#StrategyToIssueMorePerpetualPreferreds

Strategic Analysis: Issuing More Perpetual Preferreds

Executive Summary

The decision to increase perpetual preferred issuance requires rigorous analysis across regulatory, structural, and market dimensions. These hybrid instruments offer distinctive advantages in the current rate environment while presenting unique risks demanding sophisticated management. This analysis examines strategic rationale, market timing, structural optimization, and execution considerations for a successful issuance program.

Strategic Rationale and Capital Optimization

Regulatory Capital Enhancement

Perpetual preferreds occupy a unique position in regulatory capital hierarchies. For banks and insurers subject to Basel III and Solvency II, they typically qualify as Additional Tier 1 or Tier 2 capital, providing loss-absorbing capacity without diluting common equity holders. This enables institutions to meet enhanced capital requirements while preserving return on tangible common equity.

With Basel IV implementation timelines approaching and stress testing scenarios incorporating climate risk factors, preemptive capital buffer construction is prudent. Issuing perpetual preferreds now positions balance sheets advantageously before potential regulatory tightening cycles.

Tax Efficiency and Arbitrage

The dividends received deduction available to US corporate holders of preferred stock creates natural demand from insurers and other tax-advantaged investors. This tax asymmetry allows issuers to achieve lower after-tax cost of capital compared to similarly rated senior debt. International issuers face more complex considerations but may achieve partial deductibility through hybrid capital treatment in certain jurisdictions.

Current Market Conditions

Interest Rate Environment

The 2024-2025 rate environment presents a finite issuance window. Following aggressive monetary tightening, fixed income yields have normalized at levels attractive to income investors while remaining below late-2023 peaks. This Goldilocks scenario—elevated yields without extreme volatility—creates favorable conditions for locking in long-term fixed-rate funding.

Perpetual preferred spreads to Treasuries have compressed from regional banking turmoil wides to current levels of 300-400 basis points. Against the 10-year historical average of 350-450 basis points, this represents historically attractive entry points. Yield curve flattening has reduced the term premium typically associated with perpetual instruments.

Supply and Technical Dynamics

Primary issuance volume has contracted since the 2022-2023 tightening cycle, creating pent-up institutional demand. Insurance companies, registered investment companies, and pension funds have maintained stable preferred allocations while supply has contracted. The redemption wave of high-coupon preferreds issued pre-2022 has generated substantial reinvestment capital. Issuers entering the market now benefit from reduced competition and concentrated investor focus.

Structural Optimization

Fixed-to-Floating Rate Structures

Modern perpetual preferreds increasingly employ fixed-to-floating rate structures, where dividends switch from fixed coupon to floating benchmark plus spread after a 5-10 year non-call period. This provides investors interest rate protection while offering issuers call optionality aligned with liability management objectives.

A 10-year fixed period provides extended funding cost certainty and reduces refinancing risk. A 5-year structure may achieve modestly tighter pricing through earlier rate reset protection. Analysis suggests marginal benefit beyond 7-10 years is negligible in the current flat yield curve environment.

Call Features and Make-Whole Provisions

Make-whole call provisions represent a structural innovation benefiting both issuers and investors. Traditional perpetual preferreds featured hard non-call periods followed by par call options, providing limited refinancing flexibility. Modern structures increasingly incorporate tax call, regulatory call, and make-whole provisions enabling opportunistic refinancing while compensating investors for reinvestment risk.

Make-whole premiums should be carefully calibrated. Current market conventions suggest Treasury plus 35-45 basis points represents a fair compromise—sufficient to protect investors without negating refinancing benefits.

Dividend Mechanics and Deferral Features

Discretionary dividend suspension provides valuable balance sheet flexibility during stress scenarios. However, issuers must carefully consider signaling implications of deferral and arrearage accumulation. Non-cumulative structures, while more favorable for issuer credit profiles, typically require coupon premiums of 25-50 basis points relative to cumulative structures.

Cumulative structures are strongly preferred by retail and yield-focused institutional investors, while bank regulatory capital treatment may favor non-cumulative features for Additional Tier 1 eligibility. A tiered issuance strategy may be optimal.

Investor Targeting and Distribution

Institutional versus Retail Allocation

The investor base bifurcates between institutional accounts and retail investors. Benchmark transactions of $1 billion or greater typically require institutional participation for sufficient scale, while smaller transactions may be efficiently absorbed by the retail preferred market.

The growth of preferred-focused ETFs has created a hybrid distribution channel combining institutional professionalism with retail scale. ETF providers have demonstrated willingness to anchor offerings and provide secondary market support. Issuers should prioritize relationships with major preferred ETF sponsors during pre-marketing.

International Participation

Cross-border demand for USD-denominated perpetual preferreds has increased substantially as international investors seek yield in low-yielding home currencies. Asian private banking clients and European insurers have become significant marginal buyers, particularly for issuers with established credit stories and transparent regulatory frameworks.

Currency hedging costs remain elevated relative to historical averages, reducing all-in yield available to international investors on an unhedged basis. Marketing should emphasize structural advantages rather than competing solely on yield.

Balance Sheet Implications

Leverage and Capital Adequacy

Bank holding companies must carefully consider Tier 1 leverage ratio implications. Perpetual preferreds are included in Tier 1 capital but excluded from the leverage ratio denominator, creating opportunities to improve capital ratios without corresponding leverage ratio deterioration.

For non-financial corporates, rating agency hybrid capital methodologies have become increasingly favorable. Both Moody's and S&P assign 50-75% equity credit for qualifying perpetual preferreds, significantly enhancing balance sheet metrics without full equity dilution.

Dividend Coverage

While preferred dividends are not legally required like debt interest, market expectations effectively render them mandatory for issuers seeking ongoing capital access. Pro forma fixed charge coverage ratios should be modeled under stress scenarios. Historical analysis demonstrates coverage ratios below 2.0x trigger significant market concern and equity depreciation.

Implementation Roadmap

Phased Issuance Strategy

A phased approach may optimize execution across market windows. Initial issuance of $300-500 million establishes the issuer in the preferred market, creates a reference curve, and generates investor familiarity. Subsequent tap issuance can achieve additional scale at tighter spreads once secondary liquidity develops.

The inter-meeting period between FOMC decisions historically provides favorable issuance windows with reduced rate volatility. Coordination with syndicate desks on timing based on economic data and geopolitical developments is essential.

Documentation Considerations

Increased retail participation necessitates plain English disclosure regarding dividend suspension mechanics, call features, and subordination provisions. Indenture modifications for make-whole call provisions require careful legal analysis to ensure compliance with Trust Indenture Act requirements and applicable corporate law.

Risk Factors and Mitigation

Interest Rate and Refinancing Risk

The perpetual maturity structure transfers interest rate risk from periodic refinancing decisions to the issuer's ability to service fixed-rate dividends indefinitely. While call features provide optionality, they do not eliminate refinancing risk.

Issuers should stress-test dividend service capability under multiple rate scenarios and consider establishing liability management frameworks incorporating opportunistic repurchases when securities trade at discount to par. A preferred stock buyback program, analogous to open market debt repurchase programs, provides valuable flexibility.

Regulatory Risk

The regulatory treatment of perpetual preferreds remains subject to potential modification. International convergence efforts continue to refine hybrid capital eligibility criteria, and domestic tax policy regarding dividend deductibility may face reform proposals. Issuers should incorporate regulatory change scenarios into capital planning and maintain dialogue with supervisory authorities.

Conclusion and Recommendations

The strategic case for increasing perpetual preferred issuance is compelling under current conditions. Favorable technical dynamics, attractive spreads relative to history, and modern structural flexibility create a constructive issuance environment unlikely to persist indefinitely.

Recommended immediate actions: engage with regulatory authorities to confirm capital treatment, retain investment banking syndicate desks for market sounding, prepare draft offering documents incorporating make-whole and fixed-to-floating rate features, and develop an investor presentation framework emphasizing credit quality and structural protections. Execution during this favorable window will provide lasting balance sheet benefits while establishing the issuer as a sophisticated participant in the perpetual preferred market.