In early 1999 I was looking to put $100,000 in fixed-income with a high yield, but not a junk bond. My Fidelity rep suggested a new issue whose syndicate they were in: Foster Wheeler Preferred Capital Trust I, a preferred-type instrument with a 9% interest rate. My rep said it would always trade around $25 a share. I bought 4,000 shares. Well, it traded around $25 from March to December 1999 and then the bottom dropped out. Foster Wheeler common stock was removed from the S&P 500 list and dropped like a rock. My preferred dropped from $24 to $13. It still pays 9% interest but Fidelity won't comment on why it has fallen. Was this a bag job? -- Hank Humphrey

Hank,

There's just nothing good about this situation. So I'm not sure anything I have to say is going to make you feel any better. But let me at least try to explain what happened.

You bought trust preferred securities issued by

Foster Wheeler

, a leading New Jersey-based engineering and construction company that was indeed dropped from the S&P 500 index at the end of January. As far as I can tell, though, that didn't have anything to do with why your preferred shares are in the tank.

As a previous

Fixed-Income Forum explains in greater detail, preferred shares are a stock-bond hybrid. They're more like bonds than stocks, though. From the investor's perspective, they're like stocks only in that they're exchange-listed. Like bonds, they have a face value (typically $25), a maturity date, and they pay interest at a fixed rate -- in your case, 9%. So for each share, you receive $2.25 a year in four quarterly installments until the shares mature in 2029 or are called.

Preferred shares are different from bonds in a key respect, though: They are less secure. A company has to pay its bondholders before it can pay its preferred shareholders. And companies reserve the right to defer for up to five years dividend payments to their preferred shareholders. (They have to pay preferred dividends before they can pay common dividends, however.)

Your story has at least two troubling aspects. The first is that you say you wanted "fixed-income with a high yield, but not a junk bond." Well, technically you didn't buy a junk bond. But the line between junk bonds and your preferreds is very fine.

Like bonds, preferred shares generally carry ratings from the leading credit rating agencies,

Moody's Investors Service

and

Standard & Poor's

. S&P initially rated your preferreds BBB-minus, which is the lowest rating a debt instrument can have and still be considered investment grade. But Moody's rated it Ba2, which is a junk rating. Your rep ought to have told you that. A Fidelity spokeswoman says the company's policy is to present at least three different options fitting a customer's parameters, and the customer makes the final decision.

On to what happened after you bought the shares: As this chart shows, your shares held up reasonably well until late November, when they crashed.

Preferred No More
Foster Wheeler preferreds took a sudden dive in late November.

The chart for the common shares, while not a pretty sight, doesn't show anything like the violent debacle that befell the preferreds.

A Measured Decline
Foster Wheeler's common shares fell out of favor more gradually.

A lot happened over that period. To summarize, Foster Wheeler and its preferreds started out with low ratings in part because the company has a lot of debt, in part because of tough conditions for its sector and in part because of a particular problem it had in Robbins, Ill.

Foster Wheeler's investment in a recycling plant in Robbins became uneconomical in 1996 when Illinois repealed a state subsidy.

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Starting before your preferreds were issued, Foster Wheeler went back and forth on whether to write off the investment and if so, how much of it. Finally, in October, it reached a debt restructuring agreement with bondholders who had financed the Robbins plant, and said it would take a $214 million charge against fourth-quarter earnings.

None of this had a particularly deleterious effect on the preferred share price. The common share price reacted predictably to the company's quarterly earnings announcements detailing Robbins-related losses and to the stock and debt ratings downgrades that sometimes followed. (Moody's still rates your preferreds Ba2. S&P adjusted them to junk status in February 1999, based on a change in its methodology affecting all preferred ratings, then downgraded them to BB in September.)

But the real damage to the preferred shares didn't come till late November, and it's not clear exactly why. On Dec. 1, the decline extended when three Robbins-related Foster Wheeler subsidiaries declared bankruptcy. This wasn't news, really. It was all part of the debt restructuring agreement for the Robbins bonds, and it didn't affect Foster Wheeler's other obligations. But hearing "Foster Wheeler" and "bankruptcy" in the same sentence was probably enough to prompt some people to sell.

What isn't clear is why the heavy selling started when it did, a few days before the Dec. 1 announcement. There was no other news on the company during that period. Foster Wheeler didn't respond to an invitation to comment. That's the other troubling aspect of your story.

It may have been simply because a large seller wanted out of the shares. The head of one firm's preferreds desk told me that the word on the Street was that a dealer owned a large block of the issue (400,000 to 500,000 shares) and was ordered to get out of it. Impossible, obviously, to confirm.

Now, you should also realize that that your preferreds are not alone in the tank. Many exchange-traded fixed-income products (also including closed-end bond funds) were sold with a vengeance at year-end. After a year in which rising interest rates had pushed their prices down, investors took losses that could be booked against the fabulous gains many had in the equity portion of their portfolios. The

Merrill Lynch Preferred Stock Fixed Rate Index

fell 1.3% in November and 3.4% in December.

Low-rated preferred like yours bore the brunt of the selling. If you want to see other examples, look at the charts for

Bergen Brunswig Capital Trust

(BBC-A)

or

Fremont General Financing

(FMT-)

.

This is liquidity risk. A low-rated company may not be anywhere near default. But that doesn't mean the price will hold up when someone wants to sell a lot of it. Obviously you should not have been told that the issue would always trade around 25. The Fidelity spokeswoman says its reps may provide historical trade data, but don't attempt to predict future prices. Still, an investment-grade preferred

should

always trade around 25, meaning in the 22 to 26 1/2 range. Junk preferreds, as you now know, are more vulnerable.

The only real good news is that those fat 9% dividends keep coming, and that's probably why you bought the shares in the first place. And with the fourth-quarter developments, the company has supposedly put Robbins behind it.

Send your questions and comments to

fixed-incomeforum@thestreet.com, and please include your full name. Fixed-Income Forum appears each Friday.

TSC Fixed-Income Forum aims to provide general bond information. Under no circumstances does the information in this column represent a recommendation to buy or sell bonds, funds or other securities.