*Accrued Interest* has deprecated US Preferreds as an investment, using what I call the ‘worst of both worlds’ argument; that the upside is limited compared to common and the downside is much greater (or at least more probable) than senior bonds.

I have written a short post with some background on US TruPS.

As I noted on FWF on the weekend:

I find – when having conversations such as this with stockbrokers – that it is very useful to look at actual numbers. In my article A Vale of Tiers, I looked at various Royal Bank investment vehicles and compared their expected returns to their degree of subordination.

Perhaps this thread could be profitably employed to update and expand the “Table 1” of my article.

Preferred shares represent a range on the risk/return spectrum that will be of interest to many investors. I will note that despite some alarmist stockbroker talk very few issues actually default. There are nine defaulted issues on the NYSE, according to Quantum Online; four of which are from Thornburg Mortgage. As counterexamples, one may consider Citibank and Fortis Bank, both of which have massively diluted their common shareholders and cut the common dividend (the latter to zero) without inconveniencing the preferred shareholders. For many battered companies, issuance of preferred stock is the only palatable option; they are not going to cut their own throats by cutting the dividend with gay abandon.

For investors in Canadian bank preferreds, it should be noted that preferred stock and innovative tier 1 capital are capped at a limit of 30% of total Tier 1 Equity. If they were to slowly drift into bankruptcy, they would be taken over by OFSI and the CDIC when their Tier 1 ratio declined below 4% (possibly at the 5% level). At these levels, there will still be some common equity left; preferred capital will not be impaired.

Therefore, the most realistic nightmare scenario is a jump to default; investors may assign their own probabilities to this.

Diversify!

I would have been much more impressed with the *Accrued Interest* post had he used actual numbers and made some effort to quantify risk. Yes, you can lose every dime investing in preferreds – you can lose every dime investing in any corporate security. But what are the odds? Let’s see an attempt to quantify risk whenever we quantify return.

That being said, it should be noted that Wachovia had a Tier 1 Ratio of 7.35% (well below the Canadian average of about 9.5%) and a Total Capital ratio of 11.82% (about the Canadian median). Determining the effective subordination of the issue highlighted by *Accrued Interest* is made a little more difficult by the prospectus note for the issue highlighted (NYSE: WBPRC):

Wachovia receives a significant portion of its revenue from dividends from its subsidiaries. Because it is a holding company, its right to participate in any distribution of the assets of its banking or nonbanking subsidiaries, upon a subsidiary’s dissolution, winding-up, liquidation or reorganization or otherwise, and thus your ability to benefit indirectly from such distribution, is subject to the prior claims of creditors of any such subsidiary, except to the extent that Wachovia may be a creditor of that subsidiary and its claims are recognized. There are legal limitations on the extent to which some of its subsidiaries may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with, it or some of its other subsidiaries. Wachovia’s subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay amounts due under Wachovia’s contracts or otherwise to make any funds available to it. Accordingly, the payments on the LoTSSM, and therefore the Trust Preferred Securities, effectively will be subordinated to all existing and future liabilities of Wachovia’s subsidiaries. At December 31, 2006, Wachovia’s subsidiaries’ direct borrowings and deposit liabilities was $730 billion.

… and I ain’t gonna do it! I will say, however, that before opining on the merits or lack thereof on an investment in these TruPS, it should be done!

Incidentally, further down in the FWF thread where I made my comment, there was another post:

We were talking upthread about corporate versus preferred rates. While the IShares corporate bond ETF has not moved much, I noticed on the Waterhouse Fixed Income site that virtually all corporate banks now have a significant spread against their provincial same-rated counterparts. The spread approaches 1% starting three years out. Just a couple of years ago, that spread would have been maybe 0.2-0.3% (as I recall). So, it would appear that bank corporates have definitely been hit by the credit crisis.

See my note about the BoC Review of June 2008 … financials used to be 40-ish bp tight to industrials … now they’re even-ish.

Here’s another strangeness in which unitholders in the fund have an interest:

BMO Perpetuals | |||

Issue | Dividend | Quote 7/21 |
Pre-Tax Bid-YTW 7/21 |

BMO.PR.J | 1.1250 | 18.11-30 | 6.33% |

BMO.PR.K | 1.3125 | 20.90-00 | 6.40% |

BMO.PR.H | 1.3250 | 20.11-26 | 6.72% |

BMO.PR.L | 1.4500 | 23.05-40 | 6.48% |

One of these things is not like the others! One of these things is not quite the same! This is a very sloppy market. I have noted the volatility of the BMO.PR.H / BMO.PR.J spread previously. BMO.PR.H has – just now – been deleted from the TXPR index, so that might – might! – have something to do with it.

Sloppiness aside, PerpetualDiscounts moved up again … but are still below the levels they were at on July 11 and are still down 5.94% on the month.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30 |
|||||||

Index | Mean Current Yield (at bid) | Mean YTW | Mean Average Trading Value | Mean Mod Dur (YTW) | Issues | Day’s Perf. | Index Value |

Ratchet | 4.34% | 3.96% | 36,460 | 0.08 | 1 | +0.0000% | 1,122.4 |

Fixed-Floater | 4.68% | 4.41% | 71,453 | 16.31 | 6 | +0.2993% | 1,084.3 |

Floater | 4.16% | 4.19% | 54,301 | 17.04 | 3 | -0.7064% | 886.4 |

Op. Retract | 5.00% | 4.75% | 143,332 | 3.57 | 17 | -0.0920% | 1,038.7 |

Split-Share | 5.42% | 6.61% | 63,024 | 4.01 | 14 | +0.3773% | 1,020.3 |

Interest Bearing | 6.16% | 6.16% | 41,965 | 3.69 | 3 | -0.1677% | 1,118.4 |

Perpetual-Premium | 6.17% | 6.17% | 71,221 | 10.63 | 4 | -0.4322% | 977.4 |

Perpetual-Discount | 6.42% | 6.48% | 235,521 | 13.24 | 67 | +0.4173% | 825.1 |

Major Price Changes |
|||

Issue | Index | Change | Notes |

PWF.PR.I | PerpetualDiscount | -3.0928% | Now with a pre-tax bid-YTW of 6.41% based on a bid of 16.52 and a limitMaturity. |

BAM.PR.B | Floater | -2.9240% | |

TCA.PR.X | PerpetualDiscount | -2.8970% | Now with a pre-tax bid-YTW of 6.19% based on a bid of 45.25 and a limitMaturity. |

RY.PR.B | PerpetualDiscount | -2.4066% | Now with a pre-tax bid-YTW of 6.29% based on a bid of 19.06 and a limitMaturity. |

IGM.PR.A | OpRet | -2.0519% | Now with a pre-tax bid-YTW of 5.59% based on a bid of 25.30 and a softMaturity 2013-6-29 at 25.00. |

BMO.PR.L | PerpetualDiscount | -1.9149% | Now with a pre-tax bid-YTW of 6.48% based on a bid of 23.05 and a limitMaturity. |

POW.PR.D | PerpetualDiscount | +1.8898% | Now with a pre-tax bid-YTW of 6.75% based on a bid of 18.69 and a limitMaturity. |

HSB.PR.C | PerpetualDiscount | -1.5707% | Now with a pre-tax bid-YTW of 6.87% based on a bid of 18.80 and a limitMaturity. |

RY.PR.F | PerpetualDiscount | -1.3691% | Now with a pre-tax bid-YTW of 6.30% based on a bid of 18.01 and a limitMaturity. |

BNA.PR.C | SplitShare | -1.3521% | Asset coverage of 3.2+:1 as of June 30, according to the company. Now with a pre-tax bid-YTW of 8.94% based on a bid of 17.51 and a hardMaturity 2019-1-10. Compare with BNA.PR.B (8.48% to 2016-3-25) and BNA.PR.A (6.22% to 2009-10-31). |

TD.PR.P | PerpetualDiscount | -1.1905% | Now with a pre-tax bid-YTW of 6.10% based on a bid of 21.58 and a limitMaturity. |

RY.PR.A | PerpetualDiscount | -1.0805% | Now with a pre-tax bid-YTW of 6.20% based on a bid of 18.31 and a limitMaturity. |

GWO.PR.H | PerpetualDiscount | +1.0811% | Now with a pre-tax bid-YTW of 6.56% based on a bid of 18.70 and a limitMaturity. |

CIU.PR.A | PerpetualDiscount | +1.1170% | Now with a pre-tax bid-YTW of 6.16% based on a bid of 19.01 and a limitMaturity. |

SLF.PR.C | PerpetualDiscount | +1.1869% | Now with a pre-tax bid-YTW of 6.61% based on a bid of 17.05 and a limitMaturity. |

POW.PR.B | PerpetualDiscount | +1.1988% | Now with a pre-tax bid-YTW of 6.66% based on a bid of 20.26 and a limitMaturity. |

BAM.PR.M | PerpetualDiscount | +1.2232% | Now with a pre-tax bid-YTW of 7.27% based on a bid of 16.55 and a limitMaturity. |

BNS.PR.J | PerpetualDiscount | +1.2287% | Now with a pre-tax bid-YTW of 6.16% based on a bid of 21.42 and a limitMaturity. |

PWF.PR.E | PerpetualDiscount | +1.2315% | Now with a pre-tax bid-YTW of 6.73% based on a bid of 20.55 and a limitMaturity. |

CM.PR.D | PerpetualDiscount | +1.2840% | Now with a pre-tax bid-YTW of 7.06% based on a bid of 20.51 and a limitMaturity. |

CM.PR.J | PerpetualDiscount | +1.2939% | Now with a pre-tax bid-YTW of 6.89% based on a bid of 16.44 and a limitMaturity. |

SLF.PR.B | PerpetualDiscount | +1.3609% | Now with a pre-tax bid-YTW of 6.52% based on a bid of 18.62 and a limitMaturity. |

WFS.PR.A | SplitShare | +1.3636% | Asset coverage of just under 1.6:1 as of July 10, according to Mulvihill. Now with a pre-tax bid-YTW of 9.75% based on a bid of 8.92 and a hardMaturity 2011-6-30 at 10.00. |

BCE.PR.C | FixFloat | +1.4577% | |

ALB.PR.A | SplitShare | +1.5414% | Asset coverage of just under 1.6:1 as of July 17, according to ScotiaManagedCompanies. Now with a pre-tax bid-YTW of 5.78% based on a bid of 24.25 and a hardMaturity 2011-2-28 at 25.00. |

CU.PR.A | PerpetualDiscount | +1.7204% | Now with a pre-tax bid-YTW of 6.23% based on a bid of 23.65 and a limitMaturity. |

CM.PR.P | PerpetualDiscount | +1.7551% | Now with a pre-tax bid-YTW of 7.03% based on a bid of 19.69 and a limitMaturity. |

BNS.PR.N | PerpetualDiscount | +1.8771% | Now with a pre-tax bid-YTW of 6.06% based on a bid of 21.71 and a limitMaturity. |

CM.PR.E | PerpetualDiscount | +1.8782% | Now with a pre-tax bid-YTW of 7.02% based on a bid of 20.07 and a limitMaturity. |

SLF.PR.A | PerpetualDiscount | +2.1358% | Now with a pre-tax bid-YTW of 6.45% based on a bid of 18.65 and a limitMaturity. |

BAM.PR.H | OpRet | +2.2403% | Now with a pre-tax bid-YTW of 5.77% based on a bid of 25.10 and a softMaturity 2012-3-30 at 25.00. Compare with BAM.PR.I (6.31% to 2013-12-30), BAM.PR.J (7.04% to 2018-3-30) and BAM.PR.O (6.47% to 2013-6-30). |

ELF.PR.G | PerpetualDiscount | +2.3573% | Now with a pre-tax bid-YTW of 7.27% based on a bid of 16.50 and a limitMaturity. |

CM.PR.H | PerpetualDiscount | +2.4332% | Now with a pre-tax bid-YTW of 7.00% based on a bid of 17.26 and a limitMaturity. |

PWF.PR.F | PerpetualDiscount | +2.9186% | Now with a pre-tax bid-YTW of 6.57% based on a bid of 20.10 and a limitMaturity. |

DF.PR.A | SplitShare | +3.4375% | Asset coverage of just under 1.8:1 as of July 15, according to the company. Now with a pre-tax bid-YTW of 5.47% based on a bid of 9.93 and a hardMaturity 2014-12-1. |

POW.PR.A | PerpetualDiscount | +3.9652% | Now with a pre-tax bid-YTW of 6.57% based on a bid of 21.50 and a limitMaturity. |

Volume Highlights |
|||

Issue | Index | Volume | Notes |

TD.PR.O | PerpetualDiscount | 74,800 | (Three different?) Anonymous (es?) bought from Nesbitt 2 blocks of 10,000 each at 20.60, and one block of 12,900 at 20.75. Now with a pre-tax bid-YTW of 5.90% based on a bid of 20.65 and a limitMaturity. |

PWF.PR.I | PerpetualDiscount | 42,750 | Nesbitt crossed 38,700 at 24.01. Now with a pre-tax bid-YTW of 6.41% based on a bid of 23.50 and a limitMaturity. |

CL.PR.B | PerpetualPremium | 40,900 | Nesbitt crossed 40,000 at 25.26. Now with a pre-tax bid-YTW of 6.02% based on a bid of 25.25 and a call 2011-1-30 at 25.00. |

BNS.PR.J | PerpetualPremium | 39,210 | Anonymous bought 10,000 from Nesbitt at 21.35. Now with a pre-tax bid-YTW of 6.16% based on a bid of 21.42 and a limitMaturity. |

RY.PR.H | PerpetualDiscount | 32,800 | National Bank crossed 25,000 at 24.10. Now with a pre-tax bid-YTW of 5.95% based on a bid of 24.10 and a limitMaturity. |

There were twenty-one other index-included $25-pv-equivalent issues trading over 10,000 shares today.

I guess there’s a typo: in the Major Price Changes column, SLF.PR.C is listed as a SplitShare but I believe it should be listed as a PerpetualDiscount instead.

Oopsy! I guess you’re right!

Thanks!

[…] and Thornberg prefs were mentioned yesterday and as it happens both are in the news […]