Some might think "criminal" is too strong a word; I don't. I'm referring to the Federal Reserve's latest proposal to maintain "exceptionally low levels for the federal funds rate at least through late 2014."
So what does that mean? Besides income investors being thrown under the bus, it means the federal funds rate – the rate at which banks lend among themselves – is basically zero. Short-term lenders are getting nothing for their trouble.
It's almost as bad for long-term lenders. Thanks to Fed Chairman Ben Bernanke laying the groundwork for yet another round of large-scale bond purchases, long-term rates will continue to trudge along at ridiculously low rates. A five-year CD yields about 1.8%; a 10-year Treasury note yields a mere 1.9%.
Flooding the market with currency and forcing yields so low that many fixed-income investments offer only negative after-tax returns is, in my opinion, criminal.
We can blame the Wall Street establishment and the coast-to-coast commercial banks for the Fed's free-money ways. Buy enough sub-prime collateralized mortgage obligations and achieve economy of scale on your screw ups, no problem. The Fed has to bail you out, lest the rest of the economy crumble into chaos.
The rest of us, of course, pay the piper through a prolonged recession, a devastated housing sector, and anemic economic growth.
To a lesser degree, shareholders in the too-big-to-fail financial leviathans also pay, through either loss of equity or through slashed income streams.
Admittedly, the worst is over, but don't be fooled into thinking the big-bank survivors have learned their lesson. Consider this revealing 2010 quote from JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon:
"Not to be funny about it, but my daughter asked me when she came home from school 'what's the financial crisis,' and I said, 'Well it's something that happens every five to seven years. We shouldn't be surprised, but we need to do a better job."
Now, this isn't to say that I'm down on banking in general; banks can be a great source of income and yield. But I'm only interested in banks that have proven they can "do a better job."
Texas-based Cullen/Frost Bankers (NYSE: CFR) is one of those banks. In fact, Cullen/Frost might be the best-run bank in the nation. It recently reported another year of annual earnings growth, posting $217.5 million for 2011, a 4.2% increase over 2010 earnings of $208.8 million. At the same time, Cullen/Frost saw non-performing assets decline by $44.0 million from the fourth quarter of 2010 and $18.3 million from the third-quarter 2011.
Cullen/Frost's superior management team was rewarded this past December when Standard & Poor's bestowed the bank with an A+ credit rating. S&P cited Cullen/Frost's "strong capital, excellent liquidity, consistent profitability and solid credit performance relative to peers," reinforced by the company's "conservative strategy and solid market position in Texas."
Cullen/Frost remains a value since it was recommended this past April. Cullen/Frost is trading at only 15 times this year's EPS estimate of $3.65 and its dividend, which has been raised every year for the past 18 years, yields 3.3%.
When an insider invests a million dollars in the bank he knows intimately, I take note. Board director and insider M. Lynn Parrish recently invested a million dollars of his own money to purchase 42,000 shares of High Yield Wealth holding Community Trust Bancorp (NASDAQ: CTBI), a Kentucky-based regional bank.
So what was Mr. Parrish investing in? A small-cap disciplined bank that focuses on the basics – taking in low-cost deposits and prudently lending out these deposits to its consumer and commercial base.
Community Trust continues to excel at the basics. The bank posted another profitable year, with EPS growing 17% to $2.53 in 2011.
Readers who took our recommendation to buy Community Trust are up 12.5% on their investment. They also have collected $0.93 in dividends per share. In my opinion, dividends define Community Trust. The bank has hiked the dividend payout every year for the past 34 years.
Investors should expect more share appreciation and more dividend hikes in the future. Community Trust trades at only 11.8 times next year's EPS estimate of $2.60 – the low end of the historical 10-to-17 range. This is an exceptional value for a stock yielding 4.1%.
The third bank in the High Yield Wealth portfolio – Ares Capital Corp. (NASDAQ: ARCC) – isn't a bank in the contemporary use of the word, but I consider it a bank nonetheless.
You see, Ares is a business development corporation. It raises funds through equity and bond offerings and then lends these funds to middle-tier private corporations. In that sense, Ares is really an old-school bank – a merchant bank.
Ares is also a cash-generating machine. Last month, it raised its annual distribution to $1.44 per share, which provides a forward yield of 9.1%.
Ares is as much a value today as when it was recommended nearly a year ago. It trades at book value, when it normally trades 25% above book value. The shares are priced at only 10.3 times 2012's estimate for $1.56 per share. And it continues to provide a growing stream of income after raising its quarterly distribution.
The banks in the High Yield Wealth portfolio provide not only exceptional income and share-price appreciation potential, they provide piece of mind.
These banks have no choice but to perform. There is no Federal Reserve subsidy and no TARP bailout in their future. They are small enough to fail. Because they can fail, management knows it must master risk management and the business of borrowing and lending.
Fortunately for their investors, these banks have proven over time that they are consistent and exceptional risk managers and bankers, despite what the politicians and central bankers throw their way.