With dwindling expectations for Federal Reserve rate cuts, American banks are reassessing the expense of their preferred stocks, a move that could trigger a flurry of transactions in this vital capital source.
Recently, Goldman Sachs Group Inc. (GS, Financial) issued $2.25 billion in new preferred shares to replace an older series, while Citigroup Inc. (C, Financial) has initiated the repayment of $1.25 billion in previous issues. JPMorgan Chase & Co. (JPM, Financial) is also preparing to redeem four series of its preferred stock with a fresh issue on the horizon.
This shift marks a vibrant period for the US banking sector's capital market, reversing the quiet of past months. The anticipation of lower costs for floating-rate preferred shares has been replaced by a proactive approach due to the prolonged high-interest rate environment.
Douglas Baker of Nuveen Services LLC observes a trend of banks moving to cut their losses, unwilling to continue paying high coupons amid rising inflation concerns.
Currently, banks are holding over $25 billion in preferred shares with floating dividends, which are costing them significantly more than the fixed rates secured in recent transactions.
Preferred stocks serve as a mechanism for banks to raise Additional Tier 1 capital. Initially issued with a fixed coupon, these instruments can switch to variable dividends, allowing issuers the option to repay them, usually quarterly.
The decision to repay often hinges on forecasting interest rates and comparing the costs to issuing new fixed-coupon series. The Secured Overnight Financing Rate (SOFR), closely tied to Fed policy, plays a crucial role in this calculus.
For instance, Goldman Sachs might have found it more cost-effective to maintain its preferred stock last year when multiple rate cuts were anticipated. However, with current forecasts predicting fewer cuts, the situation has evolved.
Robert Smalley from UBS Securities LLC points out that the clear indication of rates staying high, coupled with strong demand for new issues, is prompting banks to refinance their preferred shares.
While the regulatory landscape, particularly the Basel Endgame adjustments, initially suggested a quiet year, recent clarifications from Fed chair Jerome Powell have eased some concerns, potentially stimulating more activity in the preferred shares market.
Despite the unique circumstances surrounding each redemption decision, the direction of interest rates and improved capital planning conditions are encouraging banks to issue new preferred shares, possibly inviting mid-sized regional banks back into the fray if spreads continue to improve.
