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Investors need to be satisfied with the present yields on floating rate preferreds (FRPs), because the coupon is not likely to adjust higher for a long time.

Although the call decision for the issuer is not as straightforward with a floating rate as with a fixed rate instrument, investors ought to be aware of the prospect that the security could be called. HBA Pr G is trading below its call price, so the yield-to-call is higher than the yield-to-maturity shown in the table below.

The typical floating rate preferred pays the higher of a floor rate, usually 3% or 4%, and a rate determined by a formula, typically a markup of 50-75 basis points over three month LIBOR. Most floating rate preferreds are now paying their minimum coupon rate. The last column of the table below shows how much the three-month LIBOR rate would have to rise in order for the coupon rates to rise above the floor rate and adjust higher.

Normally, three-month LIBOR moves in line with the federal funds rate, although it can rise with concerns about the credit quality of banks. If the Fed doesn’t begin raising rates until 2012, it will likely take at least two years before the coupons on most floating rate preferreds adjust higher.

The list of securities that meet our selection criteria (liquidity - outstanding par amount of at least $100 million, and average trading volume during the past 30 days of at least 5,000 shares; quality - an investment grade rating from both Moody’s and S&P; call protection – at least two years) has been shrinking for some time. Since most preferreds are issued with five year call protection, and issuance has been sparse during the past 2 ½ years, the list of eligible securities is dwindling.

The Table below lists the FRP that we believe has an attractive yield for its credit rating. The name meets the selection criteria, except, it has less than two years of call protection.

Ticker

Issuer

Rating

Next Call

Strip Price

Coupon

Yield

LIBOR↑ *

HBA PrG

HSBC USA Inc.

Baa1 A-

8/1/2011

23.65

4.00%

4.23%

3.01%

* LIBOR increase needed for coupon rise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: A Floating Rate Preferred With Value