Strange Days Indeed

These are not "normal days in the capital markets. Current conditions are not typical even of bear markets and economic recessions. Contrary to what some pundits insist, today's economy is not similar to the banking crisis and depressed home values of the early 1990s. However, I have not come to rehash this argument, but to address some a-typical occurrences and discuss their causes.

Many financial advisers have asked me: "Why are the trust preferreds of several large banks (C) trading lower when they are paying their dividends"?

The reasons are two-fold. First, if an insufficient amount of preferred equity is exchanged into common, TRUPs and E-TRUPs investors may be permitted to participate (at the same 7.30768 common shares per preferred share). How does one coerce trust preferred owners to convert? One way is to suspend dividends (interest payments). Notice how the trust securities are trading at similar prices as the non-cum CprP and CprM? Another reason is that they are rated CC by S&P. That is forcing some investors to sell their shares.

Some advisers have asked me what will happen to investors who choose to neither convert nor sell CprP or CprM? They would then own non-paying, non-cumulative preferreds. It is unlikely that trading levels would remain in the $8 area. $1 or $2 Would be more likely. Owners of non-cum preferreds of the C, BAC and even WFC may want to move higher on the respective capital structures or simply move onto other investors. One could make the case for selling into any strength and move on to other investments


Some advisers and investor have expressed concerns that GE may spin off GE Capital. Although this is possible it is unlikely GE would spend more money to sufficiently capitalize GECC as a stand-alone company than it will to prop it up. Also consider that GECC is a bank holding company and has access to TARP and can issue more TLGP bonds. Some estimates state that GECC could issue another $70b worth of TLGP bonds. With the government on the hook for already-issued TLGP bonds I believe that GE CEO Immelt will be encouraged by the government to continue to support GECC (which has already received $9.5B from GE).

Why the big sell off in GE shares and GE bonds? It is due to fear and speculation. A very simple summary of what is happening to GE in the equity and CDS markets. GE shares are selling off out of concern that GE will expend large amounts of cash to support GECC. These cash expenditure concerns are also causing investors to seek default protection in the CDS market. This pushed up the cost of protection. The equity market sees this and sells off GE common. As the common price falls, the demand for credit protection rises. The equity market sees this and trades GE common lower. It is a fear-driven (with some initial substance) negative feed back loop.

Ford is reportedly seeking agreements with creditors o pay some bonds off at 28 cents on the dollar. The proceeds would be paid in cash and stock. This does not affect Ford Motor Credit which is responsible for its own debt. It is becoming decreasongly likely that any of the Detroit automakers will survive the recession (or worse) intact.