
IPDP: The formula for determining the dividend rate includes a reference to the “Immediately Preceding Dividend Period”.
Other: This only came up once. The terms were so weird they deserved a separate note.
The only “bad” term in this table is IPDP. Any of the other categories would be a form of protection. In most cases where LD IAS is present, I did not check for IPDP because LD IAS should cancel it out.
Immediately Preceding Dividend Period Examples
The language around the immediately preceding dividend period could be different. Bolding was added to clarity.
This text would get a share flagged for IPDP:
If fewer than three New York City banks selected by us do not quote rates in the manner described above, the Three-Month LIBOR Rate for the applicable Dividend Period will be the same as for the immediately preceding Dividend Period, or, if there was no such Dividend Period, the dividend shall be calculated at the dividend rate in effect for the immediately preceding Dividend Period.
This text would not get a share flagged for IPDP:
The final alternative method sets the dividend rate for a Dividend Period during the floating rate period at the same rate as the immediately preceding Dividend Period during the floating rate period or, in the case of the first Dividend Period in the floating rate period, the most recent dividend rate that could have been determined had the floating rate period been applicable prior to the first Dividend Period in the floating rate period.
These are just examples, as each share may use different terms.
The Table Showing Each Share
Here’s the table:
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