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Selloff Can't Tarnish Banks' Yields

Laurie Kulikowski

A sharp selloff in the financial stocks has investors diving for dividend yield.

The KBW bank index, which follows the large-cap bank stocks, is down 6% this month, and the Amex broker-dealer index, which tracks the big brokerage houses, is off 7%.

The swoon has confounded some investors, coming as it does during a run of strong earnings for the group. JPMorgan Chase (JPM Quote - Cramer on JPM - Stock Picks) has dropped more than 10% in two weeks since it posted stronger-than-expected second-quarter earnings. Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) is down 12% over the same period and almost 20% below last month's 52-week high.

"The second quarter was one of the best quarters in some time in terms of beats/misses," writes Lori Appelbaum, an analyst at Goldman Sachs. Yet "the results clearly did not translate to better stock price performance, as the group traded down amid broader market credit fears."

The selloff has some investors focusing on high-quality names that pay out big dividends. Among the names that come up repeatedly in discussions with fund managers are Citigroup(C Quote - Cramer on C - Stock Picks), Bank of America(BAC Quote - Cramer on BAC - Stock Picks), Wells Fargo(WFC Quote - Cramer on WFC - Stock Picks) and Wachovia(WB Quote - Cramer on WB - Stock Picks).

Last week, Bank of America upped its quarterly dividend by 14%, to 64 cents a share, while Wells Fargo raised its payout 11% to 31 cents. But the number many investors look at more closely is dividend yield -- the annual dividend rate divided by the recent stock price.

BofA is "trading less than 10 times forward earnings and [has] dividend yield of 5.3%. It's not a distressed stock, it's not a distressed company," says Ganesh Rathnam, an equity analyst at Morningstar. "These businesses -- they earn 20% of return on equity. These are great businesses. There are fabulous opportunities to be had in this company."

Wachovia's 14% share-price decline this year has also created a "buying opportunity," adds Keith Horowitz, an analyst at Citigroup.

"We've been surprised by how weak the stock has been," Horowitz writes in boosting his rating to buy from hold. "We see Wachovia's credit quality as more likely to be a future positive catalyst for the stock as we see less of a credit headwind here than other banks."

Like most banks, Wachovia's provision for loan losses was substantially higher in the second quarter. But Horowitz believes the bank's losses will be "manageable," and at recent prices the stock yields 4.6%.

Citi yields 4.4% at recent levels and Wells 3.6%. Among the harder-hit financial stocks in recent weeks, J.P. Morgan yields 3.4% and Goldman just 0.7%, according to Yahoo! Finance.

Others remain skittish. Dick Bove at Punk Ziegel, for instance, points to the collapse of the subprime mortgage market and an overflowing pipeline for high-yield debt tied to leveraged buyouts.

"In general, I think we're in a period of questioning asset quality," says Bove. "When you start to question asset quality in a bank, it doesn't matter what the bank earns, people won't buy the stock."

Bove, who earlier this month issued a sell rating on the big brokerage stocks due to huge possible losses tied to bad debt, said he expects bank stocks to keep going down "until you start to see a shift in nonperforming assets," which rose at most banks in the latest quarter.

Likewise, Charles Lahr, a portfolio manager at Franklin Templeton(BEN Quote - Cramer on BEN - Stock Picks) who runs the Franklin mutual financial services fund, says investors should be on the sidelines for at least another 12 months.

His fund holds positions in few U.S. banks right now. Among those he owns are Citi and U.S. Bancorp(USB Quote - Cramer on USB - Stock Picks), a Minneapolis-based regional bank that yields 5.1% after a recent selloff.

"All of the large banks in the U.S. have exposure in one way or other to the securitization markets ... and ultimately you're seeing significant risk aversion after a very benign time," Lahr says.

"For the U.S. [banks], this is a time to be looking," he says, not buying. "We're not really at trough valuations yet."