Selling A Financial Position To Buy A Financial Position

| About: Wells Fargo (WFC)

In my most recent Team Alpha Retirement Portfolio Update, I noted that I would be taking a look at making a change in one of our holdings. iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF) seems to be facing an uphill battle right now:

  • PFF is heavily weighted in the banking sector.
  • The banks have been calling in some of their preferred shares (like Bank of America (NYSE:BAC) most recently) so that they do not have to pay out the higher dividends.
  • As the banking sector becomes healthier, I believe more of the higher paying preferred shares will be called. This could impact the future dividend yield of this ETF.
  • Many of the preferred shares are also being sold by investors, as the share prices have moved well above par value. This behooves the banks to have more reason to call in the shares since they will only pay par to shareholders.
  • With both investors taking profits, and banks calling in the higher yielding stocks, the overall yield could be negatively impacted.

With the most recent news of PFF announcing a "distribution" of $.175/share to shareholders of record as of April 1st, I have decided to take this distribution and run.

Given the headwinds (noted above) that preferred shares face (specifically in the financial sector) I believe that the portfolio will be better served by taking a direct position in the common shares of Wells Fargo (NYSE:WFC), with an eye on JPMorgan Chase (NYSE:JPM) to add down the road as well.

My Reasoning

First of all, the dividends being paid by PFF came up quite short last month at only $.05/share. I do not mind the distribution of course, but this should not be confused with dividend yield. If in fact the banking sector becomes healthier, and I believe it will, then more preferred shares will be called, and that will have a direct impact on the dividends and yield of PFF. Not to mention the costs of this ETF as well.

Secondly, I believe the mortgage market is gaining momentum along with the housing recovery. As reported in this article, mortgage applications are heading higher once again.

According to the group's Weekly Mortgage Applications Survey, the Market Composite Index, a measure of loan application volume, rose 7.7 percent for the week ending March 22. On an unadjusted basis, the index increased 8 percent week-over-week.

While refinancing activity remained at the same percentage of all applications, first mortgage applications rose heartily.

WFC, in particular, is perhaps the largest beneficiary of the increased demand in mortgages, since they happen to be the largest in that business segment already. Take a look at the latest Seeking Alpha "market current" on this fact:

3:39 AM Wells Fargo (WFC) is enjoying the benefits of charging forward in the mortgage market while its rivals have retreated, with the bank accounting for 28.8% of all home loans issued last year as "production" hit a record $524B. The strategy has brought massive profits, although questions are being asked about what Wells will do once the refinancing boom, which has driven its growth, drops off.

That being said, there are even more catalysts for mortgage lenders. As noted in this article, it appears that younger folks are now ready to buy new and existing homes. Of course that means even more mortgage lending.

The PulteGroup Home Index Survey (PGHI) showed 65 percent of renters between ages 18 to 34 with an annual income of at least $50,000 said their intention to buy has increased significantly or somewhat over the past year.

The majority of millennials, or 52 percent, are interested in buying because they view a home as an investment and have a desire to own and build equity.

Home buyers of this age and income are highly unlikely to purchase a home with an all cash deal. As the mortgage segment grows, banks who lend mortgages will benefit greatly. Most of the banks have been reluctant to lend because the interest rates were so low, and the risks too high.

Now, with the new CFPB regulations, banks that conform to the rules set forth will be free from litigation, PLUS the loans will be on solid footing. The qualifications now favor the banks to lend even at lower interest rates, because the risks of default, and litigation, have been greatly reduced.

The bottom line is that folks who can qualify for a mortgage under stricter guidelines, will be able to buy a home and pay the debt. WFC will benefit dramatically by offering more mortgages to more people and will approve only the ones that qualify. By lending more, WFC stands to increase revenue as well as profits.

The Basic Fundamentals Of WFC

Wells Fargo: Price: $36.88/share, Dividend Yield: 2.75%, ESS Rating: Bullish

  • A price to book ratio of only 1.34.
  • Operating margins of nearly 40%.
  • YOY revenue growth of over 8%.
  • YOY earnings growth of nearly 24%.
  • Over $206 billion in cash.
  • A dividend payout ratio of only 26%.
  • Nearly 80% of all outstanding shares are held by institutions.
  • A forward P/E of just 9.48.

Given the fact that the entire sector is mending and the common shares offer a sound dividend, which will likely be increased again, as well as healthy room for capital appreciation, WFC is a better fit for the Team Alpha Portfolio than PFF.

As of the next trading day (4/03/2013), I will be selling 100 shares of PFF and purchasing 100 shares of WFC. As a result, our Team Alpha portfolio now consists of Ford (NYSE:F) Chevron (NYSE:CVX) Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NYSE:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Annaly Capital (NYSE:NLY), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Healthcare Select Sector SPDR (NYSEARCA:XLV), and Wells Fargo .

My Opinion

Our mix of financial stocks consists of BKCC, KFN, NLY, O, and now WFC. It has always been my opinion that financial stocks lead the way in a bull market and an economic recovery. Adding Wells Fargo to the mix gives us a solid bank within our core holdings.

Please remember to do your own research prior to making any investment decisions. The opinions expressed here are not recommendations to wither buy or sell any security.

Disclosure: I am long AAPL, BKCC, BMY, CSCO, CSX, F, GE, JNJ, KO, MCD, NLY, O, PFF, T, XLV, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I will be selling PFF and buying WFC on 4/03/2013