Preferred Securities Overview & Preferences

Preferred Securities Overview & Preferences

CIO ? Global Wealth Management ?? 10 July 2019 Frank Sileo, CFA, Senior Fixed Income Strategist

Monthly

The enclosed list is not a template for the construction of your personal portfolio. You should discuss investment decisions with your Financial Advisor.

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This report has been prepared by UBS Financial Services Inc. (UBS FS). Analyst certification and required disclosures begin on page 18.

Preferred Securities Overview and Preferences

Will preferreds stay cool this summer? At the midway point of 2019, the preferred securities sector has generated impressive year-to-date gains of more than 11%, driven largely by declining interest rates. And it appears that rate risk may have diminished further with the Federal Reserve's latest signalling. Following its 19 June meeting, the Fed alluded to an increase in market uncertainties, and Fed projections for the federal funds rate now show that eight of 17 members forecast at least one rate cut in 2019. At CIO we expect the Fed to cut rates by 50 basis points on 31 July unless we see unusually strong economic data. And while we still expect rates to rise over the next year, we lowered our 12-month forecast for the 10-year Treasury yield to 2.4% from 2.8%.

A more benign rate environment should help support preferred stocks into the summer months. However, in summers past, preferred stock valuations have had a tendency to move toward the "tight side" during the third quarter. Yield premiums can help the sector absorb credit or rate volatility. However, over the past three years, preferred sector yield premiums hit the lows for the year in July through September. And in each of the past three years, fourth-quarter performance was the year's worst. Specifically, the USD 25 par preferred sector saw yield spreads reach 52-week lows in September 2018 followed by a loss of 4.4% in the fourth quarter. There was a similar pattern two years earlier, when yield premiums troughed in September 2016 and then a 4.2% loss followed in the fourth quarter. In 2017, yield spreads hit the lows in July, which preceded marginal monthly gains of 0.5% or less for the remainder of the year (and a fourth-quarter gain of just 0.4%).

So far, however, overall valuation seems fair. Price appreciation has been tempered and not excessive. ETF inflows, which can occasionally amplify performance, have picked up but not to extremes. Therefore, against a backdrop of plunging Treasury yields, we have actually seen some widening in yield spreads. This may buffer near-term volatility.

In the months ahead, if yield premiums tighten toward historically lower levels, preferreds may see a pullback if yields then suddenly and rapidly rise to meaningfully higher levels due to higher interest rates or rising credit spreads (i.e., risk aversion). But so far preferred sector valuation is beginning the third quarter at reasonable levels.

We continue to favor fixed-rate preferreds with above-average coupons and F2Fs with longer-term call dates. Specifically, our preference is for those F2Fs with at least four years of call protection, high reset spreads, and strong prospectus language regarding coupon calculation in the absence of Libor.

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Preferred valuations appear reasonable Yield spread over Treasuries in basis points

450 400 350 300 250 200 150

USD25 par preferreds

Source: Bloomberg, ICE BAML, UBS, as of 5 July 2019 Based on adjusted-yield of Core Plus Fixed Rate Preferred Index

Steady ETF inflows have been supportive Asset flows in USD mn

650 450 250

50 -150 -350 -550 -750

Jul-17

Nov-17 Mar-18

Jul-18

Nov-18 Mar-19

Jul-19

Source: Bloomberg, ICE BAML, UBS, as of 9 July 2019

CIO GWM 10 July 2019 2

Preferred Securities Overview and Preferences

List Changes Attractive List

Identifer: Action: From:

Goldman Sachs L + 67bps; 4.0% floor Goldman Sachs L + 75bps; 4.0% floor Morgan Stanley L + 75bps; 4.0% floor Goldman Sachs 5.30% fixed to call; then L+383.4bps Morgan Stanley 5.85% fixed to call; then L+349.1

GS pr D GS pr C MS pr A 38148BAC2

MS pr K

move move move move

move

Neutral Neutral Neutral Neutral

Neutral

Public Storage 5.4% perpetual

PSA pr B

move Neutral

Digital Realty Trust 5.85% perpetual

DLR pr K

new

----

Public Storage 5.60% perpetual

PSA pr H

new

----

Nextera Energy Capital 5.65% due 3/1/2079

NEE pr N

new

----

Neutral List

Identifer: Action: From:

Ebay Inc. 6.00% 2/1/56

EBAYL

DTE Energy 6.00% 12/15/2076

DTY

Southern Co. 6.25% 10/15/2075

SOJA

Bank of America Corp. 6.20% perpetual BAC pr C

J.P. Morgan Chase & Co. 6.10% perpetual JPM pr G

J.P. Morgan Chase & Co. 6.15% perpetual JPM pr H

American Express 5.2% fixed to call; then 025816BJ7

L+ 342.8bps

Capital One Financial 5.55% fixed to call 14040HBH7

date; thereafter L+380bps

Public Storage 5.15% perpetual

PSA pr F

PS Business Parks, Inc. 5.25% perpetual PSB pr X

move move move move move move

move

move

new new

Attractive Attractive Attractive Attractive Attractive Attractive

Attractive

Attractive

-------

Unattractive List Digital Realty Trust 5.25% perpetual Public Storage 5.05% perpetual PS Business Parks, Inc. 5.20% perpetual

Identifer: DLR pr J PSA pr G PSB pr Y

Action: From:

new

----

new

----

new

----

Refinanceable List

Aegon 6.500% perpetual ING Groep NV 6.375% perpetual Public Storage 6.00% perpetual Source: UBS

Identifer: AED ISF PSA pr Z

Action: From: removed ---removed ---removed ----

Rationale: Current yield / intermediate duration Current yield / intermediate duration Current yield / intermediate duration YTC valuation / reset spread / call date YTC valuation / reset spread / call date Quality / yield / high coupon vs issuer complex Call date / yield / high coupon vs issuer complex Quality / Call date / yield / high coupon vs issuer complex Quality / Call date / yield / high coupon vs issuer complex

Rationale:

Weaker valuation / low yield-to-call Weaker valuation / low yield-to-call Weaker valuation / low yield-to-call Weaker valuation / low yield-to-call Weaker valuation / low yield-to-call Weaker valuation / low yield-to-call Preference for longer call protection / higher reset spread Preference for longer call protection / higher reset spread Favor higher coupons Favor higher coupons

Rationale: Low coupon Low coupon Low coupon

Rationale: Called and redeemed Called and redeemed Called and redeemed

CIO GWM 10 July 2019 3

Preferred Securities Overview and Preferences

Top Picks - Highlighted preferreds

Security Name

Symbol/ Last Next YTW YTM / CY YTC Eff

CUSIP

Price Call Date (%)1 (%)2 (%) Dur3

Attractive $1000 par fixed-to-floating coupon (Not NRA eligible, pays qualified dividend)

Bank of America 6.25% fixed to call date;

thereafter 3mo LIBOR+370.5bps

060505EH3 $108.60 9/5/2024 4.40% 5.60% 4.40% 4.6

Bank of America 6.10% fixed to call date then 3m LIBOR+389.8bps

060505EN0 $108.60 3/17/2025 4.30% 5.60% 4.30% 5.0

Citigroup 6.25% fixed to call date; thereafter

3mo LIBOR+451.7bps

172967KM2 $110.10 8/15/2026 4.60% 6.00% 4.60% 5.9

Goldman Sachs Group, Inc. 5.30% fixed to call date; thereafter 3mo LIBOR+383.4bps 38148BAC2 $104.60 11/10/2026 4.50% 5.60% 4.50% 6.3

Attractive $25 par fixed-rate coupon

Brighthouse Financial Inc 6.25% 9/15/2058* BHFAL

$26.00 9/15/2023 5.30% 6.00% 5.30% 8.6

Digital Realty Trust 5.85% perpetual**

DLR K

Brighthouse Financial Inc 6.60% perpetual+ BHFAP

Nextera Energy Capital 5.65% due 3/1/2079* NEE N

$26.10 3/13/2024 4.80% $26.70 3/25/2024 5.00% $26.10 6/15/2024 4.80%

5.60% 6.20% 5.40%

4.80% 8.6 5.00% 7.5 4.80% 10.0

Source: Bloomberg, UBS, as of 9 July 2019 *NRA-eligible, pays fully taxable interest income. **Not NRA-eligible, pays fully taxable interest income. + Not NRA eligible, pays qualified dividend income 1YTW = "yield to worst" is the lowest estimated yield among possible redemption date scenarios. 2YTM calculation for F2Fs uses assumed LIBOR rates based on the forward curve through Bloomberg analytics. CY for fixed rate coupon is current yield. 3Duration is calculated using Bloomberg analytics.

CIO GWM 10 July 2019 4

Preferred Securities Overview and Preferences

Floor coupon floaters Floating-rate preferreds with coupon floors and low reset spreads could trade with low "fixed" coupons, since the combination of low reset spread and coupon floor could create a high hurdle for the coupon to begin floating. Therefore, the floater may behave more like a low coupon fixed-rate preferred, with those low coupons comprising the only compensation for both credit and interest rate risk. So they could have high sensitivity to interest rates and to credit spreads. Still, their "quirkiness" could provide diversification benefits from a portfolio management standpoint.

Secur ity Name

Symbol/ First Reset (a) Calculated (b) Coupon (a) - (b) Last Discount Cur r ent Eff

CUSIP Call Date Spread Coupon (%) Floor (%) Differ ence Pr ice to Par Yield Dur

$25 par

Aegon 3mo LIBOR+87.5bps;4% floor

AEB

12/15/2010 87.5

3.22

4.00

(0.78) 22.70 -9% 4.40 6.2

Bank of America 3mo LIBOR + 35bps; 4% floor BAC pr E 11/15/2011 35

2.69

4.00

(1.31) 22.50 -10% 4.40 7.2

Bank of America 3mo LIBOR + 50bps; 4% floor BML pr L 5/21/2012 50

2.84

4.00

(1.16) 21.70 -13% 4.60 7.7

Bank of America 3mo LIBOR + 65bps; 3% floor BML pr H 11/28/2009 65

2.99

3.00

(0.01) 19.50 -22% 4.10 4.5

Bank of America 3mo LIBOR + 75bps; 3% floor BML pr G 11/28/2009 75

3.09

3.00

0.09

19.90 -20% 4.10 4.2

Bank of America 3mo LIBOR + 75bps; 4% floor BML pr J 11/28/2010 75

3.09

4.00

(0.91) 22.10 -12% 4.50 6.8

Goldman Sachs 3mo LIBOR + 67bps; 4.0% floor GS pr D 5/24/2011 67

3.01

4.00

(0.99) 20.60 -18% 4.80 7.5

Goldman Sachs 3mo LIBOR + 75bps; 3.75% floor GS pr A 4/25/2010 75

3.09

3.75

(0.66) 19.80 -21% 4.70 6.6

Goldman Sachs 3mo LIBOR + 75bps; 4.0% floor GS pr C 10/31/2010 75

3.09

4.00

(0.91) 20.70 -17% 4.80 7.3

MetLife, Inc. 3mo LIBOR+100bps; 4% floor

MET pr A 9/15/2010 100

3.34

4.00

(0.66) 23.60 -6% 4.20 5.1

Morgan Stanley 3mo LIBOR+70bps; 4% floor MS pr A 7/15/2011 70

3.04

4.00

(0.96) 20.90 -16% 4.80 7.5

SunTrust Banks 3mo LIBOR +53bps; 4% floor STI pr A 9/15/2011 53

2.87

4.00

(1.13) 22.90 -8% 4.40 6.7

US Bancorp 3mo LIBOR+60bps; 3.5% floor

USB pr H 4/15/2011 60

2.94

3.50

(0.56) 20.00 -20% 4.40 6.6

$1000 par

Average 4.48

US Bancorp 3mo LIBOR+102bps; 3.5% floor 902973866 4/15/2011 102

3.36

3.50

(0.14) 79.81 -20% 4.50 5.0

Goldman Sachs 3mo LIBOR + 77bps; 4.0% floor 381427AA1 6/1/2012 76.75

3.11

4.00

(0.89) 81.00 -19% 4.90 7.3

Goldman Sachs 3mo LIBOR + 77bps; 4.0% floor 38144QAA7 9/1/2012 77

3.11

4.00

(0.89) 80.20 -20% 5.00 7.2

Source: Bloomberg, UBS, as of 09 July 2019

Average 4.80

CIO GWM 10 July 2019 5

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