By Roger Choudhury
Signaling a fear factor in the markets, 10-year Treasuries remain below 2%. Dark clouds are also impending over European financial markets. The first round of French elections resulted in a lead by Hollande, portraying the electorate's disgruntled view of fiscal austerity. The dissolution of the Dutch cabinet demonstrates similar sentiments. Plenty of other macroeconomic uncertainties surround the markets, so it would be wise to shift your assets toward more fixed-income. I ran a screen on high-yielding bank preferred stocks such that their dividends qualify for the 15% tax rate. Here is what I found:
Merrill Lynch (BAC) (6.375% Depositary Shares Non-cumulative Preferred Stock, Series 3)
$23.61 per share
Yes, at $25 per share, since Nov 2010
$0.3984375 per quarter
Next dividend payment is on May 28
Record date is on May 13
Ticker symbol (Yahoo! / Google / Fidelity)
BML-PI / BML-I / BML/PI
Merrill Lynch is a subsidiary of Bank of America. At the end of 2011, the ratio of earnings to fixed charges and preferred dividends stood at 0.89. Without any other considerations, this is troubling, but you must look at the entire picture. Bank of America has cut interest expense by 58.3% since 2007. Additionally, the firm posted a loss of $230 million in 2011, after being in the red for $1.323 billion in 2010. First-quarter results showed a profit of $653 million, after a debit valuation adjustment. Now, consider that preferred dividends total to $211 million annually. Given the positive momentum of earnings, I conclude that Bank of America should continue to make dividend disbursements over the next couple of years, at least.
You have an opportunity to make 5.2% in capital appreciation if the Bank calls the shares. In an attempt to cash in on the low-interest rate environment, I would expect Bank of America to call this within the next few years. Along the way, you should beat inflation and collect a few percentage points in yield.
I believe that shares should trade between $23.50 and $24 over the next couple of weeks. Risk aversion and a flight to safety will convince investors to move more funds away from equities and into fixed-income. Thus, now would be a good time to get in. I recommend this for income investors that are looking to take on a modest amount of risk. Retirees should look for a safer investment due to the BB+ rating.
HSBC (HBC) (Finance Corp., 6.36% Depositary Shares, Non-Cumulative Preferred Stock, Series B)
$24.58 per share
Yes, at $25 per share, since Jun 2010
$0.3975 per quarter
Next dividend payment is on Jun 15
Record date is on Jun 1
Ticker symbol (Yahoo! / Google)
HSBC-PB / HSBC-B
The ratio of earnings to fixed charges and preferred dividends is 1.64. This is an above adequate figure. The firm has raised this ratio steadily since 2008, when it was 1.13. Also, fixed charges have declined by 58.8% since 2007 to $27.768 billion, adding more confidence to the bank's positive direction. In the midst of a challenging business environment, the firm has increased preferred dividends from $288 million 2007 to $699 million now. I am willing to say that HSBC should be able to make dividend payments over the next three years.
Recently, the company announced the first international renminbi bond to be released outside Chinese territory. The three-year RMB-denominated bond was launched in London, and was issued from and distributed within Europe and Asia. The firm expects the international RMB bond market to go past RMB 1 trillion within three years. HSBC was the first foreign bank to settle cross-border RMB trade in all six continents. The company has led 87% of all European RMB issuance since 2011.
For HSBC, Citigroup (C) provides some hopes of growth in Asia. In its international consumer banking division, in the first quarter, Citigroup grew revenue by 5% in Asia to $1.896 billion, and card purchase sales rose by 12%. There is some sign of increased willingness to spend by the Asian consumer.
In any case, the RMB bond issuances provide an important revenue source for HSBC in an environment of slowing Chinese growth. 60% of the firm's profit before tax was generated in Hong Kong and the rest of Asia-Pacific. However, macroeconomic factors are impacting negatively the share price of this preferred stock. It is essential to HSBC's profitability that China has a soft landing and that Chinese consumers spend more of their disposable income by lowering their saving rate by 30 to 50 basis points. As investors price in a slowing Chinese economy, over the next four weeks, I expect this to dip below $24.25, which would be a 6.6% yield. I suggest that retirees purchase shares now to lock in this decent yield as well as take advantage of the investment-grade rating.
Grupo Santander (STD) (Finance Preferred, 6.50% Non-cumulative Guaranteed Series 5 Preferred Stock)
$20.60 per share
Yes, at $25 per share, after Jan 30, 2017
$0.40625 per quarter
Next dividend payment is on Jul 31
Record date is in the second week of Jul
Ticker symbol (Yahoo! / Google / Fidelity)
STD-PC / STD-C / STD/PC
In 2010, the ratio of earnings to fixed charges and preferred dividends was 1.52. In 2011, dividends of $2.074 billion were paid out with earnings before taxes (EBT) of $14.295 billion. Putting one and one together, at the end of 2011, the ratio remains above 2011. Doing business in Europe, UK, and Latin America, the company still managed to grow revenue by 5.3%. The firm grew branches internationally by 4.8% to 14,756, and increased such presence in Continental Europe by 9.0%. Santander is the largest bank in the eurozone by market cap. Also, considering the consistent track record of this issue, I expect that the firm will continue to make preferred dividend payments for the next two years.
Spanish mortgages form a key part of the Santander's revenue. From the peak in 2009 with $1.417 billion, in December 2011, in Spain, total mortgages fell to $1.317 billion. In 2010, new housing stock fell by 0.1%, which reflects stabilization, and in 2011, this figure moved upward. According to the firm, the upturn was due to retained demand awaiting fiscal changes in housing, which was postponed until 2012. So, new housing stocks should fall in 2012 and 2013.
Yet, it is important to consider that the firm has a low risk mortgage portfolio concentrated in urban areas with lower unemployment rates. The average maturity is adequate at 15.1 years. Additionally, there is adequate loan-to-value (LTV) in the total mortgage portfolio that reduces risk exposure. In fact, 56% is the weighted average LTV.
Contrast this to Lloyds (LYG). In the UK, net new mortgage lending has amounted to only 0.7% of outstanding balances in 2011. It does not seem the bottom has been reached in housing prices in the UK as well. The same goes for Spain, but the slowdown of the rise of non-performing loans in Spain gives more hope for the Spanish housing market relative to the UK's.
Share price should continue downward to below $20 over the next couple of months as part of the risk-off trade involving Spanish sovereign bond troubles. Yet, the fundamentals of this preferred stock are much better than on first impression. I suggest that investors looking for high yield from an international fixed-income instrument should take a serious study here.