A tax-relief bill the House Ways and Means Committee proposed this week is making investors in a hybrid bank debt security nervous.
What worries them is that the bill ignores the subject.
Bankers and many on Wall Street expected the committee to produce a tax relief bill eliminating the tax deductibility in trust-preferred securities, which have enjoyed a surge of popularity since their debut last year.
Investors hoped the tax break would be eliminated. Bankers hoped it would be spared.
Trust-preferreds let banks raise regulatory capital cheaply and offer attractive yields to investors. But critics view them as an example of "corporate welfare."
Talk of removing the tax deductibility feature has been active in Congress for months, and action had long been expected in June. But the House proposal-presented Monday by Ways and Means Chairman Bill Archer, the Texas Republican, did not mention the securities at all, suggesting that their tax deductibility may remain intact.
In fact, one Washington lobbyist said eight House Democrats wrote letters to Rep. Archer, saying they did not want the issue brought up in the tax policy blueprint.
Many investors, however, were caught by surprise and did not take the news well.
When Rep. Archer presented his bill Monday, investors poured out of the securities, forcing spreads out by 5 basis points.
While some investors crept back into the market, anxiety still was apparent during Wednesday trading, some observers noted.
"Part of the value in the trust-preferreds comes from the expectation that it would be a limited market," pointed out Michael Buchanan, a bond trader with Conseco Capital Management, Carmel, Ind. "But if the window remains open, you have a scarcity value which really isn't there."
Mr. Buchanan said that he expects most of the anxiety in the market to dissipate over the next few days, since "you still can find good value in the market."
Bank bond analyst Matthew Burnell of Merrill Lynch & Co. said the reaction of the market has been premature since "no one knows any more than they did last week about the fate of trust-preferred securities." Indeed, the Senate Finance Committee could eliminate the tax deductibility in its upcoming proposal.
"I expect the market to continue to be volatile, particularly in the lesser names," said Mr. Burnell.
Bank bond analyst Allerton G. Smith at Donaldson Lufkin Jenrette Securities Corp. said the widening spreads actually present a buying opportunity.
"Most of the sellers are those who thought they would get a little pop once the window was closed," said Mr. Smith.
The analyst argued that in a worse-case scenario, some trust-preferred securities still have some upside.
Mr. Smith said that many trust-preferred securities should not trade much wider based on the analysis of the call feature. "The market is within 10 basis points of its fair value," he said.
