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Like Money in the Bank With These 'Nonbanks'

NEW YORK (TheStreet) -- The traditional banking sector is bracing for downgrades in the weeks ahead, and it's enough to keep the stock market spooked for a while longer.

Moody's Investors Services recently indicated that it's likely to reduce the credit ratings on close to 17 big banks by the end of June.

Sources tell me that this will include five or six of the largest financial companies in the U.S. If the downgrades occur, it will most likely raise the cost of debt issuance and curtail some of their more lucrative activities.

Names including Bank of America (BAC) , Citigroup (C), J.P. Morgan Chase (JPM), Goldman Sachs (GS) and Morgan Stanley (MS) have been mentioned as possible downgrade targets.

This is adding to the general economic angst that investors are feeling as the stock market tries to recover from May's over 6% correction and the fallout from the European debt crisis.

The worry about the European Union and its currency dissolving, beginning with the Greek election next Sunday, makes the potential for a downgrade of big U.S. banks more ominous.

The SPDR S&P Bank ETF (KBE) and The Financial Select SPDR ETF (XLF) were falling on Monday. The credit downgrades have been bantered around since February, so investors are not totally surprised by the weekend headlines on the topic.

But until this situation is rectified and the scope of these downgrades are finally announced, it will cast a pall of gloom on the banking sector.

So let's focus our investing attention on the "non-banks" that can make their money in similar style to the big money-center banks without the looming downgrade stigma.

By borrowing money at or close to the Federal Funds Rate (0%) and investing it in government-guaranteed bonds that pay 2% or 3%, these companies can generate huge profit and operating margins.

When these publicly traded "non-banks" are doing this "spread" trade with hundreds of millions of dollars they make enough money to pay some mighty generous dividends to their shareholders.

The leading example of these "non-banks" is Annaly Capital Management (NLY). It has chosen to be structured as a Real Estate Investment Trust (REIT) for federal tax advantages.

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