Chaka’s Note: Today, we have a special guest essay from longtime PBRG friend Stephen Hester.
As the banking crisis continues, you need to watch out for land mines that can blow a hole in your retirement.
In today’s essay, Stephen tells you an unexpected way to detect a bank failure before it happens.
Read on to find out more…
All eyes are on the banking sector, and everyone is wondering the same thing: Who’s next?
First Republic Bank (FRC) was supposed to be the last domino to fall. But this story isn’t over.
Being an investor in times like these can feel scary. Speculating on the wrong stocks will cost you. Ignoring the banks altogether isn’t safe, either. And if too many fail, the economy will sink, as will stock prices.
At Intelligent Income Daily, we focus on guiding you to safe, reliable income-producing plays that’ll help you sleep well at night. That includes showing you how to avoid land mines that can blow a hole in your retirement.
Today, I’ll tell you an unexpected way to detect a bank failure before it happens.
I haven’t seen this secret mentioned by anyone else. But it’s indicated every bank failure this year – weeks or months before it happened.
And best of all, you won’t need to dust off any old accounting textbooks or take out a calculator. You can easily apply this method with websites you already use.
By familiarizing yourself with this tactic, you’ll be ahead of most investors… And can weather this ongoing banking crisis with ease while others fall victim to it.
The Secret to Seeing a Bank Failure Coming
My secret is something I started developing 15 years ago, the last time we were in a banking crisis.
Back then, I was a trader at a hedge fund. Yet no one I worked with identified this “canary in the coal mine.”
Let me tell you how it applies to what is going on today…
Earlier this month, the Federal Deposit Insurance Corporation (FDIC) took over First Republic Bank. That was on May 1.
But what if I told you that I already knew First Republic Bank would likely fail… back in March?
It all has to do with something called “preferred stocks.”
Preferred stocks are a hybrid between a company’s common stock and bonds. Almost all preferred stocks, including the ones we’ll talk about today, have a par value of $25.
If the company goes under, the bondholders typically get paid first, then the preferred shareholders, and lastly the common stock investors.
In many ways, a preferred stock is like a fixed-rate bond that trades with a normal stock ticker.
We don’t need to go into the weeds of preferred stocks as an investment. But for our purposes, you just need to understand that preferred stocks are something you can find in any brokerage account, and their dividends – while fixed – are safer than common stock.
Below is a price chart of First Republic Bank’s Series K preferred stock. Until May 1, anyone could buy shares using symbol FRC-K (or FRC-PK depending on your broker).
FRC-K was trading at $6.85 back on March 20. Remember, most preferred stocks have a par value of $25.
FRC-K paid a fixed dividend of $1.03125 per share, or 4.125% at par value. When it was down at $6.85, it yielded 15%.
That means if you bought the preferred stock at $6.85, not only would you earn a double-digit yield, but you could stand to make a 265% return when shares eventually returned to $25.
If there was even a tiny chance the bank was going to survive, people would buy that preferred stock hand over fist.
But that’s not what we saw.
Remember, preferred stock and bond buyers are typically Wall Street heavyweights and industry insiders. When they head for the exits, we should pay attention.
Seeing how far the preferred stock had fallen… and how the “smart” money wasn’t scooping up shares… told us the bank was a lost cause six weeks before First Republic Bank failed.
This allowed us to steer clear of the bank and avoid losing our shirts trying to earn a quick buck.
This is the same warning sign I saw before the collapse of other banks like Silicon Valley Bank and Signature Bank this year. Both times, the preferred stock sank weeks – or months – before the failure.
And both times, we avoided the carnage as the common stock went to zero.
The Telling Power of Preferred Stocks
If a company has preferred stock, it’s easy to find right through your brokerage or a financial website.
Type the common stock symbol into most of these websites, and you’ll see the company’s preferred stock. It’ll also be listed in all the company’s quarterly and annual filings.
Here’s a good rule of thumb to follow:
Any time you see a preferred stock trading at half or less of the $25 par value, you know to tread carefully. And if the preferred stock is trading well below $10, the risk of bankruptcy is high.
Let’s look at one final example of a bank on the edge…
Below is PacWest Bank’s (PACW) preferred stock that trades under the symbol PACWP.
Back in March 10, PACW common stock was still trading around $20. But PACWP sunk under $10 per share by March 13.
Now PACWP is trading around $10 per share as the market tries to figure out if the bank is going to make it.
If PacWest Bank’s stock begins trading below this point on a consistent basis soon, it will join the fate of First Republic. So keep an eye on this metric in the days to come.
Conversely, preferred stock can also show us which companies are strong.
Currently, my two favorite buys in the regional banking sector both have preferred stocks. And despite the overall volatility in the space, they’re trading between $17 and $23 per share.
This is just one way we use alternative methods to find the best deals in the market. In fact, in our recently launched High-Yield Advisor service, we target undervalued preferred stocks to earn double-digit income safely.
It’s just one of the three ways we generate above-average income outside the regular stock market.
Just like this trick I shared with you today, few people outside of Wall Street know these strategies. But thanks to my years of experience, I share them with regular investors just like you. Click here to learn more about High-Yield Advisor.
Stephen Hester, CFA
Analyst, Intelligent Income Daily