2 Safe Bets Amidst Big Banks' Worrying High Yields

By Jennifer Yousfi

Fifth Third Bancorp (FITB) just became the latest in a string of hard-hit financial firms to slash its dividend to preserve much-needed cash.

Wednesday, the Ohio-based regional bank slashed its dividend to 15 cents down from 44 cents, becoming the 17th company to reduce or eliminate its dividend completely this year, Bloomberg News reported.

Fifth Third certainly wasn’t the first bank to have to resort to this unpopular measure, nor will it be the last.

Financial firms of every stripe have taken a beating from the subprime mortgage crisis that has accounted for $396 billion in write-downs so far. From national consumer banks such as Wachovia Corp. (WB) to the regional banks such as Fifth Third, everyone’s feeling the pinch. As stock prices continue to plunge and liquidity becomes alarmingly scarce, the banks have to evaluate how they’re going to survive until the economy turns around.

Over $300 billion in emergency capital infusions have rolled in so far, many of those investments coming from preferred stock sales to foreign sovereign wealth funds (SWFs). As much as $65 billion more may still be needed according to a recent research report from Goldman Sachs Group Inc. analysts.

But while the banks desperately need the cash, it’s really bad news for common shareholders as well. Those preferred shares were sold with a hefty yield of their own and preferred stockholders have first dibs on the financial firms’ dwindling revenue streams.

High Yields are Bad?

It used to be that a juicy yield was a good thing in a stock because it meant a nice dividend and a steady income stream. But with banks struggling to maintain capital requirements as credit lending continues to tighten and income from operations declines, financial stocks are taking a beating. Declining share prices lead to higher yields.

Historically, bank stocks have yielded around 3% to 4%, Chief Executive Officer Gary Townsend, of Hill-Townsend Capital in Chevy Chase, Md., told Fortune in a recent interview. But many financial stocks punished by the recent market now have yields in the high single digits. Those firms have the potential for a dividend decrease.

“When you get to about 8%, that speculation becomes quite pronounced,” said Townsend, a former Wall Street bank analyst.

And just because a bank has already slashed its dividend doesn’t mean it won’t be forced to reduce it even lower.

In addition to the banks already mentioned, Citigroup Inc. (C), KeyCorp (KEY), Washington Mutual Inc. (WM) and National City Corp. (NCC) have all been forced to reduce their dividends.

Many feel that Bank of America Corp. (BAC) will be the next to fall as it struggles with its takeover of subprime villain, Countrywide Financial Corp. (CFC). With a fat quarterly dividend of 64 cents, Bank of America is yielding over 9% with a share price that has plunged over 30% year-to-date. Shares closed at $28.37 Wednesday.

With a mean analyst estimate of just $2.74 earnings per share this fiscal year, according to MarketWatch data, Bank of America is going to be hard-pressed to come up with the cash to maintain its current dividend level of $2.56 annually.

But not everyone sees a dividend-cut in Bank of America’s future.

Oppenheimer & Co. analyst Meredith Whitney said she felt the national bank’s dividend was safe after a recent chat she had with Chief Executive Ken Lewis. Whitney’s opinion is nothing to sneeze at, as she was one of the first to predict the bearish turn in the financial sector. And even though she feels the financial crisis is “far from over,” she feels Bank of America will be able to maintain its payout.

Safe Bank Bets

Does this mean all financial stocks are worthless? Not at all.

In fact, you can take your cue from one of the savviest investment minds out there, Berkshire Hathaway Inc.’s (BRK.A) Warren Buffett.

Buying what Buffett has bought is a pathway to superior returns. In fact, over the past three years, this strategy has delivered double the return of the Standard & Poor’s 500 Index, according to research by professors at both American University and the University of Nevada at Las Vegas.

And the Oracle of Omaha has made some pretty shrewd banking investments, managing to steer clear of most of the subprime slime.

Berkshire Hathaway is the largest shareholder for U.S. Bancorp (USB), the sixth-largest domestic commercial bank. With a 43-cent quarterly dividend and a share price that is down only 5% year-to-date, the bank’s stock currently yields 5.66%. Shares closed at $30.01 Wednesday and have traded in a relatively tight, stable range of $27.86 to $35.25 in the past 52 weeks. And if Buffet’s opinion isn’t enough to convince you, Fortune recently named USB to its list of 40 best stocks for retirement.

Another Berkshire Hathaway holding is Buffalo-based regional bank, M&T Bank Corp. (MTB). It has a juicy 70-cent quarterly dividend and currently yields 3.7%.

With a close Wednesday of $75.89, it’s a bit further off of its 52-week high of $115.81 than U.S. Bancorp, but still up from its 52-week low of  $70.49. With a mean analyst estimate of $6.73 earnings per share for this fiscal year according to MarketWatch data, and a balance sheet that hasn’t suffered too badly from the subprime mess, M&T should have enough cash to maintain its quarterly payout.

Comments

[User 171371]

The investment and regional banks should be beat down after the scam they ran with the CMO's and sub prime.I have a large position in local bank upstate NY that is run very well,profit increases the last two quarters and foreclosure rate well under 1%.Now the share price is in the dumpster.USB has been on my watch list but I'm reluctant to touch any financial and my guess is the financial sector will take years to recover.

Right on article.

[texalope]

It's been surprising how many financial institutions sacrificed lending standards for sales gains. I don't know why you should assume that a Buffet investee didn't follow the herd. Wells Fargo is a prime example.

[Ranni]

How about SunTrust? ;)

[squashnut]

Wells Fargo is doing fine. Loan delinquencies haven't gone up that much. Of course they changed the definition of "delinquent" on their statements. Minor details...

[bearfund]

The fact that USB is down only 5% is a large part of why I'm not buying. At 2.6x book (2x if we ignore treasury stock), it's just too damned expensive. Yes, it's a great bank. Unfortunately, it's priced like one. If there's even a glimmer of a crack for USB, you'll lose 30% in a day. I wouldn't have that kind of confidence if my own mother were chairman and CEO. I'd rather take small positions in stocks people have thrown in the trash. If USB ever sees 20 again, I'll buy. But a 5.6% yield isn't worth the risk of buying a stock that's priced for perfection and has very little capital appreciation upside. If you want the income, find some preferreds instead.

[blah-blah]

Ah you had to mention the scary BAC - the stock price has been trying so lately to look like Citigroup. The world is ending, I guess I should sell.

And my favorite WFC - a prime example you say
I'm so scared of both of these that I'm not selling one share.

[OJO Zafado]

USB ? What are you looking for, a bank stock for capital gain or a bank stock for yield? If you venture into USB, best to overweight your investment in the USB-PrE & take the +7.5% dividend. As the author noted, it is safe from the the share of capital to be paid out to commoners. If things turn around in the economy in 2009 and it continues strong in 2010 there is a chance the "E" will be called at it's 2010 call date. Even without a call the issue will gain in value as it will be subject to call. That could be a near 25% capital gain compounded by the 7.5% quarterly payout. While I own the "E", I do not own the common.

[gordo]

Well obviously youre right...running a bank is like running an insurance company and what really matters because youve got a commodity is the management...great risk managers who concentrate on return on equity will build a safe bank...managers who want to grow at huge cost to shareholders by making dumb deals will lead to value destruction...

[C.W. Heileg]

Our country was sacked of its gold reserves years ago. The Fed paper that can be printed daily and is worthless in saving any entity. This Fed paper is simply a promise to pay a DEBT!.....whether it is a foreign or a domestic debt. The more the debt paper, the greater the debt to the US taxpayer. If you happen upon a Fed Debt Paper, you should invest this worthless paper for something substantial, as in the "Four G's;" Gold, Grain, Guns and Gas!! It's time to prepare for our country's demise. Capitalist Marxism has worn out its welcome in this country.