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Debt, CFA, Portfolio Manager, preferred stocks
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Since the beginning of the credit crisis, I have been writing about the travails of The Royal Bank of Scotland (NYSE:RBS) and opportunities available in its preferred stock (latest here and here).

The returns on my recommendations (with all humility) have been rather decent:

The now currently paying ("NCP", formerly known as "may pays") have done very well for investors and have regained a significant amount of ground since getting absolutely crushed when the dividend was suspended.

The 2013 May Pays (otherwise known as the ABN preferred, which were "turned off" nearly a year later) have begun to perform and I expect that as dividends keep flowing in the NCPs, they will continue to perform well.

By now, you might be asking yourself, is this just Mike patting himself - and his book - on the back? The answer is no. Honestly, I don't need to do that as it gets me nowhere - yesterday's returns are just that: yesterday's. As I am long the RBS complex, I am more focused on the future and outperforming going forward - that is why we are all here, we are seeking alpha.

If we turn our attention to the present, we see the following attributes of the RBS preferred complex:

Click to enlarge

As the above table shows, there is still upside in the NCP group as yields converge to the always paying ("AP") group. There is significant upside available in the 2013 May Pays when just looking for the convergence to the NCP group, nevermind the AP group.

Readers might recall that my article entitled "Royal Bank Of Scotland: Preferreds Are Attractive" (linked previously) had the following trade idea:

How I plan to trade these:

I will sell my current pays and roll into the "will pays" when they start to pay (keep the income) or combine them in some fashion (depending on levels) and take the capital I committed to the "will pays" and buy the ABNs. This keeps my income flowing and allows me to "roll" the "may pay" trade into the new "may pay - ABN" trade. Income and appreciation without changing net exposure levels.

Since then, I have kept some of my RBS-H and RBS-L in the AP group. First thing I am going to do is swap out of the RBS-L and deploy these funds into the RBS-G. I will continue to hold my RBS-H (and my NW-C) as a protective measure (against an implosion repeat - there has been chatter of nationalization, which I dismiss as just chatter) and end up with a lighter position in the AP, the same position in the NCPs and a new position in the 2013 MPs.

Why not just throw it all into the 2013 MPs? Risk. Until they pay, there is a risk they do not pay. With this new structure, I own the AP benchmarks, the NCP for convergence to the AP and the 2013 MP convergence to the NCP.

I must stress, however, that all of these positions have risk. RBS has been doing an admirable job managing down their balance sheet and risk exposures, but LIBORgate (yeah, every scandal needs a gate), Ulster bank and continued pressure in their service territories continue to put pressure on the bank. While I have committed a decent amount of capital to the RBS trade over time, the positions have never summed over 8% of the portfolio. Many investors may not be comfortable with the risk of the 2013 MPs and should then focus on the upside of the NCPs or the yield on the APs (although I would buy Banco Santander (NYSE:SAN) Es at 10% with similar must pay language first - which I have written about numerous times and own myself). While somewhat riskier, these preferred stocks should have greater upside potential (as well as yield) than similar troubled U.S. banks such as Citigroup (NYSE:C) and Bank of America (NYSE:BAC).

Source: Royal Bank Of Scotland Preferred Stock Update And Trade Ideas

Additional disclosure: I am long RBSPrL, RBSPrH, RBSPrS, NWPrC, SANPrE and SAN equity.This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.