Recent banking turmoil in the U.S. and Europe has been a source of panic, but analysts are pointing to a pocket of opportunity: the preferred shares of the big banks. “Of all the asset price movements driven by the banking panic in the past few weeks, one of the few notable pockets of value created in markets appears to be subordinated financial debt,” Citi said in a April 2 note, referring to preferred shares of banks. The large banks are “doing just fine,” Loreen Gilbert, CEO of WealthWise Financial, told CNBC’s ” Street Signs Asia ” on Monday. She said yields on the preferred stocks of the big banks are near 10-year highs. “We are not in favor of buying common bank stocks right now; rather, there is an opportunity in buying preferred stocks of the large banks as the dividends must be paid before common stock holders,” Gilbert added. Preferred stocks have characteristics of both stocks and bonds — they trade on exchanges like stocks but they have a face value and pay dividends like bonds. They are also like bonds in that when the value of the preferred stock goes down, yields rise. They typically offer a higher yield than other fixed income products and can be riskier. Go big Gilbert said she would focus on preferred shares of the United States’ big, national banks instead of its regional ones. “To be on the more defensive side, using preferred that are focused on the large banks is the more cautious way to go and they still provide a nice yield between 5% and 6%,” she told CNBC. She named Bank of America , JPMorgan and Morgan Stanley as her picks. A diversified basket of investment-grade preferred shares now yields more than bonds that are less than investment grade — by the highest level in over a decade, according to Citi. Some have yields near 8%, it said. AT1s Some types of preferred shares of banks are also known as additional tier-1 bonds (AT1s). They recently came under the spotlight, with Credit Suisse’s AT1 bonds losing all their value after the bank was taken over by UBS. AT1s are a type of debt that is considered part of a bank’s regulatory capital. The debt can be written down to zero in emergency situations, such as when a bank’s capital ratio falls below a specific threshold. Still, Citi analysts are bullish on this type of investment, saying it’s an opportunity right now as prices drop after the crisis. “When market volatility subsides, the relative value of preferreds may allow for appreciation potential,” Citi analysts, led by chief investment officer David Bailin, wrote in the note. Other potential catalysts include a decline in inflation leading to Fed rate cuts over the next 12 months, as well as the banking sector stabilizing as management focuses on improving liquidity, they wrote. “Short of a systemic financial event akin to the Great Financial Crisis, it’s unlikely for bank earnings to become so stressed that these banks can’t make dividend payments on their equity – meaning preferred payment performance on coupons is likely to continue,” Citi analysts wrote. “While a higher degree of selectivity will be required, we believe the AT1 market may offer an interesting risk/reward opportunity for investors who properly understand the risks of the instrument and issuer,” they concluded. How to invest There are many funds dedicated to preferred shares, as well as those that offer preferred shares as part of a larger fixed income allocation, according to Citi. Investors can also buy the preferred shares of any company directly. There are exchange-traded funds, such as the Invesco Preferred ETF, that track the ICE BofA Core Fixed Rate Preferred Securities, which is a widely followed index. The index is up more than 6% so far this year. The Global X U.S. Preferred ETF tracks the ICE BofA Diversified Core U.S. Preferred Securities Index. Both ETFs have yields of around 6% or more. Under Morningstar’s coverage of funds, the five-star rated Virtus InfraCap US Preferred Stock ETF has a 30-day SEC yield of around 10%.
Read the full article here
