Hunting For Yield Among Bank Stocks

Bank Stocks: Hidden Bargains for Income Investors

In the past, bank stocks were an excellent source of dividends for income-oriented investors.

The traditional “3-6-3″ model of banking – borrow at 3%, lend at 6%, and be on the golf course by 3 p.m. – led to nice, if somewhat unexciting, lives for bankers. It also offered a stream of reliable dividends for shareholders.

But today, bank deposits are a rotten investment, as they pay almost nothing (though they at least have a Federal deposit insurance guarantee). Meanwhile, bank stocks don’t pay much more and are subject to the storms of the next financial downturn.

It sure seems as though bank stocks are a total disaster right now…

How Did We Get Here?

When monetary policy was relaxed in 1995, the banking model changed significantly.

The largest banks charged into all sorts of exotic derivatives, and they were incapable of managing the associated risks. Smaller banks, pumped up by easy money, rushed into subprime mortgage, real estate, and leveraged buyout lending – and they never even attempted to manage the risks.

The result was a massive bank bailout in 2008, after which all the banks slashed their dividends close to zero to rebuild capital.

On the other hand, seven years of zero interest rates pumped up bank profits and encouraged them to lend to more real estate and leveraged buyouts, as well as energy and (to a lesser extent) technology startups.After 2008, nothing much changed except that the Feds kept inventing newer and more arcane excuses for levying billion-dollar fines on the largest banks, which played merry hell with their profitability.

Dividends, though, didn’t rise to their previous levels, as even 2% yields kept share prices safely above their net asset value. Thus, the largest banks aren’t very interesting investments for income investors these days.

JPMorgan Chase (JPM), for example, yields just 2.9%. Even the most solid of the big banks, Wells Fargo (WFC) – which does less investment banking than its peers – has only a 2.6% yield. That’s not chopped liver in this era of deposit rates below 1%, but it also doesn’t pay for the risk of another market meltdown, bank bailout, and accompanied shareholder dilution.

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