I’m introducing a little diversification into banking today.
music selection: “Not An Addict” — K’s Choice
You have to be careful with mega banks. The “too big to fail” banks go through a regular cycle where share values collapse due to scandal and mismanagement. It’s a moral hazard issue. The government has taken away their risk so they act recklessly. Smaller regional banks are different. They very rarely have blow ups. Their risk is real and they act accordingly. Over long periods of time, regional banks also outperform the mega banks. A large part of this is the most attractive regional banks often get bought out by the mega banks at substantial premiums.
Today, I’m adding to my watchlist (I’m waiting on free capital, probably from Chevron), to buy shares. The target is SPDR Series Trust – SPDR S&P Regional Banking ETF (KRE). The fund yields a modest 1.68%. It is reasonable to expect some dividend growth going forward. We want to value banks by their price to book multiple. The P/B for KRE is 1.30, which I think is pretty good for a basket of firms with good growth prospects. Diversification is strong here with the largest holding making up only 1.31% of the allocation. This is important because there is some risk in regional banking right now for banks that are over exposed to the oilfield.
We are holding for growth so covered calls will be written around 10% out of the money and about six weeks out. In this case, that will be the 48 strike 31DEC2015 call. It can currently be sold for about 22 cents. If opened today, the trade would be open 44 days. Annualized yield would be 3.8%. Combined with the 1.68% dividend yield, total yield would be 5.48% while we wait for capital gains. I think that beats the pants off the index-and-draw-4%-a-year approach. Your mileage may vary.
Devour your prey raptors!