4 Financial Preferreds For Strong Gains

Includes: BAC, C, GS, JPM
by: Investment Underground

By Roger Choudhury

Since the financial crisis, many investors have chosen to avoid banking stocks altogether. Though I believe we will see more upside in the banking sector in coming quarters, I remain hesitant to invest directly in these stocks. With that said, there are strong investment opportunities for those looking at preferred stocks. In this article, I will discuss four financial preferred stocks and show how they can be played for gains.

Recently, Bank of America (NYSE:BAC) expanded its Global Liquidity Platform to encompass enhanced global Physical Cash Concentration capabilities. Through consolidated cash positions, clients are able to pinpoint excess operating cash for other investment opportunities, repatriation and make debt payments. This solidifies Bank of America's commitment to better technologies for its treasury management and corporate banking clients. Additionally, Bank of America becomes more competitive in this arena. Bank of America is also accomplishing revenue diversification in an environment, where it is keeping assets relatively static in order to increase the tier 1 capital ratio. Moreover, the company is shifting away from the mortgage business. All in all, the company's preferred stocks should be impacted positively. More revenues would yield a higher likelihood of future dividend distributions.

Bank of America, 6.25% Non-Cumulative Perpetual Preferred Stock (Series 7) is thinly traded as of late, and so it is trading near $23.50 per share. The Google Finance ticker symbol is BML-O. I believe that the shares are undervalued relative to the rest of Bank of America's preferreds. The ascent of the share price has been comparatively tame. I expect the shares to move down slower as the markets correct, so a good entry point would be $22. Because of its BB+ rating, I recommend this for income investors that seek a good amount of yield, but are looking to take on a modest amount of risk. The current yield is 6.6%.

The treasury recently announced that it completed the sale of the rest of the mortgage-backed securities that it bought as part of the Fannie and Freddie bailouts. Citigroup (NYSE:C) shares stand to benefit from this move, as a mere psychological boost. Also, a Morgan Stanley analyst raised earnings forecasts for the company, attributable to higher expected trading revenues and investment banking fees. Ultimately, this offers better prospects for continued preferred stock dividend payments.

Citigroup 8.125% Depositary Shares Series AA Non-cumulative Preferred Stock has a high current yield at 7.4%. The realities of the shape of the housing market may lead to a flight to safety. On Wednesday, March 21, existing home sales are due to come out. The January number was a 4.57 million annual rate, which is a 20-month high. This is very high, and the equity markets are bound to be punished in the event of adverse figures. After all, distressed sales made up 35% of sales in January. Thus, expect this to remain relatively static, as the bulls and bears battle it out. A good purchase price would be at $26.50, in the next couple of weeks. I suggest this for income investors who are willing to take on a fair amount of risk, as it is rated BB+.

The Fed recently expanded the list of firms that it will fine for their foreclosure practices, and Goldman Sachs (NYSE:GS) managed to make it on that list. This comes after Greg Smith's letter, and does not help the firm's image. However, this should not impact the preferred stock dividends. What does matter is the effect of Basel 3 on capital charges. Goldman projects that in its private equity, global credit products and mortgage trading divisions would need 1.5 times, 2.0 times and 2.5 times as much capital when compared to Basel 1 requirements. An indicator of potential effects is Goldman's 1.32 ratio of earnings to combined fixed charges and preferred stock dividends, which has lowered from 3.12 in 2009. Yet, the company will aim to continue to make dividend distributions to improve or maintain its credit ratings. The firm may also choose to call or convert some of its preferred shares or debt to reduce fixed charges and dividend commitments.

Goldman Sachs Depositary Shares Floating Rate Non-cumulative Preferred Stock Series A has a BB+ rating, but it is trading at under $20 per share. This is a 4.8% yield. I expect this to trade relatively flat over the next two weeks, based on previous trading history. Also, WTI Crude is nearing $110, and this is bound to eat into consumers' wallets, so over the next six to eight weeks, expect this to fall toward $19.25. Those who are more risk averse may want to consider this because it has an attractive value alongside some capital appreciation potential. However, retirees should stay away. The Google Finance ticker symbol is GS-A.

JPMorgan Chase (NYSE:JPM) believes that, on mortgage servicing, default costs are expected to remain high for the medium term to handle modification and foreclosure volumes. Also, in 2011, the company incurred $504 million in losses in its real estate portfolios, and continues to expect losses through 2013. Despite all of this, at the end of 2011, the firm maintained a 2.72 ratio of earnings to fixed charges and preferred stock dividends. Thus, I believe that the firm will make preferred dividend distributions for the near future.

JPMorgan Chase Capital XIV, 6.20% Capital Securities, Series N offers good yield and is investment grade. The shares are technically trust preferred securities, and the Google Finance ticker symbol is JPM-J.

I expect shares to appreciate handsomely over the next several months as the firm makes gains from the troubles of Citigroup and Bank of America. The latter made one-time gains of $5.3 billion in the fourth quarter by selling preferred and debt instruments and its interests in Chinese Construction Bank. However, Bank of America only managed to earn $2 billion then. Citigroup has its own problems with bloated global operations and further cost-cutting. So, I recommend this to retirees looking to collect a decent amount of yield and for peace of mind.

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