Buy fear like Buffett, 2 times cheaper, yield +7%

Co-author of Hidden Opportunities.

Warren Buffett completed some of the biggest banking deals during the banking industry’s darkest days.A review of past transactions and success stories shows that he is not worried about buying at the absolute lowest price, and Make the last nickel. As the business changes and grows, the Oracle of Omaha seeks substantial long-term funding.

“The best thing that happens to us is when a great company gets into temporary trouble… We want to buy them while they’re lying on the operating table.” – Warren Buffett

On August 7, Moody’s announced rating actions on 27 U.S. banks. These include downgrading the ratings of 10 banks, changing the outlook of 11 other banks to negative from stable, and putting six banks under review for possible downgrades. In making these decisions, credit rating agencies consider several factors, including banks’ second-quarter earnings releases, interest rate risk and more.

The credit agencies pointed out known issues, nothing surprising. Just like when Fitch downgraded the U.S. sovereign credit rating, Wall Street is likely to use Moody’s downgrade as an excuse to sell financial sector stocks.

Yes, the rapid rate hike cycle has created some problems and banks have had little time to adjust their balance sheets; the industry has been put on the operating table. With interest rates stable, higher rates benefit banks whose primary business is lending money and collecting interest.

Eventually, the market will start to ignore it. If investors insist on waiting for “clear” signals that interest rates are moderating and recession fears are dispelled, they will miss out on buying opportunities.

“The future is always uncertain; you pay a high price in the stock market to achieve happy consensus. Uncertainty is actually the long-term value buyer’s friend.” – Warren Buffett

Buffett likes to pick long-term winners in industries that have been around for centuries, and few are more durable than banking. What can be more durable than banks, capital markets, and insurance companies? These are time-tested industries and we will control more of the global transactions around us. Now let’s discuss two high-yield stocks that have benefited from this sell-off.

Option #1: BTO – 9.8% Yield

John Hancock Financial Opportunities Fund (BTO) is a closed-end fund (“CEF”) whose portfolio is jointly established by U.S. and international financial services companies. source.

BTOs are actively managed and investors can expect to see allocation changes from time to time as fund managers identify better opportunities. BTO’s top brass includes two leading alternative asset managers at a time when private equity consolidation is hitting new records. CEF holds 164 positions and operates with 20% leverage to increase total returns from its actively managed strategy.

BTO share prices have fallen sharply in recent sessions as credit agencies downgraded the ratings of major players in the banking sector, but there is no similar correlation with NAV (Net Asset Value). It is worth noting that BTO holds 4 of the 10 banks whose ratings were downgraded.

Income seekers can now buy BTO at a modest 2% premium to NAV, the cheapest valuation for a high-quality CEF this year, and the fund has beaten the market during the turmoil of the past three years, with NAV up 21% .

BTO has been around for about 30 years and has an excellent record of consistent performance and net asset value retention. BTO pays a quarterly dividend of $0.65 per share. Based on this calculation, the annual rate of return is 9.8%. For the two quarters of FY23, BTO’s distribution is 17% NII (net investment income), 37% ROC (return on capital) and 46% long-term capital gains, which is quite efficient from a tax perspective.

We can expect BTOs to continue to seek safer bets in this weathered industry and capture value for shareholders. Here’s a cheap CEF to buy during uncertainty and sit back and collect those big tax-advantaged distributions.

Option #2: RILY Senior Bonds and Baby Bonds – Yields up to 7.9%

B. Riley Financial Corporation (RILY) is a diversified financial services company that is ubiquitous in everyday transactions on Wall Street. From asset management to non-performing loans, from consulting and appraisal to liquidation and bankruptcy restructuring, the company is involved in businesses of varying degrees of health. source.

In the second quarter, RILY reported closing more investment banking deals year-over-year, and the firm added several new and current businesses to its pipeline. RILY also reported an increase in retail clearings in the United States and Europe, with continued strong demand for its financial advisory and valuation services. source.

The company has been aggressive in making acquisitions amid market uncertainty. Recently, RILY announced the acquisition of Crawford & Winiarski, a boutique forensic accounting and litigation consulting firm located in Detroit, Michigan. Earlier this year, the company acquired Farber Group, a Toronto-based restructuring and business advisory firm. In recent weeks, RILY has raised $115 million through a common stock offering, which has cast uncertainty and doubt about the company’s debt, dividend security and overall liquidity.

RILY reported total adjusted EBITDA of $234.7 million for the first half of 2023. This was enough to cover interest expense of $94.8 million, preferred stock dividends of $4 million and common stock dividends of $80 million during the same period. For the third quarter of 2023, the company expects operating adjusted EBITDA of at least $105 million, which provides sufficient coverage for quarterly debt obligations and preferred stock dividends and leaves a healthy amount for ordinary dividends and other corporate activities.

As of the end of the second quarter of 2023, RILY reported cash and investments of $1.9 billion, and total debt after cash and investments was $406 million. RILY has an impressive 50% insider ownership, suggesting management decisions are closely aligned with shareholder interests. Insiders, including CEO Bryant Riley, have continued to increase their holdings of common stock in recent quarters. source.

Therefore, the stock issuance does not currently raise any red flags for the company’s financial health. RILY preferred stocks and baby bonds continue to offer safe income investments at deep discounts.

baby bonds

• 5.0% Senior Notes due December 31, 2026 (RILYG)

• 5.5% Senior Notes due March 31, 2026 (RILYK)

• 6.375% Senior Notes due February 28, 2025 (RILYM)

• 6.5% Senior Notes due September 30, 2026 (RILYN)

• 6.75% Senior Notes due May 31, 2024 (RILYO)

• 6.0% Senior Notes due January 31, 2028 (RILYT)

• 5.25% Senior Notes due August 31, 2028 (RILYZ)

Of these bonds, RILYT and RILYZ have yields to maturity of 11.8% and 13% respectively, providing stable +7% interest payments until 2028. RILYT offers a higher current yield of 7.5%, while RILYZ offers 7.3% and slightly higher capital upside than par value.

preferred stock

• 6.875% Series A Cumulative Perpetual Preferred Stock (RILYP)

• 7.375% Series B Cumulative Perpetual Preferred Stock (RILYL)

With a deep discount to face value and a redemption date of just 13 months, RILYP’s preferred stock has an impressive redemption yield of 21%. However, it’s worth noting that both preferred stocks are perpetual and the company can keep them trading indefinitely after the redemption date. Among preferred stocks, RILYP’s current yield is as high as 7.9%, with about 14% upside potential over common stocks. Both preferred stocks pay qualified dividends.

Considering RILY’s high insider ownership, countercyclical business model, and general popularity of Wall Street events, the preferred stock and baby bonds offer attractive income opportunities for the foreseeable future.

in conclusion

Our investment team is a buyer of discount dividends, and our goal is to make our portfolio a paycheck producer we can count on in good times and bad. In a downturn in the market, it is common for a few businesses to encounter setbacks and headwinds. But with careful diversification through +45 instruments, we can withstand (and even thrive on) adverse dividend decisions from some companies.

“The most important decision when evaluating a business is pricing power. If you have the ability to raise your prices without losing business to your competitors, then your business is in very good shape. If you have to pray before you’re going to raise your prices by 10%, Then your business will be in trouble.” – Warren Buffett

The financial services sector is experiencing a sell-off, with quality companies becoming strong buys. Banks are not going away. In fact, the more important and prominent players will be more dominant in the future. The giants will absorb smaller, troubled players, and the financial system will thrive again. We look forward to enjoying the show while strategically leveraging substantial gains in mature securities that have proven to adeptly navigate challenging market conditions and risks. Amid widespread market concerns, interest rates of up to 9.8% can greedily increase your retirement income.