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The Safer Way to Buy Financials

01/04/2012 11:00 am EST


Neil George

Editor, Profitable Investing

While banks remain on the defensive, their preferred shares and debt securities offer attractive yields, says Neil George in this exclusive interview with

Neil, financials have been just beaten up. Is it time to step in and buy?

Well, Karen, I think the key thing to look at is that we’ve had a series of constant analysis of what’s happening at some of the major commercial banks in the US and in Europe and so forth. People keep looking at, well, where is going to be the bottom?

There are a lot of bargain buys, and people keep prognosticating the idea that you can be able to buy into some of the big banks, and then what happens is we get yet another round of earnings announcements, whereby things are disappointing and you have to have more explanations: "Well, we’re still sort of cleaning things up, and there’s still hope..."

And they’re trading at such low valuations—many of the big banks are actually trading at discounts to a book value, which is really sort of unheard of historically—if they are going to do this, then those banks are considered bargains.

However, the key thing to keep in mind is that the reason that they’re bargains is that there are going to be continued troubles. Therefore, the idea of when we can start to talk about some of those troubles, you know, we can actually see where there’s going to be some opportunity.

Do we have any idea of the exposure that these too big to fail banks have to the European mess, after what happened with the subprime mortgage mess?

Well, I think the key thing to look at is that you are looking at most of the major banks, looking at their loan portfolios. Whether they have European exposure, where they still have some of the mortgage and some of the corporate exposures.

Banks, the major ones like JPMorgan (JPM), Goldman Sachs (GS), Regions (RF), and a variety of others, are basically being told that they need to continue to reduce their loan portfolios. They’ll have to increase some of their actual capital for both domestic regulators in the US as well as the global banking regulatory capital authorities, which is governed by the Basel III agreement, as well as with the European banking authority, which has basically recently come out with calling for an increase in cap requirements.

What it all comes down to is that banks are having to effectively reduce their loan portfolios, clean up and boost up their balance sheets, and—particularly in the US with Dodd-Frank, regardless of what happens as far as what actually happens with those rules—banks are going to have to do away with some of the more juicy parts of how they were able to sort of jazz up some of their quarterly earnings.

They’re going to have to go back to being bankers, which means they’re going to be seen, instead of being out sort of wining and dining and doing all sorts of high-flying sorts of financial transactions, they’re going to be sitting behind the counter seeking checking accounts and trying to make loans and open up passbook savings accounts.

Therefore, it’s a much slower rate of growth, but much more certainty, and that’s where the market is going to be going. Not just for the next few quarters, I think the next few years. Therefore, the common stocks are not going to be doing well because of the fact that they’re not going to get a big boost.

So, while you might not buy a lot of common stocks here, the key thing you want to look at is the bonds and the preferreds, because here’s where you can lock in some good solid yields and knowing that all of the regulators are doing their jobs as far as cleaning things up and making their balance sheets, you know, basically as rock steady as possible.

And we are definitely all investors looking for income in a low-yield environment. So give me some recommendations.

So let’s have a preferred: one is from a bank called Regions Financial, based in the US, a focus on sort of the South Central US and elsewhere.

They have a Regions Financial Preferred (RFZ) and it currently is paying a dividend. It pays quarterly, a total of about 9%. Again, the bank basically used to offload a lot of its fees in home business and a lot of its financial transaction business and really sort of honing in on going back to being a regular bank.

Now, if we look at some of the bigger banks and some of the more broader ones, two in particular, I think are worth looking at: Bank of America (BAC) and Goldman Sachs. Both of these firms have what I basically term as mini-bonds. These are actually shares that look and trade like a preferred, but actually are corporate bonds of both of these banks.

So if you look at for Bank of America Preferred (IKM), and if you look at Goldman Sachs Preferred (JZS). Both of these have dividend yields paid on a quarterly basis—that are locked in, so you don’t have to worry about any change in preferred policies—of about 6.5% to 7%.

Again, a very steady, locked-in yield, based on proven balance sheets. And it’s a good way to cash in on banks—even though the common stocks aren’t going to do well, their debt is going to be more fortified.

And it’s a longer-term play?

This is a good buy-and-own sort of strategy for folks that want to basically lock in cash flows and have a lot more certainty and a lot less volatility.

Neil, do you own any of these for your own account?

Karen, I tend to eat my own cooking, so, you know, I’ve had some of these myself for some time now. 

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