Goldman Sachs recently issued $2.5 billion in perpetual preferred bonds with a 6.5% yield, coinciding with preferred stock pricing spreads narrowing to their most favorable levels since the 2008 financial crisis. This move allows Goldman Sachs to refinance a more expensive $750 million note callable in August 2026, locking in lower-cost capital. Similarly, Bank of New York Mellon recorded the narrowest preferred stock pricing since the financial crisis, issuing $500 million in preferred equity with a reset spread of 1.868 percentage points, the smallest ever for that specific share structure. This aggressive hunt for yield has compressed spreads to historic lows, making banks eager to refinance older, costlier notes. These preferred shares count as Additional Tier 1 capital under Basel III rules, allowing banks to strengthen capital ratios without diluting existing shareholders.
However, some market participants express concern over these "ridiculously" tight spreads. Analysts note that investors are accepting lower compensation for the risk associated with perpetual securities. Douglas Baker, head of preferred securities at Nuveen, stated that his firm is passing on more deals than they participate in due to doubts about whether pricing adequately reflects varying risks among banks. The average yield-to-call for these securities, at 5.85%, is still higher than global high-grade bonds, but the compressed spreads increase investors' vulnerability in a downturn. The standard deviation in reset spreads for US lenders' newly-issued preferred stock has more than halved compared to the previous year, with European AT1 spreads coalescing around the low 300 basis points.
While this environment benefits banks by reducing their funding costs, particularly for those needing to maintain robust capital levels ahead of potential regulatory changes, it poses risks for investors. The perpetual nature of these instruments means that market value can sharply alter with changes in interest rates or credit conditions. If interest rates rise, the appeal of these lower-yielding preferred shares diminishes, potentially leading to greater price volatility and leaving income-focused buyers exposed. Some analysts caution that differences among banks in terms of profitability and loan exposures are being underappreciated in the current market, suggesting that the incremental spread may not be enough to compensate for the true risk involved.
