As the issuance of trust-preferred securities heats up again, so has the disagreement among analysts over the value of some of the hybrid instruments.
On Tuesday, Morgan Stanley & Co. recommended that investors selectively sell "highly rated (trust preferred) securities and lock in their gains" because of tightening spreads and the high price of some of the issues.
Corporate bond strategists Krishna Memani and Rachel Muszala advised investors to buy similar securities offered by such insurance company issuers as Aon Insurance Inc. or Travelers Inc.
In the last three months, banks have issued more than $18 billion worth of trust-preferred securities because they are the cheapest way to raise regulatory capital. Proceeds of the securities are tax deductible and can be applied as Tier 1 capital.
Investors initially clamored for the securities because of runaway yields. However, spreads have narrowed as a result of oversupply and aggressive pricing on the part of underwriters, analysts said.
Market observers noted that First Union's $250 issue, which came to market on Monday, was initially priced at 104 basis points over comparable Treasuries, but had since widened to 115 over Treasuries by midday.
A Compass Bancshares $250 million issue, which came out on Tuesday, started out at 139 basis points over comparable Treasuries but is expected to widen.
Mr. Memani and Ms. Muszala argued that many of the higher-rated public issues trade at a premium because of the 10-year call options offered on most of the securities, which mature in 30 years if the option is not exercised.
Banks are likely to exercise the options because the Treasury probably will change the tax deductibility of the securities, Mr. Memani and Ms. Muszala wrote, and upcoming legislation may eliminate it.
Either scenario could force banks to turn to more expensive refinancing, such as issuing dividend-received deductions, preferred securities, or 20- year capital securities.
The strategists estimated that public trust preferreds callable in 10 years could trade at a premium 25 to 45 basis points less than a subordinated bank bond from the same issuer.
"Because the market is discounting the best case and ignoring the worse case, we believe investors should take profits in higher-rated public issues," the strategists warned.
Other analysts say investors should continue to buy trust-preferred securities because the market continues to offer value.
Analyst Allerton Smith of Donaldson Lufkin & Jenrette said that his bond division had added more trust-preferred securities in its model portfolio because the securities still offer a low risk and high value.
"I would never recommend that someone buy these securities indiscriminately, but for the most part the trust-preferred security structure remains an attractive alternative for investors."
Mr. Smith said that the chances of banks exercising their call options is highly unlikely. "To suggest that banks would call the securities in 10 years and refinance with new 20-year trust preferreds is incorrect."
Mr. Smith pointed out that the Federal Reserve has not allowed securities with 20-year maturities to count as Tier 1 capital - one of the reasons why banks began issuing trust-preferred securities.
He also noted that issuing other securities, such as dividend-received deductions, is much more expensive.
Another reason to invest: "Bank fundamentals are at record levels, bank credit quality is excellent, and trust-preferred securities present an opportunity to attain more yield within bank corporates without substantially increasing credit risk."
