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My guess is you haven't brought the
Restoring American Financial Stability Act (the official
name of the just-passed financial reform act) to the lake
with you this summer.
At 2,300 pages and filled with 100-word sentences written in
complex legalese, the bill -- signed into law with much
fanfare by President Obama on July 21st -- is not exactly
light reading.
However, buried in this legislation is Section 171, the
Collins Amendment. And this single amendment dramatically
impacts us income investors. It completely alters the status
of one of the more popular high-yield investments.
The good news is that this change will give savvy investors
who know where to look the ability to lock in attractive
6-7% yields, investment-grade safety, and the potential for
capital gains within three to five years.
But this opportunity will not be around for long. The rule
changes are already in place. The window is open now, but
begins to close in 2013 and shuts completely at the end of
2015.
The high-yield opportunity I'm talking about lies with trust
preferred stock, also called trust unit preferred shares or
"TruPS." Banks are usually associated with these shares...
but that may be changing. (If you own the preferreds of a
bank, they stand a good chance at being trust preferreds.)
You see, TruPS aren't issued directly by the bank. Instead,
the bank sets up a new company or off-balance sheet trust.
When TruPS are issued, the trust receives the offering
proceeds, not the bank. However, the trust then turns around
and loans the proceeds to the bank. This convoluted
financing was worth it because banks were allowed to count
TruPS toward Tier 1 capital -- a basic measure of a bank's
financial strength. During the height of the financial
crisis, banks issued $149 billion of trust preferred stock,
according to the Federal Reserve Bank of Philadelphia.
But the financial reform act changes all that. In the
future, banks won't be able to include TruPS in Tier 1
capital. The phase out period begins January 1, 2013 and
will be complete by December 31, 2015.
This change has major implications for us income investors.
The biggest is that some banks may choose to redeem their
TruPS over the next three to five years. Today, however,
these TruPS carry high coupons associated with 30-year
investments.
Since TruPS will no longer serve their original purpose of
counting as Tier 1 capital, banks will have no reason to
hold them. As well, the additional costs of setting up and
maintaining the issuing trust are unattractive.
That leaves three possible outcomes. First, some banks will
choose to do nothing and simply allow their TruPS to mature
and not issue any more. Most mature by 2030. Other banks may
choose to issue traditional preferred or common stock to
shore up Tier 1 capital and then offer TruPS holders the
option of converting to these issues.
A third outcome is redemption... and that's where the
opportunity lies.
Banks could begin calling TruPS as early as October of this
year. If you buy TruPS below their par value (typically
$25), this will lead to potential capital gains if the
security is called. Of course, that is in addition to the
high yields these pay while you wait. Remember that these
were issued with a long-term outlook, so the yields they pay
are associated with 30-50 year bonds, instead of the 3-5
year outlook before the law changes and TruPS don't count as
Tier 1 capital.
If you want to do some hunting for trust preferred
securities on your own, I'd recommend
QuantumOnline.com. They have a list of current TruPS on
the market. (It's free, with registration. Look under than
"Income Tables" tab.) Remember, not all TruPS will be
called, so you have to be selective. Be on the lookout for
those trading below par value and backed by investment-grade
credit ratings.
Good Investing!
Carla Pasternak's Dividend Opportunities
P.S. -- If you're interested in earning high
yields from this opportunity, you'll love my September issue
of
High-Yield Investing. There, I highlighted two of my
favorite plays -- both with 6%-plus
yields and the chance for capital gains. And it all comes
thanks to Washington's latest legislation.
Click here to learn how to receive my September issue.
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Related reading from Dividend
Opportunities...
Washington can impact your investments for better... or
worse. Carla recently put together an article on what could
happen to our favorite income plays if tax rates on
dividends rise. Read:
What could Happen With Your Favorite Income Spots. |
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