Myth Busters

During the course of my ever busier work days, I am confronted with all kind of investment (in some cases, conspiracy) theories. Let's address some actual theories put forth by investment advisers.

1) Bank are issuing non-cumulative preferreds because they can "get away with it."

Okay, let's be clear. It is in an issuers best interest to issue cumulative trust preferreds which are 1099-INT reporting as they can write the interest payments off at tax time. This is why over 90% of the preferreds issued since 1993 have been a form of trust preferred. Companies do not issue non-cumulative preferred securities with the idea that they may need to eliminate the dividend. That is asinine as doing so will exclude one from accessing the capital markets. The reason why issuers are coming to market with traditional non-cumulative preferreds is that companies are full up in their Tier-2 debt capital buckets. They need to come to market with dividend paying Tier-1 to maintain capital ratios even though it is more expensive for them to do so.

2) Buying the biggest discount will ensure me the biggest gain when they are called at par.

Hint, the biggest discounts are found with bonds and preferreds which have the lowest coupons and are the least likely to be called.

3) Preferreds trading near par in this environment stand to drop in value more than issues trading at discounts.

Actually, the opposite is true. The higher the coupon, the shorter the duration. The shorter the duration, the less volatile they are when rates rise and / or spreads widen to result in higher yields.

4) When interest rates rise, prices of corporate bond and preferreds will fall.

Maybe, maybe not. It call depends on credit spreads. One only needs to look back over the past year. Interest rates fell (as observed in the treasury market), but yields of many corporate bonds and preferreds in the bank and finance sectors rose. It all had to do with widening credit spreads. As these companies fell on hard times their balance sheets were stressed and they became less creditworthy. The result was that interest rates and credit yields moved in opposite directions. In theory, the opposite should be true during a recovery. Note: Due to balance sheet damage and increased supply of bonds and preferreds, it is unlikely that we will see a return to the record-tight spreads of a few years ago.

5) The Treasury instituted its rescue plans of the GSEs so it could take them over.

This is so ridiculous I shouldn't waste my time commenting on it. There is no upside for anyone (except maybe agency bond and MBS holders at the expense of EVERYONE else) if the GSEs are nationalized).

6) The automakers are too big to fail.

This is 2008, not 1958, 1968 or 1978. The government has its hands full with the banks and GSEs (either of which are more important than the autos at this time).

If investment advisers read real research and used common sense instead of listening to media talking heads, fund managers talking their books and looking for conspiracy theories, everyone would be better off.