Preferred stock pricing spreads have reached their narrowest levels since the 2008 financial crisis, creating a favorable environment for banks to issue new preferred shares. Goldman Sachs recently capitalized on this by issuing $2.5 billion in perpetual preferred bonds at a 6.5% yield. This move was strategic, as the proceeds will be used to redeem an older, more expensive $750 million preferred note callable in August 2026, effectively locking in lower-cost capital.
Bank of New York Mellon Corp (BNY) also took advantage of these tight credit spreads, issuing $500 million in preferred equity. The reset spread for BNY's issue was a record-low 1.868 percentage points, the smallest ever recorded for that specific preferred share structure. The aggressive hunt for yield by investors in a low-rate environment, coupled with improved bank creditworthiness, is driving this compression in spreads.
While beneficial for banks seeking to refinance older, costlier notes and strengthen their capital ratios under Basel III rules, the tight spreads pose risks for investors. These slim spreads mean investors are accepting lower compensation for the risk associated with perpetual securities. Any future shifts in interest rates or credit conditions could sharply alter the market value of these instruments, potentially leading to greater price volatility.
Analysts note that while the current environment supports banks' ability to issue preferreds as Additional Tier 1 capital without diluting common shareholders, the reduced cost associated with lower reset spreads decreases banks' motivation to call these securities later. This increases investor uncertainty regarding the lifespan and ultimate return on their perpetual preferred investments. Despite strong demand for yield, investors need to weigh the risks of accepting reduced compensation for perpetual securities with potential future interest rate fluctuations.
