If You Like Bank Stocks, You Will Love These

Includes: BAC, C, HSBC, ING, MS, PGF, XLF
by: Sammy Pollack

If you are bullish on banks, then you should love bank preferred shares. Preferred stocks are special securities that have properties of both an equity and debt security. In the capital structure, preferred shares are senior to equity holders but junior to debt holders. This means that in the event of a bankruptcy, preferred shareholders would receive money only after all bond holders are paid in full. However, preferred shareholders would get money before common equity holders.

Preferred shares also tend to pay higher dividends than both common stock and debt of a company. Preferreds pay higher dividends than bonds because they are more risky. They pay higher dividends than equities because they do not have the same potential for capital appreciation.

The preferred shares of banks have recently been hit along with the common shares. If investors believe that the largest banks in the world will not go bankrupt, then the preferreds are a great buy. The real winners of the bailout in 2008 were not common stock holders, rather preferred stock holders. The chart below show shares of Citigroup (NYSE:C) (orange) vs Citigroup preferred (blue) -- CpE.

Click to enlarge

(Source: CNBC)

As you can see, the bailout of Citigroup did little to help Citi's common stock. However, the bailout helped the preferred shares significantly. In fact, over 5 years the preferred stock was roughly unchanged, while the common stock was down nearly 100%. The preferred stock has also paid a consistent dividend of around 7% annually, making the preferred stock appealing.

I believe that a eurozone crisis will most likely end with bailouts where common share holders benefit very little, but preferred stock holders could see huge gains. Preferred shares of both U.S. and European banks are better bets than common shares. One of the biggest arguments about buying banks is that the government will stand behind the largest banks in the world. However, as seen with Citi in 2008, government bailouts do little for the common stock, but have major impacts on preferred shares.

How to trade preferred shares:

One way to buy preferred shares is to buy an ETF that holds these securities. PGF holds bank preferred shares and is currently yielding over 7.5%. Various Bank Of America (NYSE:BAC) preferred shares are also interesting-- BACpJ is currently yielding over 9%. In terms of European issues, Barclays (NYSE:BCS) BSCpD is currently yielding just under 9%. Preferred shares in ING Group (NYSE:ING), ING is currently yielding just under 10%.

The bottom line is that if you are tempted to buy the common stock of banks, first consider the preferred stock. Knowing that there is a "too big to fail" put under Bank Of America does not mean the stock cannot go down from 5 to 3, but it does mean that the preferred shares should do well.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.