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Good Banks, Bad Banks

07/29/2009 10:25 am EST


Neil George

Editor, Profitable Investing

Neil George, editor of By George, says big banks are gaming the system while smaller lenders suffer, but he says some banks’ preferred stock offers compelling value.

The biggest banks with their massive trading and investment operations and top-tier lobbyists have gamed the system so that they're rocking and rolling while the smaller banks are feeling the pinch of the credit crunch.

The big guys such as Goldman Sachs Group (NYSE: GS) and JP Morgan Chase (NYSE: JPM)—with all of their tight connections over at the Federal Reserve, Treasury Department, and 1600 Pennsylvania Avenue—are having some of their best times ever. These banks aren't in the lending business—well, not as much as their more pedestrian cousins, commercial banks.

They do own plenty of commercial, consumer, and property debt that, if brought to the markets, would be considered too toxic to handle. But because these "assets" are securitized, their owners get to assign their own values to the loans and bonds. Even better, they get to post it as collateral for all sorts of Federal loans and swaps.

Then, they still get to borrow at or near zero interest from earmarked facilities at the Fed and through the Treasury. Meanwhile, they also keep their Federal Deposit Insurance Corp. credit backing for bonds issued. In turn, they just flip all of this free cash into the market, buying other credit-enhanced securities, and presto: lots of spread and little risk, given that Uncle Sam has their backs.

Little is being cleaned up in these firms. And no wonder: As for now, there's little incentive for any of it to actually get cleaned up.

Meanwhile, the banks with whole loans on their books are still in trouble. The FDIC has actually been doing, well, some of its job recently. It's requiring banks that make—and hold—direct loans to middle-market and smaller businesses, consumers, and property loans, to actually bolster their loan loss provisions.

This is at least beginning to address the need for bad and nonperforming loan clean-up. But at the same time, the result is that these banks are turning in some pretty poor numbers this past quarter.

So, while I continue to avoid bank stocks, I very much continue to recommend that you buy and own plenty of nicely high-yielding bank preferreds for your retirement investing.

Because as they continue to clean up and bolster their balance sheets, banks are getting even better credit risks, which means that you'll be even more likely to get paid your high-yield dividends and interest payments.

So, avoid Regions Financial (NYSE: RF) common, but buy the Regions Financial 8.875% preferred (NYSE: RF-PZ). Still trading right around $22, it's a nice yielder paying you over 10%. .

Wells Fargo's common stock (NYSE: WFC) isn't what I'd want to own, but the 7% Wells Fargo preferred (NYSE: WSF) is a buy. [It] is now around $24, resulting in a still nice quarterly pay day for you amounting to a yield of near 7.5%.

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