buy bank stocks on the dip

[ChpBstrd]

Those PACW short put options I was bragging about earlier are now at $0.325 compared to $0.075 yesterday. I was paid $0.331 for them, so amazingly I'm still slightly in the green with a day and a half to go! I figure the sort of volatility that would get me assigned on Saturday morning would be the same volatility that would allow me to write a very expensive ITM call on Monday morning.

A few hours have passed and now the mid price on my short put is back down to $0.175. This is good low-stakes nerves-of-steel training!

I'll hold till expiration unless it's a close call, but I suspect PacWest will announce suspension of their preferred dividend after tomorrow's ex-div date on PACWP. PACWP fell over 21% today on the same suspicion, and will yield over 16% if the dividend is not cut. 

9.5% deposit flight in a few days is a full-fledged run. The losses recognized from liquidating a tenth of the portfolio (losses of maybe 1% of assets?) are going to pressure their CET1 ratio, which was 9.21% on 3/31. Is a weekend takeover by the FDIC off the table? IDK, and maybe that's a good reason to take profits on my short puts tomorrow.

[daverobev]

Those PACW short put options I was bragging about earlier are now at $0.325 compared to $0.075 yesterday. I was paid $0.331 for them, so amazingly I'm still slightly in the green with a day and a half to go! I figure the sort of volatility that would get me assigned on Saturday morning would be the same volatility that would allow me to write a very expensive ITM call on Monday morning.

A few hours have passed and now the mid price on my short put is back down to $0.175. This is good low-stakes nerves-of-steel training!

I'll hold till expiration unless it's a close call, but I suspect PacWest will announce suspension of their preferred dividend after tomorrow's ex-div date on PACWP. PACWP fell over 21% today on the same suspicion, and will yield over 16% if the dividend is not cut. 

9.5% deposit flight in a few days is a full-fledged run. The losses recognized from liquidating a tenth of the portfolio (losses of maybe 1% of assets?) are going to pressure their CET1 ratio, which was 9.21% on 3/31. Is a weekend takeover by the FDIC off the table? IDK, and maybe that's a good reason to take profits on my short puts tomorrow.

So:

shorts cause share price fall

share price fall causes news articles

news articles cause deposit flight

Death spiral?

Edit - $1.92 divs on $9.50 is 20% yield.

[chasesfish]

Correct.   Attempted death spiral.

If there is a next one to go, it'll be PACW.

Eventually someone will make a killing on the commons or prefs of "the next one to go" when it doesn't go.

I tried and failed to play that game once.  I'll sit on the sidelines for this one

[reeshau]

At this point, you can probably add "capitulation of long-time holders" somewhere in the death spiral, as the period of volatility stretches beyond the month mark, and with two "flash crashes" under our belt for it.

[daverobev]

Today's purchase?  BOH preferred stock.   BOH-A.

Are you adding today?

[ChpBstrd]

Eventually someone will make a killing on the commons or prefs of "the next one to go" when it doesn't go.

True. This is kind of like a game of musical chairs, where investors are trying to predict when the music will stop so they can jump into the surviving banks. Jump in too soon and your investment goes to zero. It takes a lot of wins to recoup any one total loss, so it makes sense to overshoot and jump a little too late. But when everybody plays that game... bank stocks keep getting cheaper and cheaper.

There's also the dimension of riskiness. RF, as described earlier, seems a lot less risky than PACW. RF's preferred shares yield 7.9% compared to 22.22% for PACWP. Which is the better deal? I'd argue RF's preferred shares are the better deal because RF has probably a 90% chance of surviving this banking crisis thanks to their diversification, hedging, and tighter lending standards. Who knows what PACW's odds are?

If I were 100% sure RF was going to survive without cutting preferred dividends, I'd go all in on RF-C, and retire on a very safe 5% WR with ample cash flow set aside for inflation and plenty of capital appreciation potential.

The trend of bank runs from uninsured deposits will eventually reach a practical limit. PACW, for example, lost 40% of their uninsured deposits when they lost 9.5% of their total deposits last week. That occurred after they reported on May 4 that 75% of deposits were insured, so I'm sure their insured deposits are closer to 85% now. As this process continues, any bank that can survive the ordeal becomes less and less likely to face a bank run due to the influence of flighty uninsured deposits, even if their overall risk is rising due to capital ratio deterioration and bad media.

That said, FRC apparently lost 10% of their insured deposits during their run, so even insured deposits have some flight risk amid today's panic. I'll keep watching for blood in the streets for a sign that the music is about to stop. Then I might buy some preferred stock well behind the front lines (although the front lines can be hard to discern amid an all-out crisis).
---------------
In other news, it's coming down to the wire for my PACW short put options at the $4 strike. PACW is falling - now at $4.57. I'm going to hold my position unless PACW falls below about $4.10. If it gets that low, an after-market announcement such as suspension of preferred dividends could get me assigned anyway, since short puts can be assigned well after the close, by 5:30 p.m. E.T.

[chasesfish]

Today's purchase?  BOH preferred stock.   BOH-A.

Are you adding today?

Yes, I bought more.  Not happy to be sitting down 8% on yesterday's purchase, but this is just irrational.   They're 51% checking / savings accounts in a market that's basically them and First Hawaiian Bank.   Something like 70%+ of their accounts have been with the bank for more than 20 years and their tangible book value and net interest margin mathematically rise from here. 

The high premium needed to come out of the common, Tangible Book value is $28 and the common should settle in +/- that because they're going to have some mediocre profitability, but there's no reason for much of a default premium to be in the preferreds.  These should be a 6.5% yielding asset, not 9%   There are people who just want out of the sector and not acting rationally.

My only disclaimer is I talk a lot about financials, but they are only 15% of my total book.  I'm not risking my ability not to work on any single bet (nor would my compliance manager/spouse) allow it.



Regarding @ChpBstrd comment - It's getting *very* tempting to just put a portfolio together of RF, SNV, HBAN, BOH, and FHN prefs all paying 7.5%+ at a dividend tax rate.   This is once in a decade type stuff. 

[ChpBstrd]

The bond market thinks it is not worth holding bonds from Comerica, Zions, and First Horizon to maturity just a couple of months from now. Better to get out now, traders are thinking, than to risk default.

Comerica, 7/31/23 maturity, CUSIP: 200340AS6, annualized YTW: 23.69%
Zions, 6/13/23 maturity, CUSIP: 989701BE6, annualized YTW: 16.33%
First Horizon, 5/26/23 maturity, CUSIP: 320517AC9, annualized YTW: 14.16%

Longer duration bonds for these same banks have lower yields, which is weird.

ETA: When looking at the spread between a bank's bonds and its preferred shares, there should be a difference in yield related to duration, odds of a preferred dividend cut, and the small probability of there being some small amount of assets left over after the insured and uninsured depositors are paid that can go to bondholders but not preferred equity owners. However, as the FDIC states: "In most cases, general creditors and stockholders realize little or no recovery." 

In the case of Zions, their preferred stock (ZIONP) yields 7.47% but their bonds maturing 10/29/29 are yielding 9.47%. This seems backward from a risk perspective, because the preferred stock is objectively riskier. With Regions (RF-C) the pattern is reversed and more logical. The preferred yields 8% and their longest-dated bond maturing in 12/2037 yields just 6.37%.

Still, it's weird that these yield spreads are as big as they are. The survival of these banks is a binary question, and I don't think there's a high chance of a partial liquidation. Regarding the risk of cancelled preferred dividends, FRC paid their last dividend just weeks before going bankrupt. It appears by the time a bank makes that decision, it usually has a week or two to live.

[bluecollarmusician]

It's getting *very* tempting to just put a portfolio together of RF, SNV, HBAN, BOH, and FHN prefs all paying 7.5%+ at a dividend tax rate.   This is once in a decade type stuff.

My head has been in the same place.  It just seems crazy; the market is clearly irrational with regards to some of these issues.  While I am unwilling to bet the farm on financials, it does seem like maybe the time to stretch my allocation to this sector, with the expectation to hold some of these prefs for a long while.

[chasesfish]

@ChpBstrd The preferential tax treatment and higher upside to par on the preferreds have kept their yields priced under bonds.   All finance classes would tell you that bonds are less risky than preferreds, but outside of Silvergate, all the FDIC failures evaporate both.

The news cycle risk is so tough to quantify.   We'll see how PacWest shakes out.

The shorts are on to Bank of Hawaii and extracted it's healthy multiple.   The bank has a 2.47% net interest margin, it should not have been trading at a premium to tangible book.   So what now?  Are people going to post charts to everyone to show the bank is cratering and trigger a run?   When the "crater" was a rational multiple move?

Fortunately for that bank, 50%+ of their accounts have been there for longer than First Republic was alive and television / news is a low consumption behavior on the islands.  It's not like they have a TBTF option locally to move it to.

[ChpBstrd]

It's getting *very* tempting to just put a portfolio together of RF, SNV, HBAN, BOH, and FHN prefs all paying 7.5%+ at a dividend tax rate.   This is once in a decade type stuff.

My head has been in the same place.  It just seems crazy; the market is clearly irrational with regards to some of these issues.  While I am unwilling to bet the farm on financials, it does seem like maybe the time to stretch my allocation to this sector, with the expectation to hold some of these prefs for a long while.

The yield curve is so inverted that 5% is about the best you can lock in with IG bonds long-term. Preferred stocks are about the only place you can lock in a higher yield than that on IG companies for decades into the future. Meanwhile, bank CDs, treasuries, etc. with yields slightly greater than 5% likely have only a year or two of duration or may be callable.

If we go back to a world with a lower federal funds rate, as markets are predicting, those of us with lots of CDs, treasuries, and short duration bonds will not have locked in anything. We'll be back to where we were in 2019 in terms of investing options.

That said, I'm personally excited about the prospect of locking in my cost of living with preferred yields, retiring with a theoretically too-high WR, and then just waiting 2-5 years for those preferred stocks to return to their typical values before diversifying and retiring again with a 4% WR.

I can think of no clearer hack for the limitations of SWRs than to buy bank preferreds at the right time during a banking and real estate crisis like we'll see later this year.

My best guess:
2007 = 2022
2008 = 2023
2009 = 2024

I suppose the next step on this gambit would be to make a watchlist of "not gonna fail" banks with preferreds and then to just wait until the yields get into the 7.5% to 9% range. @chasesfish likes RF, SNV, HBAN, BOH, MTB, and FHN. I'm not so sure about a couple of those so I might wait for the yields to come up on what I consider (so far) to be most likely survivor banks like BAC, JPM, C, MTB, HBAN, and RF. RF-c, b, or e are already there, but the lack of public panic makes me want to wait.

Of course, in 2020 I watched preferred yields hit attractive levels and then the juicy yields evaporated within a couple of weeks.  I remember PGF and PFF yielding 7.5% and thinking "I'd buy that if it wasn't such a risky time." Had I gone all in, I'd have retired a couple years ago. So it's important to actually pull the trigger if playing this game. This makes me worry about my CDs, treasuries, and bonds potentially taking a long time to liquidate during the event I'm watching for. I'll be steadily moving from these locked-in things into lower-yielding money market funds. I have a sort of "ladder" of maturities between 2 months and a year out, so if the blood-in-streets moment occurs in less than a year, I'll have to shuffle to deploy some of my assets. So I'll be requesting bids on some of my bonds that might be hard to liquidate in a contingency.

[chasesfish]

@ChpBstrd  It's kind of insane right now.   

I have more industry knowledge, I see some similar profiles out there in much smaller bank commons too.   My only question is will this strategy survive as these bank's loan yields rise or will the prefs snap back quickly.    The true distressed pricing in mortgage backed securities only *really* lasted from September to December 2008.   If you listen / see any of Howard Marks' work, he'll talk about Oaktree being the only buyer in some bidding during that time and how it was scary af, but the deals were gone by December.


Higher rates = better for banks.  That's been true for a long time and will be true again in the future.   The velocity of rate increases have smacked some liability sensitive banks without seasoned deposit franchises.   I go through report after report and I see banks that can have some margin squeeze for 0-3 quarters, but start looking very good in 2024 and onward.   

BOH is probably the scariest of the bunch since the total asset yield is right around 4%, if somehow all their deposits evaporated and were replaced with 4.5% - 5% replacement funds, it'd be tight.  They're also overcapitalized, so there's a 15% equity cushion now with the treasury facility. 

I'll be digging this weekend through more names and target yields and will keep buying $5,000 to $20,000 tranches.   I'm still only 13% financials and could double this comfortably. 




 

[clifp]

I haven't looked at the financials BOH, since I sold all my bank stocks circa 2015.

But I will say that Hawaii folks and businesses are very loyal, to local businesses and especially BOH.  "I've been a customer since I was 17, or my parent banked with them", any time I suggest you know Schwab bank is really good.

[SilentC]

Chasefish thanks for the comments on Pinnacle earlier this week, I haven’t had a more than a few minutes alone since then to look at it but I did realize their securities portfolio is much smaller than I thought.  It looks very promising.  Of the banks I do know a decent amount about I think the opportunity is decent on the ones without big securities portfolios but not quite insane once some conservative extraordinary losses are baked in.  Maybe I’m being heavy handed with those but that’s the margin of safety needed for one who hasn’t worked at a bank I suppose.  Another datapoint, Buffett and Munger had their annual meeting last weekend and they were quite bearish on banks and some comments on CRE seemed bearish so that’s a reason to proceed cautiously. 

Edit: got interrupted, one more thought is that credit spreads on IG and HY bonds and B-rates 1st lien new issue loans are not very elevated and that’s a guidepost to some extent of market sentiment around credit risk.  The BBB CMBS is very wide as a counterpoint which makes some of the construction and bridge loan focused lenders more attractive on a relative basis.  I don’t think I would back up the truck on financials until there is some real concern in HY - not waiting for a crash but the high yield OAS spread is 470 and it broke 550 twice in 2022, I have a hunch it will blow out again at some point in coming months and that might be the time to put dry powder to work.

[chasesfish]

Just stopping in to say I'm running a good size spreadsheet and pulling in every bank pref I can find.   I should be able to share this by Wednesday.   It's tough to find the right mix of a low coupon that'll give some nice convexity and decent cash paid yield without taking excessive tail risk.

@SilentC I like Pinnacle, First Horizon, and M&T's bond book.   Pinnacle and First Horizon also have 6%+ yielding loan books, they also pass the "can they survive a bank run" risk, the banks with sub 5% asset yields have the risk of a First Republic style deposit run sending their net interest margin negative and regulators making the survival decisions.

[SilentC]

Just stopping in to say I'm running a good size spreadsheet and pulling in every bank pref I can find.   I should be able to share this by Wednesday.   It's tough to find the right mix of a low coupon that'll give some nice convexity and decent cash paid yield without taking excessive tail risk.

@SilentC I like Pinnacle, First Horizon, and M&T's bond book.   Pinnacle and First Horizon also have 6%+ yielding loan books, they also pass the "can they survive a bank run" risk, the banks with sub 5% asset yields have the risk of a First Republic style deposit run sending their net interest margin negative and regulators making the survival decisions.

You are a legend!

[chasesfish]

@SilentC

I appreciate it.

The list isn't as long as I thought.   I generally have to fund sub 6% fixed rate coupons to fit the screen.  Anything above that means there's not enough price appreciation + yield to offset the risk.   Many of the issuances are above 6% or are fixed to floating rates and those aren't worthwhile to hold if the rate can float down.   There are some attractive $20bil regional banks paying 9%+, but have a high 6% coupon rate which caps out their appreciation and exposes the pref to redemption as rates fall. 

It seems like a mid 6% range in the rate (see TFC, FITB, and CFR) is the baseline for bank prefs and then you can earn an extra 1-4% yield based on the amount of bank specific risk your willing to take. 

The riskiest yet investable bank IMO is WAL, their WAL-A yields 11% right now.   It has news cycle risk and the bank is just below 7% tangible common equity, so it can't defend it's stock by repurchasing shares and is subject to the news cycle.  Otherwise it's deposit mix, total asset yield, and reasonable bond exposure look fine.   The asset yield is 5.4% and they are getting a bunch of 4.75% savings accounts to replace deposits.

This research makes me dislike the two preferred stock indexes more and more (PFF / PGX).   These are cap weighted, so there's a disproportionate amount of 5% yielding stuff from REITs and TBTF banks, fixed to floating prefs that don't appreciate as rates fall, and some garbage mortgage REITs.   On top of that each scrapes around a 0.50% fee for providing an index and tax reporting.

Enjoy the rest of the weekend!

[bluecollarmusician]

I second @SilentC 's sentiments.

Really appreciate all the thoughtful insight on this thread.

So many things to consider:

Though I think it is unlikely, in the scenario that the US were to default (very unlikely) or were to receive another downgrade (maybe  more possible than we would like to imagine) that could cause more pressure for interest rates to rise higher or at least stay where they are for longer; in that scenario banks would be in an even worse scenario.

On the flip side, if we make it through the debt ceiling craziness maybe that will give a relief to markets and breathing room to the Fed to sit on or relax rates.

It's really fascinating to me, and can't help thinking it is a big opportunity time for someone with capital to put to work.  Just very hard to know where there is relative safety in the market.

Thanks again to @chasesfish  and @ChpBstrd for your thoughts shared here....

[bluecollarmusician]

Sidenote-
is there a good site for following and tracking preferreds?  I struggle finding what I am looking for sometimes- typically using google and yahoo finance and etrade.

Are there other sites I should be checking?

Thanks :-)

[chasesfish]

I'll share what I have once it's finished in Google Sheets.  Google Finance can track the prices on them.   I can't find a good data set to scrape out coupon rates, financial stocks, and fixed vs. floating rate preferreds.  It's just not a big market.

I don't view the default as (much) of a risk. 

My opinion is still this is all pre-planned political theatre, the debt ceiling wasn't increased during reconciliation in December when the (partisan) budget was passed.  The Senate can debate a bill whenever they want and go to conference, the hard part was already done.  The real risk of default was getting *something* out of the house given the precarious speakership rules. 

The talk of default is absurd, the only "default" decision would be made by the treasury secretary and subsequently overruled by the courts if we got into a situation where the country had to prioritize payments.   Interest is paid first and the country collects 2x it's interest expense annually in tax revenue. 

https://www.cnbc.com/2023/05/13/debt-ceiling-standoff-may-delay-social-security-medicare-military-other-federal-payments.html

Medicaid reimbursements and government contractors will be delayed first and start screaming to their lobby, followed by the banks who loan money to the contractors and healthcare companies.   

This is entirely a stupid game of who looks less bad, the Ds for allowing a free renegotiation on a budget passed in December of the Rs for taking them up on that renegotiation.   Unfortunately  most follow their tribal politics and not see this for what it is, planned political theatre to win political points against an opponent. 

[bluecollarmusician]

I agree re: political theater vs. real threat of default.

Having seen the uproar when I was in the military of payday being delayed- neither party has the stomach for that.

[ChpBstrd]

@chasesfish some banks have more treasuries and some banks have more loans. So far in this year of falling unemployment, loans have performed fine and it’s been write-downs on market-traded securities that have captured our attention and led to bank failures. So I suspect most screening methods for financial strength using today’s data will output a list of loan-heavy banks.

If we’re heading for a recession as I think we are, chapter 2 will involve a sudden surge in loan defaults. Treasury-heavy asset bases will become popular again as they provide liquidity and appreciation potential as rates are cut. Banks that had to sell down their treasuries to pay for withdraws in chapter 1 will suddenly find themselves overloaded with the kind of asset that defaults! To add insult to injury, as rates are cut they won’t be able to ride treasuries back up.

So maybe just watch out for the fallacy of picking banks whose asset bases are heavy on real estate loans, car loans, and business loans because those sorts of banks will be in big trouble in chapter 2, even if they look like the geniuses of chapter 1. The highest-yielding loans might be the likeliest to default.

I see a lot of people driving around car loans worth more than their annual net income, and we just came off a year of highly abnormal double-digit housing inflation and extreme low affordability that looks a lot like a bubble. When the layoffs come, these people will default. I’m sure some banks will survive, as they did in 2008, but I doubt anyone will emerge unscathed. We won’t be able to ascertain the quality of loan books or mortgage backed securities until we’re deep into the recession.

[chasesfish]

@ChpBstrd You're not wrong.   A few additional observations rom the sheet I'm building. 

Out of the higher risk/return preferreds, BOH-A is the one with a large book of high quality securities vs. loans.  WAL and BankOZK are loan heavier.     All three of them are potential home runs, 8%+ yield on cost and +/- a double on appreciation upside.   

The next tier of risk is FHN-F, followed by RF-E and HBANP.  The economics of RF-E and HBANP are very similar.   FHN-F has a similar bank profile but still pays a higher yield, there's some combination of a size discount on FHN or a bunch of arbitrage funds bet on the merger happening and picking up TD Bank's credit rating and all unloaded into a bad market.

SNV has a decent issuance.

There are others that don't make sense, middle of the road size banks still paying less than 7% and a couple of banks paying 9%+, but are higher coupon preferreds so there's limited upside.  When rates go down they'll just call them away and the investor loses both an income stream and is stuck with a capital gain. 

I've enjoyed going down this hole.  I won't put 500,000 or $1mil into the strategy, but a few hundred thousand can still generate some nice income and appreciation. 

[chasesfish]

Good morning.   Here is the link to my Preferred Stock Spreadsheet

Here's some conclusions that I've come to:

- All things equal, the smaller dollar dividends (sub 5% on $25 par) stocks are better to own.  There's a dual benefit with these, the most convexity if rates get slashed and least likely to see the income stream be called away.   I like buying for income, but the high coupon rates mean UCBI, AUB, SNV and PNFP get called and generate capital gains at the same time rates are low enough that you don't have an alternative. 

- I think the HBANP, RF-E, and FHN-F have the best overall risk/return profile.   A pair of 7.5% yields and an 8.7% yield with 70-85% upside if we return to ZIRP.  The coupons are so low they are unlikely to ever be called away, these banks have loan yields above the deposit run risk, and are more C&I than CRE.

- That tail risk is a killer.  Out of the three ones in yellow that have attractive yields and convexity, I like BOH over Bank OZK and WAL.  That's a conservative bank with an old deposit franchise, it's only a yield issue and they've given granularity about being out of the "issue" in the next seven quarters.  It's also only an issue *if* they were to have a run on a mostly insured deposit base with 50% of the deposits being 20yr customers in a market without a TBTF bank.    Higher rates are good for banks that are 30%+ funded with non-interest bearing accounts in the long run.   The velocity of the rate increases have made this a temporary mathematical squeeze, which I like better than the credit risk or news cycle risk.   I wouldn't touch Capital One's consumer heavy book or Cadence's heavy CRE portfolio for sub 8% yields. 

- The spreads are interesting.   First Citizens got the "survivor blessing" from the FDIC with the asset purchases, so it yields less than 7%.  Fifth Third is 6.37% and I don't see that as enough of a risk premium compared to the essentially risk free rate of 5.82% from BofA.   I'm watching that Cullen Frost issuance too, if that ever gets into that 7.5% yield range, I'd put it in the category of HBAN and RF and it has some nice convexity. 

Looking forward to the feedback

[bluecollarmusician]

@chasesfish

This is pretty epic- Thank you so much for sharing.  I have been going and following a lot of these, but seeing them all in one place is amazing.

I am at the airport, but when I get home looking forward to poring over your hard work!

:-) Thanks for the insight, and the work on this...

[chasesfish]

The convexity has been the most surprising in doing this.

Something like HBAN or RF seems middle of the road at a 7.5% yield, but then I see a 65%+ appreciation opportunity to par.   It's much better than the usual game on preferred, gets redeemed on the nice yielding asset after five years. 

[bluecollarmusician]

That's what my brain keep coming back to- with the dislocation on prices; you get the income as long as you want, and when you don't you have a return baked in.

All with qualified dividends. 

:-0

[ChpBstrd]

@chasesfish this is a very interesting way to look at the choices. I've gathered you're asking "what happens to the value of the stock if the yield goes to X% in the future". The answers to this question illustrate how some of these preferreds (e.g. BAC-N) have relatively modest upside potential while others are more like moonshots (e.g. WAL-A).

Of course, WAL is much, much more likely to go out of business than BAC, so knowing the potential future returns tells us little about our expected future returns. Our expected future returns are probability-weighted, and tied to the odds of bank collapse.

There are hundreds (thousands?) of analysts hard at work to answer this "probability of collapse" question, and they're looking at all the information they can find about assets and deposit flightiness. Today's preferred stock prices and yields can be seen as their collective output. A preferred stock's yield spread over a similar-duration risk-free asset can be interpreted as the odds of a 100% loss.

For example, BAC-N has no stated maturity and yields 206 basis points over comparable-duration 30-year treasuries. The extra 2.06% in yield could be said to compensate the holder for a 2.06% risk of complete loss. Of course, there are at least 4 problems with this approach: (1) the actual probability math for odds calculation and avoidance of gambler's ruin is more complex, (2) default risk is not a one-time binary event and could happen after years of dividends, (3) there may be complex strategies with a lower risk of 100% loss, such as using options or shorting the common and going long the preferred, and (4) the price and yield are set not by weighing the estimates of a neutral panel of investors, but by the marginal willingness to pay by the subset of investors who are making trades at these prices - a critique of EMH. Regarding that last point, if the distribution of investors is not normal or is skewed, all the price-setting trades may be occurring amongst a tiny sliver of the investor population when the vast majority says "don't even touch it with a stick".

Despite these limitations, let's treat the spread over risk-free rates as a binary probability-of-total-loss estimate over the next 12 months. Using 30 year treasury yield as the risk-free rate, which may not be appropriate for preferreds with an earlier maturity date, one obtains:

Market-estimated risk of total loss:
BAC-N   2.06%
HBANP   3.80%
SNV-E   4.34%
RF-E           3.70%
OZKAP   4.50%
AUB-A   5.09%
UCBIO   6.27%
BOH-A   4.98%
FHN-F   4.96%
FHN-E   5.14%
PNFPP   4.30%
COF-N   3.24%
WAL-A   6.34%
COF-L   3.30%
CFR-B   2.53%
FITBO   2.47%
CADE-A   3.55%
FCNCO   3.26%

Seen in this light, WAL-A's or BOH-A's potential for returns up to 100%+ is a no-brainer if the odds of failure are only 6.34% or 4.98%. This is our alert that we need to slow down because there's something wrong with our process.

In particular, I'm looking at limitations #3 and #4 above. #4 seems untestable, so let's look at #3.

Is it possible to hedge BOH-A for example, at a lower cost than the yield?
The farthest-out duration for BOH options is currently 158 days or 0.433 years. The $35 put option for October 20 (slightly ITM) had an amazing $11.08 in time value yesterday. Thus it will decay by that much if BOH's stock price is the same on Oct. 20. Meanwhile, the preferred stock will pass through two ex-dividend dates in that timeframe, paying a total of $0.545. The common stock is selling at 274% of the price of the preferred stock, so if we assume both would go to zero together, one put option on 100 shares of BOH should hedge 274 shares of BOH-A. So our hypothetical trade would gain (274*0.545=) $149.33 in dividends while losing (100*-11.08=) $-1,108 in time value on the put. No bueno.

Of course, a trader might not ride the put to expiration because time decay quickens the closer you get to expiration. The option's theta is currently about 3 cents per day, so if the next BOH-A ex-dividend date is 7/13 or so, the highly optimistic level of time value loss (59 days*-.03 decay*100 shares =) $-177. That isn't at all compensated by the ($0.2725 dividend * 274 shares=) $74.67 dividend.

Maybe there are other tricks one could play, such as selling BOH-A short (can you do that?) to hedge a short put, but I don't see #3 as an adequate explanation for why we shouldn't trust these risk-of-failure estimates.

[chasesfish]

Nice reply.

The critique of EMH is real with these size issuances.   Is it efficient from day to day?  No.

It's probably efficient between the one week and one quarter range though. 

There is a convexity premium, as you can see side by side with FHN issuances. 
 
IMO, BOH will murder the shorts with buybacks, it's a deposit franchise with a 50/50 loan and bond book.  It's a shame the bigger premium evaporated this morning

[ChpBstrd]

Yea meme stocks really showed me the risk of a particularly bold investor subpopulation setting prices out of the range of the rest of the market. When the people buying bank preferred stocks like COF-N think these shares have a <4% chance of failing, I remind myself that all the rest of the market is staying away because the rest of the market thinks the chance of failure is >4%! If I think their odds of failure are more like 6-10%, then I have no business owning the stock, and should be in treasuries instead.

In my mind, this is setting up a lot like the Savings and Loan Crisis of the 1980s and early 90's. Per Wikipedia, between 1986 and 1995, 32% of S&L's collapsed as a consequence of Paul Volker's rate hikes, deregulation, and imprudent lending. This all sounds very familiar, and in context, the odds estimates listed above seem far too low.

In 2008, 26 banks failed including 10 with >$1B in assets.
In 2009, 140 failed, including 27 with >$1B in assets.
In 2010, there were 157 bank failures, including 23 with >$1B in assets.
In 2011, the number of failures finally went down to 92.

So I'm confident in predicting that more banks will fail in 2024 than will fail in 2023. For stock holders, it will be a long road until we can be confident in bank holdings because banks can apparently hold on by their toenails for years. I'm also thinking if <100 banks fail in 2024, that is as soft a landing as we can reasonably hope for.

[chasesfish]

I decided to fire up the old blog and put a bunch of my preferred stock thoughts out there. 

@ChpBstrd - I was out surfing yesterday and I think about that when I read your comments.  Timing is hard.   If I'm too early surfing, I miss the wave completely.  If I'm too late, the lip falls on me, churns me over a few time, and holds me down underwater.   I'm only going to put so much into this strategy because of the potential negative outcomes.

[ChpBstrd]

I wonder to what extent non-financial preferred stocks are being dragged down by bank preferred stocks.

For example, PFXF is an ETF containing preferreds from companies like AT&T, Boston Scientific, Nextera Energy, and ArcelorMittal. It yields about 6.7% today, and has a 0.4% ER.

Digging into specific issues, I have to wonder if non-bank preferreds are being sold off by diversified preferred stock funds, or treated as a single asset allocation category by institutional funds. Consider the following:

PSA-F or PSA-P: 5.22% (storage)
SHO-I: 7.5% (hotels)
INN-F: 8.2% (hotels)
MAA-I: 7.7% (apartment REIT)
T-A or T-C: 5.6% (telecom)
TGH-A: 7.5% (shipping container leasing)
TRTN-A: 8.5% (shipping container leasing, recently under contract to be acquired by another company, which probably means the preferreds get called early next year)
UMH-D: 11% (mobile home REIT)
CODI-B: 8.3% (holding company / conglomerate)
ET-E: 8.3% (pipeline MLP)
GMRE-A: 7.5% (healthcare REIT)

These might be a good way to bet on interest rates falling in the future, or a good way to lock in yield while sidestepping the banking crisis. Of course, one can't fully sidestep the banking and interest rate crisis, because all these companies are being forced to borrow at higher rates, all face recession risks, and all face the problems of reduced liquidity. But they're not banks. And yet they're yielding like banks.

The TRTN preferreds seem to really defy logic, as the company is profitable, liquid, and has recently had due diligence done by another company that will acquire them early next year. Prior to acceptance of the offer, the preferreds were selling at a premium. Yes, these shares are likely to be called away at par after the acquisition, but they sell for under par now and as a short-term play they beat CD yields by hundreds of basis points.

Further out on the perceived risk spectrum, there are several preferred stocks for shipping companies, like DSX-B (8.8%), CMRE-D (8.8%), or SB-D (8.2%). The market has been scared of these often-leveraged and cyclical companies for years, and therefore so am I. However a deep dive might reveal preferreds that are unfairly discounted.

I've just described how one could set up a whole preferred stock portfolio yielding over 7% without owning bank shares. It is possible. So I wonder if the real bargains and highest-probability survivors to emerge from the banking crisis will not be banks at all.

[Weathering]

Why doesn’t bank of Hawaii have any bonds (senior unsecured)?
I’d like to compare their yield (and rating) to that of the preferred.

[chasesfish]

Why doesn’t bank of Hawaii have any bonds (senior unsecured)?
I’d like to compare their yield (and rating) to that of the preferred.

They had no traditional debt going into 2022.   The bank has been overcapitalized since the financial crisis.   BOH mostly stayed conservative of the 2nd lien and condo stuff that rocked Hawaii, paid but didn't increase their dividend for 3-4 years, then just paid off the debt with excess capital as it matured.   The only problem in hindsight is they never shrunk the bank to match the conservative loan underwriting and ended up with a half bank / half bond book on the asset size.  Fortunately a $10bil bond book is cheaper to run than $10bil in commercial loans.

Their credit rating had to be pristine to get away with a 4.5% perpetual preferred stock issuance at the time. 

[SilentC]

I wonder to what extent non-financial preferred stocks are being dragged down by bank preferred stocks.

For example, PFXF is an ETF containing preferreds from companies like AT&T, Boston Scientific, Nextera Energy, and ArcelorMittal. It yields about 6.7% today, and has a 0.4% ER.

Digging into specific issues, I have to wonder if non-bank preferreds are being sold off by diversified preferred stock funds, or treated as a single asset allocation category by institutional funds. Consider the following:

PSA-F or PSA-P: 5.22% (storage)
SHO-I: 7.5% (hotels)
INN-F: 8.2% (hotels)
MAA-I: 7.7% (apartment REIT)
T-A or T-C: 5.6% (telecom)
TGH-A: 7.5% (shipping container leasing)
TRTN-A: 8.5% (shipping container leasing, recently under contract to be acquired by another company, which probably means the preferreds get called early next year)
UMH-D: 11% (mobile home REIT)
CODI-B: 8.3% (holding company / conglomerate)
ET-E: 8.3% (pipeline MLP)
GMRE-A: 7.5% (healthcare REIT)

These might be a good way to bet on interest rates falling in the future, or a good way to lock in yield while sidestepping the banking crisis. Of course, one can't fully sidestep the banking and interest rate crisis, because all these companies are being forced to borrow at higher rates, all face recession risks, and all face the problems of reduced liquidity. But they're not banks. And yet they're yielding like banks.

The TRTN preferreds seem to really defy logic, as the company is profitable, liquid, and has recently had due diligence done by another company that will acquire them early next year. Prior to acceptance of the offer, the preferreds were selling at a premium. Yes, these shares are likely to be called away at par after the acquisition, but they sell for under par now and as a short-term play they beat CD yields by hundreds of basis points.

Further out on the perceived risk spectrum, there are several preferred stocks for shipping companies, like DSX-B (8.8%), CMRE-D (8.8%), or SB-D (8.2%). The market has been scared of these often-leveraged and cyclical companies for years, and therefore so am I. However a deep dive might reveal preferreds that are unfairly discounted.

I've just described how one could set up a whole preferred stock portfolio yielding over 7% without owning bank shares. It is possible. So I wonder if the real bargains and highest-probability survivors to emerge from the banking crisis will not be banks at all.

I think the fixed rate prefs have sold off because the duration is huge and why buy a 6% pref in a decent company when you can buy a 10 year unsecured note in a decent company for 6%? 

[ChpBstrd]

This week’s bounce was driven by an announcement by WAL that

deposits had grown by more than $2 billion since the quarter’s end

The lender had previously reported that deposit levels had increased $1.8 billion from the end of the prior quarter to $49.4 billion as of May 9. Its latest figures indicate deposit levels increased by another $200 million between May 9 and May 12.

The article did not mention anything about the cost of these deposits.

[reeshau]

From the accompanying presentation to the announcement:

Charts are as of Q1, although comments are updated.

[chasesfish]

I think it's well known WAL is paying 5.05% on money market accounts vs. paying 5.15% via borrowings from the Federal Home Loan Bank and also offering some 5% and 5.01% CDs for 3-6 months.   The nice thing about getting these in money market deposits is WAL can inch down the rates in 90-120 days by a small percent without losing it. 

The more important part of this is outside deposits remove the FHLB or Treasury for being on the hook for a direct loss.   That's why First Republic was shot instead of allowing to zombie along, it wasn't a slow deterioration of margin, it was the federal government being on the hook.

The FDIC, while part of the federal government, is still an insurance fund.

Odds improved for survival and it was reflected in the pref yields going from 11% to 8.78% this morning.

[chasesfish]

Today was a good day.

The shorts that were banking tourists seemed to be scared away between the WAL press release and potential traction around FDIC insurance.

[Michael in ABQ]

Today was a good day.

The shorts that were banking tourists seemed to be scared away between the WAL press release and potential traction around FDIC insurance.

Yea, all my positions were up ~5-12% or so today. Still underwater on PACWP and I wish I'd picked up more BOHPRA earlier, but this is just a taxable account with a few bucks in it, so less than 1% of my portfolio.

[RobertFromTX]

Up 8% today in my positions and have a GTC limit sell order in place to unload at +24% up from here. Represents an exit at 1.3x TBV

[Weathering]

@ChpBstrd Can you add some color to the TRTN-A preferred? On the day Tritan’s acquisition by Brookfield was announced the preferred s fell in price. I would have expected the opposite. However, there are so many Brookfield business units that it difficult to determine if the TRTN-A preferred will end up in a Brookfield unit with a high credit rating or a new unit with a bad credit rating (and probably not publicly traded). There are so many opportunities in the credit market these days (I’m loaded to the gills on Agency bonds) that I’ve been staying away from anything with an even slightly opaque future. But, some shipping container leasing would certainly be a diversified for my other holdings.

My HBANP shares at $16 and $14.85 are now back in the money. But then again, they rose to $19/share a month ago and then dropped into the 12s. So I won’t get too complacent.

[chasesfish]

I'll have to go through and put some limit orders out there.   Some of the risk premiums over BofA evaporated today.

Huntington is now 0.60% above BofA
Bank of Hawaii is 1.58%

I think number where it makes sense to sell out or just swap for BofA if you want to hold these for income.   

0.5% for the bigger regionals and 1% over BofA for the smaller banks is my initial guess.

The 2.42% premium over BofA on the FHN-F is the only thing that still looks attractive, 8%+ yield, nice convexity on the upside, and not a challenged bank at all. 

[ChpBstrd]

@ChpBstrd Can you add some color to the TRTN-A preferred? On the day Tritan’s acquisition by Brookfield was announced the preferred s fell in price. I would have expected the opposite. However, there are so many Brookfield business units that it difficult to determine if the TRTN-A preferred will end up in a Brookfield unit with a high credit rating or a new unit with a bad credit rating (and probably not publicly traded). There are so many opportunities in the credit market these days (I’m loaded to the gills on Agency bonds) that I’ve been staying away from anything with an even slightly opaque future. But, some shipping container leasing would certainly be a diversified for my other holdings.

@Weathering the preferreds dropped because prior to the announcement they were selling above the $25 par value at which they could be called away. Investors now believe the preferred stockholders will be liquidated at $25/share when the transaction is consummated in the 4th quarter.

Brookfield's press release below says "Triton’s Series A-E cumulative redeemable perpetual preference shares will remain outstanding." but that's no guarantee about how long they'll remain outstanding.

https://bip.brookfield.com/press-releases/bipc/triton-international-be-acquired-brookfield-infrastructure-133-billion-take-0

It is also entirely possible the preferred shares remain in existence for a long time after the merger. Brookfield may decide they have better uses for the money, or maybe they won't be able to access funds more cheaply than the 8.5% yield, or maybe they'll just need to digest the merger for a couple of years. BIP-A and BIP-B yield 7.3%-7.5%, so that's probably close to their cost of capital.

Look up TRTN-A or TRTN-B on the following site for more details and a link to the prospectus:
https://www.quantumonline.com/search.cfm

Now that the price is right around $25, there's not much to lose from collecting a couple quarters' dividends at an 8.5% annualized rate, and enjoying the option of potentially collecting that amount for a long time in the future.

I've seen sillier things, like C-N, which Citigroup has not called away for many years despite its 9.5% yield (I bought C-N in the belief that Citigroup is even less likely to call them now if they didn't do so in 2020-2021.)

[ChpBstrd]

We can now get paid 5.116% for up to ten years with an FDIC-insured CD from Celtic Bank of UT (residents of OH and TX are ineligible). CUSIP: 15118RH34

Other banks are offering that yield on 5 and 7 year CDs. In contrast, 5 and 10 year treasuries are yielding 3.6%-3.7%.

The question is how do we use this unfamiliar tool? Almost nothing has been written for the past dozen years about a scenario like we're in now, because it was crazy talk until about a year and a half ago!

These CDs are intriguing portfolio options for early retirees with a 4% WR because the yields are 3% above the expected future rate of inflation, and because they enable the risk-free portion of one's portfolio to generate a significant amount of one's required income. E.g. a hypothetical FIREee with a 50% stock / 50% CD portfolio and a 4% WR would have 64% of their income coming from a risk-free source.

If someone positioned this way encountered a SORR event within the first 5 years of their retirement, damage would be limited to the stock half of the portfolio. Digging out of a SORR event with a coast-FIRE job or side hustle until the stock market recovers becomes a plausible contingency plan, whereas it is not plausible with a stock-heavy portfolio.

5.1% CDs are the flipside to the argument that one should never pay down a mortgage with an interest rate lower than inflation or the risk-free rate. Anyone who agrees with that reasoning about mortgages should be interested in a risk-free investment that yields higher than the likely future rate of inflation or risk-free treasury rates.

The downsides of course are that (1) CDs cannot be rebalanced as easily as stocks and bonds, and (2) the highest yielding CDs are callable. The best non-callable yield I saw was 4.5% for 5 years.

Rebalancing has been demonstrated to be THE way individual investors can generate returns greater than the weighted average of a portfolio's parts, and a big CD allocation would involve penalties with each withdraw and a lack of price appreciation like bonds do when rates fall.

Regarding the callable CDs, imagine the disappointment if we return to a low interest rate regime in a couple of years and you get a note from your bank saying your biggest, most reliable source of income is being liquidated. Meanwhile, whatever caused the sudden fall in interest rates might have decimated your stocks too! E.g. in a financial crisis, money would be flocking to FDIC-insured bank assets, and the banks which offered 5% CDs in the past could just call those CDs and replace the capital with new money going into 2% or 3% CDs. That's the bank's plan anyway!

Your money would be dumped into your hands in the midst of a financial crisis. In one sense, such timing would be fortuitous because that would probably be a great time to pivot into an equities-heavy portfolio. For retirees though, it would mean either selling stocks low each month or trading down to much lower fixed income yields than in the past.

So maybe we mitigate both of these pitfalls by keeping the callable CD allocation low enough that any imaginable level of reallocation can be done with liquid bonds and low enough so that our income plans are not too disrupted by a tranche of assets being called away.

Bank preferreds are far riskier, but "better" in the sense that many are trading below par and thus would generate large gains if called away at par. Banks looking to lower their cost of capital are much more likely to change their capital structure by churning away their highest-yielding CDs than calling away their preferred stock.

But if we think of the 4.52% yield on non-callable 5-year CDs (e.g. CUSIP 90355GDP8, 14042RVS7, or 61690U5S5 ) as our risk-free non-callable rate, then the risk premium on top-shelf preferred stocks can be put in perspective. Looks like you get an extra 1.1% or 1.2% by going with JPM-L or BAC-N rather than the guaranteed CD. You also get easier rebalancing. The cost of the better liquidity and yield is risk. In 2008, banks failed that nobody thought could fail.

[chasesfish]

Ah, the bank CDs...

The  real advantage bank CDs have are:

1) Premium over treasuries when banks need money.  Feels like 2007 finally with the premiums available.

2) Not exposed to principal loss if rates go up.  The break penalty is defined and often accretive to terminate the CD and reinvest it early.  This is attractive to me as someone who owned a few treasuries during all of this.

Callable CDs seem worthless.

[Weathering]

I don’t see any mention of Key Bank. I bought a small amount of senior unsecured bonds for Key Bank yield-to-maturity is 9% with a maturity at the end of 2025. Unfortunately, the current interest payment is low, so >10% of my gain won’t occur unless Key survives past 2025. Now, I’m seeing lots of Key Bank bonds above 8% YTM, but for HBAN, Citizens, and Regions their bond prices have recovered to <8% YTM.

What do y’all think about Key Bank?

[chasesfish]

Key pays around 7.9% on the prefs, maximum upside is just below 40% because all of their issuances are high coupons.

I don't follow them closely, but see a bunch of chatter on it from some bank analysts/hobbyists I follow.   Generally they're fine on credit quality but pay a lot more on deposits than their peers, but have a loan book that earned 5% in Q1 with few chargeoffs.   Mostly people are waiting to see if they have to cut their dividend because margins are tighter than competitors.

Prefs / debt are fine, common shareholders will take it on the chin first.

[ChpBstrd]

Huntington Bancshares' BBB bonds maturing 7/6/2024, CUSIP: 446150AQ7, are now being offered at a YTW of 8.658%. HBANP yields 6.68%.

Zions Bancorp's BBB bonds maturing 7/29/2029, CUSIP: 98971DAB6, are now being offered at a YTW of 9.245% ZIONP yields 7.35%.

Keybank National Assn's BBB bonds maturing 5/20/2026, CUSIP: 49327V2A1, are now being offered at a YTW of 9.65%. KEY-* preferred stock yields about 7.85%.

Fifth Third Bank's BBB+ bonds maturing 3/15/2026, CUSIP: 31677AAB0, are now being offered at a YTW of 7.863%. FITBP yields 6.8%.

In each case, the bank's bond is yielding almost 2% higher than the corresponding preferred stock, except for the 3 year Fifth Third bond, which is trading at a yield only about 1% higher than FITBP. In a normal world, the bonds would yield less than the preferred equity because they have a more senior claim on assets.

This is more evidence investors are "preferring" the preferreds over the bonds because they see interest rate cuts ahead, and want to lock in yield or duration-related capital gains for longer than the duration of the bonds.

They're seeing the risk of bank failure in binary, total-wipeout terms, such that the odds of preferred shareholders getting a recovery is not much different than the bondholders'. The odds of suspended preferred dividends seem not to be factored in. Not even Zions' 6-year bond can match the appeal of their perpetual preferreds.

[daverobev]

Huntington Bancshares' BBB bonds maturing 7/6/2024, CUSIP: 446150AQ7, are now being offered at a YTW of 8.658%. HBANP yields 6.68%.

Zions Bancorp's BBB bonds maturing 7/29/2029, CUSIP: 98971DAB6, are now being offered at a YTW of 9.245% ZIONP yields 7.35%.

Keybank National Assn's BBB bonds maturing 5/20/2026, CUSIP: 49327V2A1, are now being offered at a YTW of 9.65%. KEY-* preferred stock yields about 7.85%.

Fifth Third Bank's BBB+ bonds maturing 3/15/2026, CUSIP: 31677AAB0, are now being offered at a YTW of 7.863%. FITBP yields 6.8%.

In each case, the bank's bond is yielding almost 2% higher than the corresponding preferred stock, except for the 3 year Fifth Third bond, which is trading at a yield only about 1% higher than FITBP. In a normal world, the bonds would yield less than the preferred equity because they have a more senior claim on assets.

This is more evidence investors are "preferring" the preferreds over the bonds because they see interest rate cuts ahead, and want to lock in yield or duration-related capital gains for longer than the duration of the bonds.

They're seeing the risk of bank failure in binary, total-wipeout terms, such that the odds of preferred shareholders getting a recovery is not much different than the bondholders'. The odds of suspended preferred dividends seem not to be factored in. Not even Zions' 6-year bond can match the appeal of their perpetual preferreds.

On IB at least, I can't buy small amounts of the bonds - minimum purchase seems to be $250k face value. Retail investors would therefore be locked out of the bonds, only be able to trade the prefs and drive up prices?