Preferred Securities Overview & Preferences CIO – Global Wealth Management –– 10 July 2019 Month ly Frank Sileo, CFA, Senior Fixed Income Strategist The enclosed list is not a template for the construction of your personal portfolio. You should discuss investment decisions with your Financial Advisor. ab 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 Preferred valuations appear reasonable rate risk may have diminished further with the Federal Reserve's Yield spread over Treasuries in basis points latest signalling. Following its 19 June meeting, the Fed alluded 450 to an increase in market uncertainties, and Fed projections for 400 the federal funds rate now show that eight of 17 members 350 forecast at least one rate cut in 2019. At CIO we expect the Fed 300 to cut rates by 50 basis points on 31 July unless we see unusual- 250 ly strong economic data. And while we still expect rates to rise 200 over the next year, we lowered our 12-month forecast for the 150 10-year Treasury yield to 2.4% from 2.8%. USD25 par preferreds A more benign rate environment should help support preferred Source: Bloomberg, ICE BAML, UBS, as of 5 July 2019 stocks into the summer months. However, in summers past, Based on adjusted-yield of Core Plus Fixed Rate Preferred Index 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%). Steady ETF inflows have been su pportive So far, however, overall valuation seems fair. Price appreciation Asset flows in USD mn has been tempered and not excessive. ETF inflows, which can 650 occasionally amplify performance, have picked up but not to 450 extremes. Therefore, against a backdrop of plunging Treasury 250 yields, we have actually seen some widening in yield spreads. 50 This may buffer near-term volatility. -150 In the months ahead, if yield premiums tighten toward histori- -350 cally lower levels, preferreds may see a pullback if yields then -550 suddenly and rapidly rise to meaningfully higher levels due to -750 Jul-17 Nov-17 Mar-18 Jul-18 Nov-18 Mar-19 Jul-19 higher interest rates or rising credit spreads (i.e., risk aversion). But so far preferred sector valuation is beginning the third quar- Source: Bloomberg, ICE BAML, UBS, as of 9 July 2019 ter 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 pro- tection, high reset spreads, and strong prospectus language regarding coupon calculation in the absence of Libor. CIO GWM 10 July 2019 2 Preferred Securities Overview and Preferences List Changes Attractive List Identifer: Action: From: Rationale: Goldman Sachs L + 67bps; 4.0% floor GS pr D move Neutral Current yield / intermediate duration Goldman Sachs L + 75bps; 4.0% floor GS pr C move Neutral Current yield / intermediate duration Morgan Stanley L + 75bps; 4.0% floor MS pr A move Neutral Current yield / intermediate duration Goldman Sachs 5.30% fixed to call; then YTC valuation / reset spread / call 38148BAC2 move Neutral L+383.4bps date Morgan Stanley 5.85% fixed to call; then YTC valuation / reset spread / call MS pr K move Neutral L+349.1 date Quality / yield / high coupon vs issuer Public Storage 5.4% perpetual PSA pr B move Neutral complex Call date / yield / high coupon vs Digital Realty Trust 5.85% perpetual DLR pr K new ---- issuer complex Quality / Call date / yield / high Public Storage 5.60% perpetual PSA pr H new ---- coupon vs issuer complex Nextera Energy Capital 5.65% due Quality / Call date / yield / high NEE pr N new ---- 3/1/2079 coupon vs issuer complex Neutral List Identifer: Action: From: Rationale: Ebay Inc. 6.00% 2/1/56 EBAYL move Attractive Weaker valuation / low yield-to-call DTE Energy 6.00% 12/15/2076 DTY move Attractive Weaker valuation / low yield-to-call Southern Co. 6.25% 10/15/2075 SOJA move Attractive Weaker valuation / low yield-to-call Bank of America Corp. 6.20% perpetual BAC pr C move Attractive Weaker valuation / low yield-to-call J.P. Morgan Chase & Co. 6.10% perpetual JPM pr G move Attractive Weaker valuation / low yield-to-call J.P. Morgan Chase & Co. 6.15% perpetual JPM pr H move Attractive Weaker valuation / low yield-to-call American Express 5.2% fixed to call; then Preference for longer call protection 025816BJ7 move Attractive L+ 342.8bps / higher reset spread Capital One Financial 5.55% fixed to call Preference for longer call protection 14040HBH7 move Attractive date; thereafter L+380bps / higher reset spread Public Storage 5.15% perpetual PSA pr F new ---- Favor higher coupons PS Business Parks, Inc. 5.25% perpetual PSB pr X new ---- Favor higher coupons Unattractive List Identifer: Action: From: Rationale: Digital Realty Trust 5.25% perpetual DLR pr J new ---- Low coupon Public Storage 5.05% perpetual PSA pr G new ---- Low coupon PS Business Parks, Inc. 5.20% perpetual PSB pr Y new ---- Low coupon Refinanceable List Identifer: Action: From: Rationale: Aegon 6.500% perpetual AED removed ---- Called and redeemed ING Groep NV 6.375% perpetual ISF removed ---- Called and redeemed Public Storage 6.00% perpetual PSA pr Z removed ---- Called and redeemed Source: UBS CIO GWM 10 July 2019 3 Preferred Securities Overview and Preferences Top Picks - Highlighted preferreds Security Name Symbol/ Last Next YTWYTWYTW YTM / CY YTCYTCYTCEffEffEff 1 2 3 CUSIP Price Call Date (%)(%)(%) 11 (%)(%)(%) 22 (%)(%)(%) DurDurDur 33 Attractive $1000 par fixed-to-floating coupon (Not NRA eligible, pays qualified dividend) Bank of America 6.25% fixed to call date; 060505EH3 $108.60 9/5/2024 4.40% 5.60% 4.40% 4.6 thereafter 3mo LIBOR+370.5bps Bank of America 6.10% fixed to call date 060505EN0 $108.60 3/17/2025 4.30% 5.60% 4.30% 5.0 then 3m LIBOR+389.8bps Citigroup 6.25% fixed to call date; thereafter 172967KM2 $110.10 8/15/2026 4.60% 6.00% 4.60% 5.9 3mo LIBOR+451.7bps Goldman Sachs Group, Inc. 5.30% fixed to 38148BAC2 $104.60 11/10/2026 4.50% 5.60% 4.50% 6.3 call date; thereafter 3mo LIBOR+383.4bps 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 $26.10 3/13/2024 4.80% 5.60% 4.80% 8.6 Brighthouse Financial Inc 6.60% perpetual +++ BHFAP $26.70 3/25/2024 5.00% 6.20% 5.00% 7.5 Nextera Energy Capital 5.65% due 3/1/2079* NEE N $26.10 6/15/2024 4.80% 5.40% 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. There- fore, 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. Security Name Symbol/ First Reset (a) Calculated (b) Coupon (a) - (b) Last Discount Current EffEffEff CUSIPCUSIPCUSIPCall Date SpSpread read Coupon (%) Floor (%) Difference PrPrice icePrice to Par YieldYieldYield DurDurDur $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.