Banks Find New Way to Squeeze Investors: Street Whispers

NEW YORK (TheStreet) -- Fixed-income investors are in the midst of a harsh transition as banks redeem their trust preferred shares.

In June the Federal Reserve proposed enhanced capital requirements for large banks that exclude most trust preferred shares from regulatory Tier 1 capital. Since this is considered a "capital treatment event," banks can redeem their trust preferred shares, even before the call date, often at face value, despite any premium the market previously placed on trust preferred shares paying high dividends.

Investors who "went in" over the past several years -- while possibly paying premiums for trust preferred shares on top of any commissions paid to their brokers -- are not only facing possible capital losses, they face a huge headache in trying to replace as much of their lost income as possible, without greatly increasing their risk.

Investors who traditionally relied on municipal or corporate bonds for income, have faced a difficult choice for nearly two decades as yields have declined, either to accept ever-shrinking yields or broaden their horizons.

Under the Federal Reserve's proposed new capital rules, banks will be able to have noncumulative perpetual preferred stock making up between 1% and 1.5% of their Tier 1 risk-based capital ratios.

So we're in the midst of a wave of trust preferred redemptions, with some banks and financial services companies also issuing new preferred shares with lower coupons, that are noncumulative, meaning that dividends can be suspended without missed dividends in arrears being paid.