Financial Select Sector SPDR ETF (XLK) was up 0.52% yesterday, March 18, when almost everything else finished in the red. The Invesco KBWB Bank ETF (KBWB) was ahead 1.14%. Citigroup (C) gained 0.33%. Bank of America (BAC) was ahead 2.61%. U.S. Bancorp (USB) added 3.27%.
Banks are a major beneficiary of rising long-term bond yields. They borrow at the short end of the yield curve where the Federal Reserve has set its benchmark interest rate at 0% to 0.25%. And they lend–for mortgages, for example–at the long end of the yield curve. The yield on the 10-year Treasury, the benchmark for many mortgages, ended at 1.71% on March 18.
With economic growth looking strong for 2021 and with long term yields likely to end the year even higher from the current 1.71%, I think it makes sense to add exposure to bank stocks to a portfolio. (I think bank stocks are also likely to show less volatility than bonds themselves since the earnings advantage that higher yields offers to banks won’t go away with a week or two of fluctuations in yield.
I already own Citigroup in my Dividend Portfolio (where it’s up 27.03% as of March 18 from my December 8, 2020 buy.) I own Invesco KBWB Bank ETF in my Jubak Picks and Perfect 5 ETF portfolios (it’s up 6.03% from my March 6 and March 4, respectively, buys.)
And now I’d like to add more exposure to the sector. But what?
At this stage in the bank stock rally, I’m looking for well-run banks that will be able to take advantage of the increase in the yield spread to add to earnings. (As opposed to earlier in the cycle, when I added Citigroup because things were getting a lot better even for not-so-well run banks. A rising tide lifts all boats but it often lifts those of questionable seaworthiness most.)
Bank of America (BAC) is one possibility. But the stock is up 25.80% for 2021 as of March 18 and up 32.26% in the last month.
I think, instead, that I’ll go with U.S. Bancorp (USB), the country’s largest regional bank. U.S. Bancorp is up 16.96% for 2021 to date and up “only” 21.27% in the last month. It also comes with a 3.8% dividend (well above the 1.90% paid by Bank of America) that will give investors some downside protection and some income if the stock stalls for a while.
U.S. Bancorp is one of nation’s most efficient banks–and operates one of the industry’s most conservative underwriting cultures for loans and credit cards. The bank also has invested in heavily technology so that unlike many of its banking peers it operates an integrated backend system rather then the mishmash of legacy platforms at many banks. That’s helped the bank grow its payments business as a payments processor and as an acquirer of merchant accounts. Payment processing is a relatively fixed-cost business where the ability to grow scale and run it through an efficient technology platform is key. U.S. Bancorp’s integrated backend enables it to add transaction volume with very low incremental costs. The bank’s return on equity in the pre-pandemic year 2019 was 14.48%. Last year it dipped to 9.94%. A return to the five-year average of 13.56% or to the 2019 level would make this a very profitable way to add bank exposure to a portfolio.
I’m adding it to the Jubak Picks Portfolio with a target price of $69 a share. The stock closed at $56.27 on March 18.
A final note on using Call Options to increase the leverage of your investment in bank stocks.
I went looking to add Call Options for the Invesco KBWB Bank ETF today, March 18. (I also own a Call position so I was looking to increase the holding.) But I was deterred by the extreme spread between the Bid Price and the Asked Price. Looking at the June 18 call with a strike price o $65 a share (the ETF closed at $64.15 on March 18) I found a Bid Price (what someone would offer to buy my Call contract) of $3.90 and an Ask Price (what someone would take to sell me this Call contract) of $6.30. Buying with this spread would put me deep in a hole to begin the trade. I tried stealing a bid today, as I had on the previous two days, but I didn’t get any sellers during the day a $2.90 or at $4.00.
Which has led me to look at the Call Options on Bank of America and U.S. Bancorp. The Call for June 18 for U.S. Bancorp with a strike at $57.50 (the stock closed at $56.27 on March 18) had a much more reasonable spread of $2.52 Bid and $2.88 Ask. If I went out to the September 17 expiration date with the same strike price of $57.50, the Bid price was $3.80 and the Ask $4.05. For Bank of America the June 18 Call at $39 carried a Bid of $2.47 and an Ask of $2.55. (The stock closed at $38.94 on March 18.)
Tomorrow is a triple expiration date for options and that can lead to some “odd” moves on the day. I think I will add Call Options on either U.S. Bancorp or Bank of America to the Volatility Portfolio tomorrow. Which one will depend on Friday’s prices. I’ll post by buying decision here tomorrow.
