Preferential Treatment

Preferred shares are generally a sleepy and little trafficked corner of the financial markets. Not so over the past month, however, with the preferreds issued by Signature Bank and Silicon Valley Bank-parent SVB Financial Group likely to be zeroed out by the twin bank failures.

Still, despite the drama, preferreds offer a potentially lower-risk and higher-yield avenue to invest in banks today, per Barron’s Andrew Bary.

Preferred shares are generally the most senior form of equity in a company’s capital structure. They get paid out ahead of common shares in the event of bankruptcy, and in less-severe cases dividends on preferred shares come before those on common stock. That makes them generally less volatile than common shares, but still riskier than a company’s debt.

Banks have long been the largest issuers of preferred shares in the U.S., as a way to diversify their funding sources. Bank preferred shares make up roughly two-thirds of the $400 billion market.

Most trade on exchanges just like normal stocks, although not all brokers support them for all clients. There are also several exchange-traded funds that invest in preferred stocks. The largest is the iShares Preferred and Income Securities ETF (PFF). It boasts a yield of 6.5% after a more-than 6% decline this month.

There’s opportunity in the selloff, Andrew writes:

“There is uncommon value in the preferred market,” says Phil Jacoby, chief investment officer at Spectrum Asset Management, a preferred specialist. Yields are near their highest levels in more than 10 years, he observes, and spreads to yields on risk-free Treasuries are historically wide.

As for the risks, he takes comfort in federal regulatory support for banks on deposits and a new Federal Reserve program that lets banks borrow against their bond holdings…

Individual investors might also want to consider the preferred stock of top banks, such as JPMorgan Chase, Bank of America, Wells Fargo, and Morgan Stanley. These and some others are considered systemically important financial institutions by Uncle Sam, and so carry more capital and are more strictly regulated than regional banks. And, lately, they generally have benefited from deposit inflows shifted from smaller rivals.

Preferreds from the country’s biggest bank, JPMorgan, offer the lowest yields—its 4.2% series M issue yields 5.6%. Bank of America preferreds, like the 4.25% series Q, yields almost 6%, while Wells Fargo and Morgan Stanley preferreds yield close to 6.5%.

Regional banks can offer larger payouts, but also more danger. Investors appear unperturbed about preferreds from Fifth Third Bancorp, Regions Financial, and Cullen/Frost Bankers, which yield about 6.5%, only slightly more than some of their too-big-to-fail peers. Higher yields also are available on the preferred of New York Community Bancorp, which is buying assets of Signature Bank. [It yields 8.6%.]

Common shares from the same banks uniformly have lower dividend yields. But there’s more price upside should the bank turmoil pass and investors pile back into the sector. Investors have the chance to pick their own adventure—or avoid the group entirely until things settle down.

Read the rest of Andrew’s article here.