Perfect Storm Hits The Banks

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Includes: BTO, FAS, FAZ, FINU, FINZ, FNCL, FXO, IYF, IYG, JNK, PFF, RWW, RYF, SEF, TLT, USO, UYG, VFH, XLF, XLFS
by: Mad Hedge Fund Trader

There is no better sight to a hungry trader than blood in the water.

"Buy them when they're cryin" is an excellent investment strategy that always seems to work.

There are rivers of tears being shed over the banking industry right now.

Federal Reserve officials openly told investors that after the December ¼% rate hike that they would continue to do so on a quarterly basis. Only weeks later, a collapse in the stock market shattered this scenario to smithereens.

I doubt we'll see any more Fed action in 2016.

This caught investors in bank shares wrong footed in a major way.

But wait! It gets worse!

Among the largest holders of American bank shares are the Persian Gulf sovereign wealth funds, including those for Saudi Arabia, Kuwait, Oman, Qatar, and the United Arab Emirates, my old stomping grounds. Pieces of me are still there.

The collapse in oil prices has put their budgets in tatters and they now have to sell stock to fund wildly generous social service programs. The farther Texas tea drops, the more shares they have to sell, and at $26 a barrel they have to sell bucket loads.

Had enough? There's more.

The junk bond market and oil company shares are suggesting that up to half of all American oil companies will go bankrupt sometime this year, mostly small ones. It all depends on how long oil stays under $40.

Unfortunately, the oil industry has been the most prolific borrower from banks for the last decade. The covenants on many of these loans require borrowers to pump and sell oil to meet interest payments NO MATTER THE PRICE! It's a perfect formula for maxing out production and selling into a hole.

So fear of widespread energy defaults has also been dragging down bank shares as well.

Some of the moves so far in this short year have been absolutely eye popping. Bank of America (NYSE:BAC) has plunged 31% from its recent high, while Citibank (NYSE:C) is down 32% and JPMorgan (NYSE:JPM) is off 19%. Basically, they all had a terrible year just in the month of January.

Bank shares have been beaten so mercilessly that they are approaching levels last seen at the nadir of the 2009 financial crisis.

Except that this time, there is no financial crisis, not even the hint of one. For the past seven years, banks have been relentlessly raising capital, reducing leverage, and growing BIGGER.

They proved last time that they were too big to fail. Now they are REALLY too big to fail. Default rates aren't even a fraction of what we saw during the bad old days. Energy industry borrowing is only a tenth the size of bank home loan portfolios going into the crisis.

Blame the Dodd-Frank financial regulation bill, which requires banks to hold far more capital In US Treasury bonds than in the past, which by the way, are doing spectacularly well.

Blame ultra cautious management.

Whatever the reason, Big US banks are now solid as the Rock of Gibraltar.

Which means I'm starting to get interested. Interest rates don't go down forever, nor does the price of oil. And scares about loan defaults are being wildly exaggerated by the media, as always.

But there is more than one way to skin a cat.

All of these companies issue high yield preferred stock with exceptionally high dividends. For example, Bank of America issued 6.2% yielding paper as recently as October. It is paying something like 8% now.

Since these securities are stock, you get to participate in price appreciation when the panic subsides. A guaranteed 8% return, plus the prospect of substantial capital appreciation? Sounds like a pretty good deal to me.

Google bank preferred shares and you will find an entire world out there of specialist advisors, dedicated newsletters and even day trading and hedging recommendations.

One thing to keep in mind here is that you should only buy "non callable" paper. This prevents issuers from stealing your paper when better times return to cut their interest payouts.

There is another way to play this beleaguered sector.

You can buy the iShares S&P US Preferred Stock Index Fund ETF (NYSEARCA:PFF), which owns a basket of preferred stocks almost entirely made up of bank shares. As of today it was yielding 5.62%. To visit the fund's website, please click here.

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