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What about trust preferreds?
Old 03-12-2012, 10:11 PM   #1
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What about trust preferreds?

One thing about investing -- you never stop learning. It's humbling, isn't it? I count myself among those who know nothing about trust preferreds offered by banks, explained in this article. Anyone here keep a substantial percentage of his/her investments in them? Any experience to share?

Like everyone else, I'm worried about bond performance as interest rates rise and would like to consider alternatives for at least part of the non-stock portion of the portfolio.
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Old 03-13-2012, 12:50 AM   #2
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I have been purchasing some preferred stocks for about the last 3 years. They pay a better dividend than common and the price of the stock does not move that much. I see it somewhat like a bond as a security that provides a fixed income.

I first purchased MET/PRB (Met life) about 3 years ago which pays an dividend of over 6%. I have since purchased a few others mostly in Real Estate Trusts, financials and utilities.

They trade just like any other stock, but the daily volume is much lower.

I have done well with them so far. I think that I have about 50k in them now. I just replaced a bond that expired with a preferred.

The big downside is that you will not see a big gain in the price of the stock if the common goes up.
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Old 03-13-2012, 05:59 AM   #3
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Deferral of interest, non-cumulative provisions, call features, priority of claim, and tax liability implications are some of the factors worthy of consideration.
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Old 03-13-2012, 07:27 AM   #4
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Like everyone else, I'm worried about bond performance as interest rates rise and would like to consider alternatives for at least part of the non-stock portion of the portfolio.
If you are worried about rising long-term interest rates, preferred stock is among the worst places you could be since the duration is very long. A 200 basis point rise in interest rates could easily send the price of preferred's down 30%.

Don't be fooled by the fact that these are callable in 2-3 years. Yes, they will be called if rates remain low, but should rates rise significantly, they won't be. So, best case, you'll effectively have a short-term instrument yielding 6% for 2-3 years.

Also, the dividends paid by Trust Preferred's do not qualify for the 15% (or 0%) tax rate as do regular preferred's, although this may not be an issue should the Bush tax cuts expire in their entirety at the end of 2012.
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Old 03-13-2012, 09:11 AM   #5
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Deferral of interest, non-cumulative provisions, call features, priority of claim, and tax liability implications are some of the factors worthy of consideration.
Also deep subordination.
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Old 03-13-2012, 09:38 AM   #6
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Also deep subordination.
Dat's priority of claim
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Old 03-13-2012, 04:06 PM   #7
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Dat's priority of claim
Yup, didn't see it there.
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Old 03-13-2012, 10:42 PM   #8
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Deferral of interest, non-cumulative provisions, call features, priority of claim, and tax liability implications are some of the factors worthy of consideration.
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Also deep subordination.
I think I'm out of my depth. Following the "if you don't understand it, don't invest in it" maxim, I'll pass. Thanks for the posts.
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Old 03-13-2012, 11:09 PM   #9
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If you are worried about rising long-term interest rates, preferred stock is among the worst places you could be since the duration is very long. A 200 basis point rise in interest rates could easily send the price of preferred's down 30%.

Don't be fooled by the fact that these are callable in 2-3 years. Yes, they will be called if rates remain low, but should rates rise significantly, they won't be. So, best case, you'll effectively have a short-term instrument yielding 6% for 2-3 years.

Also, the dividends paid by Trust Preferred's do not qualify for the 15% (or 0%) tax rate as do regular preferred's, although this may not be an issue should the Bush tax cuts expire in their entirety at the end of 2012.
Interesting details. Does the same apply to something like the PowerShares Financial Preferred Portfolio, symbol PGF?
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Old 03-14-2012, 06:17 AM   #10
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Interesting details. Does the same apply to something like the PowerShares Financial Preferred Portfolio, symbol PGF?
I have a dozen rotten eggs on a plate. On the next table I have dozen rotten eggs in a paper bag labelled "breakfast." Which tastes better?
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Old 03-14-2012, 07:21 AM   #11
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Interesting details. Does the same apply to something like the PowerShares Financial Preferred Portfolio, symbol PGF?

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I have a dozen rotten eggs on a plate. On the next table I have dozen rotten eggs in a paper bag labelled "breakfast." Which tastes better?
Negatory?
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Old 03-14-2012, 07:37 AM   #12
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Negatory?
Anything at the right price...
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Old 03-14-2012, 07:42 AM   #13
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Anything at the right price...
Exactly
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Old 03-14-2012, 06:19 PM   #14
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I think we are being a bit too negative on trust preferred as long as the OP understands what they are buying and the numerous caveats, I think they are reasonable investment for part of your fixed income portfolio.

The one thing the article didn't highlights is that trust preferred have a very very long maturity in the 2060s for the WFC and USB for example. I think the most important think to understand is that 6% is almost certainly an absolute ceiling on what you can earn with them. There are many ways you can earn less.

The most likely scenario is that will be redeemed in the next 3 months to couple of year at par and since they are trading about 1% above par (25.25 for the Well Fargo 6.25% FWF) you'll have a modest capital loss, but get 6%+ interest until they are called. At 6%+ they are expensive capital for very strong bank like Wells Fargo, or even a strong bank like US Bank.

Risk wise they are very hard to evaluate. IMO a 1-2% increase in interest rates is actually probably good for them since it would like cause them to trade a bit below par and hence less likely to be called. On the other hand a large raise say 3-5% in interest rates would have almost certainly result in a 30%+ drop in price because their maturity is so long. They'd also fall dramatically during a new bank crisis, since it is very unclear what the status of preferred share holders for a too big to fail bank is.

Still there are some definite pros they trade like stocks, are relatively liquid, they are backed by some very solid companies, and most importantly 6+% is interest rate which provides a reasonable return after inflation.
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Old 03-14-2012, 08:34 PM   #15
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Still there are some definite pros they trade like stocks, are relatively liquid, they are backed by some very solid companies, and most importantly 6+% is interest rate which provides a reasonable return after inflation.
Not to me it wouldn't. If I am accepting a bounded best case, I want a bounded risk. Like good credits, senior position, <~3 years duration. Or, if the credits are not so good, I want them to be bought cheaply enough that a critical evaluation of defaults and recoveries would still create good results.

The only reason that we are looking at this type thing is we haven't been bitten in a while, and it looks like interest rates are fairly stable and low.

I cannot predict how or when this will change, but change it will, and soon enough to damage anyone holding 50 year paper.

Ha
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Old 03-14-2012, 09:16 PM   #16
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Not to me it wouldn't. If I am accepting a bounded best case, I want a bounded risk. Like good credits, senior position, <~3 years duration. Or, if the credits are not so good, I want them to be bought cheaply enough that a critical evaluation of defaults and recoveries would still create good results.

The only reason that we are looking at this type thing is we haven't been bitten in a while, and it looks like interest rates are fairly stable and low.

I cannot predict how or when this will change, but change it will, and soon enough to damage anyone holding 50 year paper.

Ha
Makes sense to me.

Pricing the features on these things, like coupon deferrals, is a bear. Valuing things that seem relatively straight forward, like call features, can even trip up professional investors. I can only imagine what kind of pricing retail investors get.

Like Brewer says, "anything at a price" but I think Ha's assessment is more applicable: starved for yield we're digging deep for 6% when five years ago the same yield could be had on a Aa 3 year and will be again.
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Old 03-14-2012, 09:31 PM   #17
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Makes sense to me.

Pricing the features on these things, like coupon deferrals, is a bear.
Yes, IMO a huge problem. I own a timber MLP that prior to the 07-09 stress put a good portion of the cash on their balance sheet into Tr. pfds. They were hurting for a while, as they got no payments, and could not even get quotes on these securities. As I remember, this forced some balance sheet reclassifications.

Fortunately they had no need to borrow, so it worked out, but not a cuddly situation.

Ha
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Old 03-15-2012, 03:52 AM   #18
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Makes sense to me.

Pricing the features on these things, like coupon deferrals, is a bear. Valuing things that seem relatively straight forward, like call features, can even trip up professional investors. I can only imagine what kind of pricing retail investors get.

Like Brewer says, "anything at a price" but I think Ha's assessment is more applicable: starved for yield we're digging deep for 6% when five years ago the same yield could be had on a Aa 3 year – and will be again.
All good points, I guess I am looking at them on a relative basis. You get 50% more income from the Wells Fargo preferred than 30 year treasury, for a 65 year old retiree odds are good you'll be dead before the bonds either mature or default.

To get 6-6.5% in bond you need to go out a long time 20-30 years and credit in the low investment/top of the junk category. I'd feel a bit more secure having trust preferred from Wells Fargo than 25 year bond from Qwest for roughly the same yield. Although, I am not at all confident on this statement.

Many trust preferred trade like stocks making pricing much more transparent, with a lower markup than most bonds, the ER for them is ~$10 for life if you just buy them and forget them.

Not an investment I am thrilled with for all the reason everybody says, but if you need income and relatively low risk I think there are worse places.

I am starting to think that a variation on theme "the market can stay irrational longer than you can stay solvent", is "interest rates can remain at irrationally low levels longer than you can stay solvent", maybe true.

I do long for the good old days when AA bonds 3 year were 6% and even better so were Pen Fed 5 years CD. Even for us relatively sophisticated investors this has been an hard time to make money, I really feel sorry for the typically retiree depending on income from savings to supplement their SS checks.
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Old 03-15-2012, 04:30 AM   #19
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I have held Power Shares Financial Preferred ETF (PGF) and IShares Trust (PFF) for almost 2 years. Both paying over 7% and the price has been stable. You need to know what you're iinvesting in.
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Old 03-15-2012, 07:29 AM   #20
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I believe many of these preferreds have a par value of $25, so you can see how your entry price compares to that and what you would get if called. Also, you will see call protection through a certain date, after that all bets are off as to when it will be called and as someone pointed out these are long term securities. I think they can be a reasonable part of your port to spike yield, but I would suggest limiting them to maybe < 5% of your port.
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