Banking on income

There is nothing like a crisis as a way of shaking out a few good income generating investments.

One such crisis which has gathered steam in the last few months is the sub-prime loans debacle that started in the US and has spread around the worlds financial markets like a contagion leading to the so called credit crunch. The credit crunch being effectively where banks and wholesale markets have reduced their lending to each other on the basis they were not sure how many dodgy loans that might have and therefore how much of their own capital they might need to sure up their own finances. At the same time it also cast doubt on the quality of the assets backing of the institutions that they are lending to making it difficult to measure and price risk. The cost of risk to any lender is reflected in the interest rate a lender charges.

The latest victim of this debacle has been Chuck Prince. He quit as chairman and chief executive of Citigroup on Sunday night as the company revealed it was facing between $8bn and $11bn of further losses on its holdings of mortgage-related securities.

All this is helping to drive down the values of bank stocks in the UK and US as the markets worry about the size of the potential write offs and the exposure of banks to these bad loans. All this I believe is throwing up some very good income and saving generating opportunities.

Some of the most heavily sold banking stocks have been UK domestic banks. These banks are particularly exposed to the UK housing market and any slowdown in consumer spending with the UK market. Two stocks that spring to mind are: Bradford & Bingley and Alliance and Leicester. Another stock that has been particularly heavily hit is Barclays because of concerns over Barclays Capital (a subsidiary) potential exposure to the sub-prime market.

Bradford & Bingley
Bradford and Bingley is probably the most exposed of the UK banks to a down turn in the UK housing market being the owner of Mortgage Express the UK’s largest buy-to-let lender and also having targeted aggressively the self certification mortgage market. Both these areas are very vulnerable to a slowdown in the UK housing market.

The shares are currently down from a high of 481.75p and trading at just over half this figure which is near their historic lows. The good news for income monkeys is the dividend which is projected to be just below 8% for the year end December 07 and is covered by just under two times by projected earnings.

High 481.75p Low 254p CURRENT 272p
Projected Yield 7.7%

Barclays
Barclays is one of the most established and well known names in UK retail banking. It is a massive global bank with an asset value of over £30 billion. Its share price is currently trading off its low for the year of just under £5 although it is still some way off its low point during this decade when in early 2003 it was just over £3. The broad spread of its businesses and its size means that it should be well insulated against any down turn and its projected yield of 6.3% is over twice covered for the year ending Dec 07. It is also forecast to increase to 7% for 2008 on a P/E of 7.2.

High 790p Low 498.25p CURRENT 521.5p
Projected yield 6.3%

Alliance and Leicester
Alliance & Leicester is another of the smaller retail banks which was created from the demutualisation of building societies that occurred in the late 80s & early 90s. Being smaller than international banks such as Barclays and being UK focused it is very susceptible to a down turn in the UK economy. However, unlike banks such as Bradford & Bingley and Northern Rock it has not entered so aggressively into providing mortgages and maintains instead a mix of business and retail operations. Projected dividend cover is less than the other two stocks at 1.7 earnings.

High 1197p Low 600p CURRENT 701.5p
Projected yield 7.8%

The Income Monkey Verdict

For those investors and savers with a strong nerve these banks could prove to be a solid income stream. There is no doubt that the market in its current nervous state will continued to be spooked by any new revelations about financial imprudence in the lending markets. However, remember it is the banks we are dealing with. Bankers have a very clever way of being able to get themselves out of hole when problems occur, so that it is always somebody else that is left with the loss. Look how the Bank of England is paying to save Northern Rock for instance. If the property market goes 'tits up' again it will be the borrowers who have to bite the bullet. The nature of bankers are that they ensure that others are the ones that are exposed to the really big risks.

Therefore bank incomes should be reasonably secure with dividends covered comfortably by profits. Markets will have to get much much worse for investors and savers to worry about not getting paid. Income Monkeys should bank on income & continue to buy on weakness.