Fitch Goes After REIT Preferred Stocks But Does Anybody Care?

Just after the market closed yesterday there was a certain amount of press regarding a move by Fitch Ratings to downgrade the preferred stocks issued by a couple dozen U.S. Real Estate Investment Trust (REIT) companies.

As a researcher, I am always focused on one primary question – what does it really mean for preferred stock investors? So this move by Fitch caught my attention.

More precisely, Fitch modified its formula for rating REIT-issued preferred stocks and that modification resulted in a variety of downgrades. Although some of the headlines made this sound alarming (which, of course, is the purpose of headlines), there was something about the listed companies that just seemed odd.

Fitch, and those reporting this story yesterday, forgot to mention that the majority of the affected companies do not have any preferred stocks that are currently actively trading.

Of the 21 affected REITs, only eight have preferred stock issues that are currently actively traded and only two of these companies have more than one such issue.

For the remaining 13 companies, this move by Fitch was merely an academic exercise; one that those reporting on the move should have made clear.

And then there is the other question: do the holders of the affected preferred stocks really care what Fitch thinks?

One way to answer that question is to look at how The Market reacted today, the day after Fitch’s big announcement.

Judging what The Market thinks about anything is tricky business to begin with. Prices have been falling for the last three days in reaction to the Obama plan to levy special taxes on banks.

But if The Market cared about the Fitch downgrades I would expect that the market price of the preferred stock issues that Fitch downgraded below investment grade would fall more than the issues that, even though they were downgraded, remained in investment grade territory.

Here’s today's market reaction to the Fitch preferred stock downgrades: the market price of the issues that were downgraded below investment grade fell an average of $0.10 while the issues that were downgraded, but remained in the investment grade category, fell an average of $0.44. This is the exact opposite result that we would expect if The Market was going to react to Fitch.

If The Market had any kind of reaction to the Fitch preferred stock downgrades you sure cannot tell by how holders traded their shares today. Now I realize that the sample size here is pretty slim to draw any big conclusions from; but that’s my point too. Fitch’s new preferred stock rating method does not really apply to anything.

If you’ve read my book, Preferred Stock Investing, you know that I follow the ratings issued by Moody’s more so than their competitors (Standard & Poor’s and Fitch). Subscribers to the CDx3 Notification Service are provided with real-time links to the preferred stock ratings by Moody’s.

Pre-credit crisis, it made little difference as the ratings from these three companies were extremely consistent. But by their own admission, the models used by these rating companies did not anticipate or accommodate the massive and simultaneous devaluation of U.S. real estate and everything connected to it.

The resulting litigation will continue for many more years and these agencies have been stumbling all over themselves ever since to show who can issue more downgrades. S&P changed its bank rating formulation last summer such that it would result in more downgrades, then Moody’s did the same thing last November. Now we see Fitch going after real estate companies.

But since Fitch’s efforts seem focused on companies that really do not have any currently actively traded preferred stocks their motivation for doing this becomes less clear than it should be.

If Fitch is feeling the need to re-establish some credibility, they appear to have missed an opportunity yesterday.

Many Happy Returns.