Friday Edition Addition

Is it just me, or is it really difficult to get into the spirit of a COVID Christmas?

The tree is up, the outside decorations are out, and the calendar says December. Still, with all the boat parades, tree lighting, and other big events that usually mark this time of year canceled, it has been challenging to get whipped up into the Christmas Spirit.

We may need to spend some time with bourbon and Frank Sinatra holiday albums this weekend

2020 has been a weird year, to say the least. 2021 is not going to be much different early on. Hopefully, that changes as we get a vaccine widely distributed, and we can actually get back to some form of normality.

The stock market has been in the Holiday swing of things almost continually since late March of this year. While I am skeptical of prices at these levels, I am reminded that this very much remains a carry trade. The S&P 500 yields more than the 10-year treasury bond, so a leveraged long position can be self-financing.

Traders and investors are focusing much more on the interest rate relationship than the high absolute level of valuations. Until that perception changes, it is tough to see a meaningful sell-off occur, no matter how much I want to see that happen.

We know rates will be low for a very long time. I also suspect that despite the carry trade in stocks, the long-term total return of stocks will not be up to historical standards. We have rallied sharply off the bottom this year, but we were headed for a 1930s type bear market without enormous stimulus from the Fed and Congress.

At the moment, we agree with the big picture outlook from bank-centric brokerage firm KBW who said this morning that "While we believe some of this week's weakness is attributable to seasonality surrounding Thanksgiving, virus trends remain concerning and the recovery has undoubtedly lost modest ground over the past month. While we will most likely see a partial rebound in the Index (KBW's in house Economic Index) as business activity normalizes post-Thanksgiving, we maintain the view that further gains are unlikely to come until Congress passes additional stimulus measures and/or widespread COVID-19 vaccine distribution begins."

The vaccine gets us back to normal, and normal is still a slow-growth economy that will struggle to replace the jobs that have been lost this year.

We love bank stocks right now. We stayed the course with the ones we owned coming into the pandemic and have added two names in recent weeks. I would love to own more, but for now, the stock market is not cooperating with me. When it does, we will be buyers.

Given the lower for a lot longer atmosphere and the increasing likelihood that banks avoid disaster, I also like bank debt right now.

Community and regional bank debts are pretty much institutional markets. As individual investors, you and I will seldom have an opportunity to purchase most smaller bank bond offerings directly.

These markets also tend to be even more illiquid than community bank equity markets. Getting into a community bank debt position is difficult. Getting out could be pretty much impossible.

Fortunately, there are three closed-end funds that allow us to invest in this very attractive market segment and still have daily liquidity if needed.

The granddaddy fund is StoneCastle Financial (BANX). The fund has been around since 2013 and invests in bank debt and preferred stocks issued by community banks. Most of their investments are made in the form of income-generating preferred stock with warrants or equity conversion rights. About 30% is currently in debt securities, with the rest in income-producing preferred stocks.

The fund trades at about a 7% discount to net asset value right now, and the yield is 7.80%.

StoneCastle prefers smaller banks, and most of their investments are in banks with less than %10 billion in assets.

Angel Oaks Financial Strategies Income Term Trust (FINS) is the new kid on the block. This fund is much more focused on community bank debt that preferred stocks. About 82% of the fund is in bank debt, and a much smaller portion is allocated to preferred shares.

The shares currently trade at a 10% discount NAV and yield 7.6%.

The newest fund is also from Angel Oak. Dynamic Financial Strategies Income Term Trust has a broader mandate that allows it to invest more broadly across the financial sector. The portfolio is about 20% in nonbank financial debt, with more than 70% in bank debt or preferred issues. This fund also owns larger regional banks than FINS.

This fund trades at a 13% discount to NAV and yields 7.60%.

All three funds give you access to institutional debt markets with attractive yields. I think the total return from owning these will outperform traditional stocks over the next sever layers. Adding these to a portfolio of discounted community banks should be a winning strategy as banks continue to catch up and we eventually see M&A come back into vogue.

Posted to The Community Bank Investor… on Dec 04, 2020 — 11:12 AM
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