The Highest-Quality 17% Yield Out There

That's right -- the stock I'm thinking of currently boasts a whopping 17% dividend yield. Recently, it's been borrowing money at virtually zero interest rates and investing the proceeds into higher-yielding government-backed securities. Perhaps you think I'm referring to a mortgage REIT, such as Annaly Capital Management (NYSE: NLY  ) or American Capital Agency (Nasdaq: AGNC  ) -- but I'm not. Have you looked at the American Depositary Receipts of Spanish lender Banco Santander (NYSE: STD  ) ?

Which is more risky?
Maybe you think I should have my head examined. A Spanish bank -- at this juncture? Don't you read the papers? If those are the questions that are popping into your head, here's one for you: Are you absolutely certain Banco Santander is riskier than Annaly or American Capital -- not to mention mortgage REITs with a broader investment mandate such as Chimera Investment (NYSE: CIM  ) ? As I see it, all are exposed to tail risk, whether it takes the shape of a run on the Spanish banking system or a dislocation in the U.S. repo market.

Even some of my fellow Fools display a casual nonchalance regarding the risks associated with Annaly. A few days ago, one of them wrote: "Annaly Capital will mint money for as long as the Fed holds short-term rates near zero, which makes this stock potentially the ideal recession play." I see it quite differently.

This is the front-runner
But back to our Spanish lender, Banco Santander. Do you believe all Spanish banks are toxic? Here are three points to ponder:

  • Santander is Spain's largest bank, which gives it wider access to international financing than its peers. (Banco Bilbao Vizcaya Argentaria (NYSE: BBVA  ) also has good access.)
  • In 2011, Latin America was Santander's largest source of profits -- greater than Continental Europe and the U.K. combined. This is not the result of losses elsewhere (all geographies were profitable); the distribution of group profits has been trending this way for some time.
  • Finally, among the top eight Spanish banks, Santander has the next-to-lowest proportion of problematic real-estate-related exposure relative to total loan exposure (3.4%), according to Goldman Sachs estimates (Bankinter boasts the lowest, at 3.6%).

Santander is a cut above; Goldman made this clear in its May 8 report, writing: "We see [Santander]([Conviction List] Buy) and BBVA (Buy) as the only realistic avenues for investing in Spanish banks given their diversified business mix, strong profitability and adequate capitalization."

The shares are hardly risk-free, to be sure. In a report dated Feb. 1, Morgan Stanley described three scenarios for Santander -- base, bull, and bear. The bear case assumed "Recession in Spain with real estate losses equivalent to Ireland, -10% growth in Brazil and UK contraction" (Spain, Brazil, and the U.K. are the bank's top three markets, in that order). Under that scenario -- to which they assigned a 30% probability -- the broker gave a price target for the shares of 4.50 euros (on the date of publication, they closed at 5.77 euros). On Tuesday, the stock closed at 4.58 euros on the Madrid Stock Exchange.

From bear to base
Sure enough, since Morgan Stanley's report was published, Spain has slipped into a double-dip recession and Ireland now looks like a perfectly sensible benchmark for real estate loan losses. Likewise, Brazil's contribution to group profits fell nearly 12% in the first quarter, while the U.K.'s dropped 41%. What was a bear scenario four months ago is now the base scenario, the shift displaying the speed with which events can overwhelm investors' baseline assumptions.

Macro jitters
Banco Santander shareholders continue to face a number of macro-related risks:

  • Real estate losses could exceed the bank's provisions.
  • Dilution/wipeout of the existing equity if the bank were forced to recapitalize itself on disadvantageous terms.
  • A partial euro breakup could disrupt interbank (i.e., funding) markets.

Mortgage REITs also face macro-related risks, but these are less well understood, and much less well publicized:

  • A possible disruption of repo markets linked to botched "fiscal cliff"-related negotiations between the White House and Congress at the end of the year or due to a dramatic deterioration of the eurozone crisis.
  • As over-the-counter derivatives move onto centrally cleared exchanges, clearing houses will require investors to put up collateral against these trades. This could create excess demand of high-quality collateral, i.e., the same securities on which repo markets are based. It remains to be seen how this might impact this market.

Spotting a speculation
As Ben Graham and David Dodd wrote in the classic Security Analysis, "an investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

Will Santander cut its dividend? I don't know, but a dividend yield of 17% suggests that the market thinks it will. At 17%, the yield is unlikely to be just part and parcel of an "investment operation." Santander is a speculation, but so is Annaly or American Capital, and yet people who wouldn't dream of investing in the former are happy to own the latter. Aversion is the bedfellow of opportunity, while nonchalance lies down with risk.

If you want to invest -- rather than speculate -- in financials, you can't afford to miss "The Stocks Only the Smartest Investors Are Buying."

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio; you can follow him on LinkedIn. The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (41) | Recommend This Article (104)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 06, 2012, at 1:43 PM, tblakeslee wrote:

    How can you compare a bank that owns loans without federal guarantees with ANGC? Here is a quote from their Yahoo profile:

    "It invests in residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by government-sponsored entities or by the United States government agency."

    Where is the risk when there are federal guarantees?

  • Report this Comment On June 06, 2012, at 1:48 PM, Turfscape wrote:

    ^

    "It puts out at least two contradictory articles on everything everyday. Take your pick - Is (insert name of stock) the perfect stock? followed by Is (insert name of same stock) bankrupt?"

    So you DON'T want to be exposed to alternate viewpoints? You only want to hear one side, either 'buy' or 'sell'?

    Perhaps Jim Cramer is more your speed. This site tends to focus on educating rather than speculating.

  • Report this Comment On June 06, 2012, at 2:00 PM, EGTalbot wrote:

    I happen to think Annaly is risky and I've stayed away. But a Spanish Bank?

    If you honestly believe a large U.S. mortgage REIT is in the same league of risk as a bank in a nation that very realistically could wind up having its currency collapse (Germany won't bail them out, so either Germany or Spain will wind up leaving the Euro), you're beyond help.

  • Report this Comment On June 06, 2012, at 2:41 PM, mikecart1 wrote:

    "Highest-Quality 17% Yield Out There"

    I smell oxymoron! :)

  • Report this Comment On June 06, 2012, at 3:53 PM, chopchop0 wrote:

    Yes. Echoing others. I'd put $10K in NLY before I put $1 in a spanish bank lol

  • Report this Comment On June 06, 2012, at 4:15 PM, TMFAleph1 wrote:

    <<Yes. Echoing others. I'd put $10K in NLY before I put $1 in a spanish bank lol>>

    That's my point.

  • Report this Comment On June 06, 2012, at 5:42 PM, hardnokgrad wrote:

    I'm getting really SICK of these MF pipe-dreams! Once again, a pump job on a FOREIGN high yield, and NO MENTION WHATEVER of the DIVIDEND WITHHOLDING TAX, which in Spain is NOW 21% (raised from 19% eff. 1-1-12). How many clicks does it take to check that? Of COURSE the Author holds NONE, so wouldn't see it on HIS Statement, which is HOW READERS WILL EVEN FIND OUT about it, since Broker Quote sheets omit it, too. YES, the 1040 has a Foreign Tax credit, but it is NON-REFUNDABLE (tax offset only) so if you trade in an IRA or zero out after deductions , YOU ARE OUT OF LUCK!

  • Report this Comment On June 06, 2012, at 5:54 PM, swedenclunk wrote:

    Take a look at UK bank bonds. Paying ca10% last I looked, a few months ago. Lloyds has preceded bonds ie paid before dividends. Nat west are also worth a look.

  • Report this Comment On June 06, 2012, at 6:00 PM, TMFAleph1 wrote:

    <<Where is the risk when there are federal guarantees?>>

    There are two sides to a balance sheet: Assets and liabilities.

  • Report this Comment On June 06, 2012, at 6:01 PM, TMFAleph1 wrote:

    @swedenclunk

    Those bonds sounds interesting, and it's nice to come across a constructive comment once in a while.

  • Report this Comment On June 06, 2012, at 6:04 PM, TMFAleph1 wrote:

    <<Once again, a pump job on a FOREIGN high yield...>>

    If I were operating a "pump job", I would guard myself from labeling the shares in question an outright speculation in the last paragraph of the article.

  • Report this Comment On June 06, 2012, at 6:20 PM, showme wrote:

    Would you invest in a high risk company that has the symbol STD? This could have been saved for next April 1.

  • Report this Comment On June 06, 2012, at 6:45 PM, SAMSCREEK wrote:

    I really don't understand why people get so up

    tight about some of the articles that are printed by

    the Motley Fool. They are simply giving you other

    options or ideas to think about.

    It doesn't cost you anything to read the articles

    and no one is twisting your arms, making you

    read them.

    I never would have thought about investing in a

    spanish bank, and still wouldn't, but it was a

    different idea.

    I have gotten many good ideas from the MF,

    and I have read many not so good ideas.

    Keep the articles coming and I will keep reading them.

    Tom

  • Report this Comment On June 06, 2012, at 7:28 PM, Teacherman1 wrote:

    Interesting article Alex

    I happen to own STD as well as BBVA and don't consider either to actually be speculative in the sense that they are likely to go bankrupt.

    Where the speculation comes in is in the intermediate term price fluctuation.

    In the longer term, both will prove to be good investments if purchased at the right price.

    JMO and worth exactly what I am charging for it.

  • Report this Comment On June 06, 2012, at 7:44 PM, TMFAleph1 wrote:

    <<I happen to own STD as well as BBVA and don't consider either to actually be speculative in the sense that they are likely to go bankrupt.>>

    I agree inasmuch as I don't think they are likely to go bankrupt, but I don't think they meet Ben Graham's criteria for an "investment operation." On that basis, I'm forced to label them as speculative.

  • Report this Comment On June 06, 2012, at 8:06 PM, JohnMaxfield37 wrote:

    There's definitely a double dose of fear crimpin' STD's style. It's a financial. And it's European.

    It's hard to argue with your logic.

    That said, I think a dilutive event seems more likely than not. Depending on how long and deep Spain's recession is, there could be a load of non-performing loans waiting to be triggered and realized.

    The question, in turn, is how significant of a dilution should investors factor into their analysis.

    Furthermore, while I dislike NLY and its ilk on principal, unless the repo market freezes, which would be hardcore since the Fed could step in and accept the agency bonds as collateral, any securities they're buying now are probably pretty good. As best I can tell, banks aren't presently originating many bad mortgages. And I don't see the yield curve inverting anytime soon.

    Thus, as time progresses, and as much as I hate to admit it, I think there's a legitimate bull case developing for mREITs.

  • Report this Comment On June 06, 2012, at 8:35 PM, savvied wrote:

    STD is changing symbol to SAN, so an April Fool's joke won't work next April. There is dilution with the ability of taking the dividend as shares, WITHOUT Spanish taxes. But if the bank survives, and one takes the shares, will it have been a good stock to own long term. I have owned this bank since before the financial meltdown, and keep looking for a good reason to buy more. Thanks for the article about Santander.

  • Report this Comment On June 06, 2012, at 9:06 PM, mapbc wrote:

    Not a good idea to go tell your honey you picked up some STD today. I'm not sure what's going to happen but it looks like this thing might keep growing.

    She'll probably take if the wrong way.

  • Report this Comment On June 06, 2012, at 9:21 PM, TOM48 wrote:

    How about a closed end utilities fund GABUX. Pays .07 per share every month for the last 15 years & some of that is return of capital that you do not have to pay tax on. This works out to 13% annually. I haven't found anything that beats it. Never been lower that $5 or higher than $7. Look into to it. It has solved monthly income for me. $150000 gets you $1625 every month & never touch the principal.

  • Report this Comment On June 06, 2012, at 9:23 PM, irwinjj1108 wrote:

    I remember when someone recommended IBM way back because it was sporting some great dividend yield. Guess what??? IBM lowered it's dividend!!!! wow! It wasn't such a great deal after they did that. My guess is that Santander is going to do the same thing! Bye, bye 17%!

  • Report this Comment On June 06, 2012, at 10:56 PM, lowmaple wrote:

    STD could lower it's dividend and still yield well Of course the stock may drop at that point. I bought TEF on Friday and it yields only 19% at that price. Of course divident cut could happen there also but I couldn't resist.

  • Report this Comment On June 07, 2012, at 7:58 AM, RLR0528 wrote:

    I say ride that mREIT pony as far as she runs. There are no risk-free investments today with returns that aren't a joke. No investor should buy and forget; monitor closely and be quick to respond when factors change.

  • Report this Comment On June 07, 2012, at 4:47 PM, dross203 wrote:

    I'm a fairly new investor and was thinking of buying about 1k of this in my IRA. Can somebody further explain the comment below left by hardnokgrad in more detail? I'm sure it's exactly as he said it but I'm confused. If I buy this and have it auto-reinvest the dividends do I still pay the ~20% Spain tax on the dividend?

    Thanks.

    ---------------------------

    "I'm getting really SICK of these MF pipe-dreams! Once again, a pump job on a FOREIGN high yield, and NO MENTION WHATEVER of the DIVIDEND WITHHOLDING TAX, which in Spain is NOW 21% (raised from 19% eff. 1-1-12). How many clicks does it take to check that? Of COURSE the Author holds NONE, so wouldn't see it on HIS Statement, which is HOW READERS WILL EVEN FIND OUT about it, since Broker Quote sheets omit it, too. YES, the 1040 has a Foreign Tax credit, but it is NON-REFUNDABLE (tax offset only) so if you trade in an IRA or zero out after deductions , YOU ARE OUT OF LUCK!"

  • Report this Comment On June 07, 2012, at 5:06 PM, Teacherman1 wrote:

    dross203

    This is from the STD webpage

    Receive a fixed amount of cash from Santander (Spanish tax withheld at a rate of 21 %),

    Sell rights in the market for cash (no guaranteed price but no Spanish tax withheld) or

    Receive new ADRs (no Spanish tax withheld).

    A benefit for those who receive ADRs or sell their rights in the Spanish market will be that they will not be subject to Spanish withholding tax which applies to cash dividends. ADR holders who opt to receive cash by selling their rights back to Santander at the fixed price will incur a deduction of 21% on account of Spanish withholding tax as in any other cash only dividend, but will be certain of a fixed payment amount

    You have the option to receive it in additional ADRs, which would be the same as if you "reinvest" with your broker.

    Hope this clears it up for you.

  • Report this Comment On June 07, 2012, at 5:13 PM, TMFAleph1 wrote:

    @Teacherman1

    Thanks for pitching in and living up to your username!

  • Report this Comment On June 07, 2012, at 6:11 PM, Mega wrote:

    Any discussion of European banks needs to include Basel III. Collectively, the amount of capital they need to raise is pretty huge. In my opinion it will suppress share prices for the next few years until it is resolved.

  • Report this Comment On June 07, 2012, at 6:19 PM, TMFAleph1 wrote:

    @MegaShort

    Collectively, yes, but it's not huge for Santander, specifically.

  • Report this Comment On June 07, 2012, at 6:42 PM, TheDumbMoney2 wrote:

    For me the problem with Spanish banks is that if the fit hits the shan, they are going to end up owing a lot of Euros to foreign creditors, and having only pesos to pay with. This is totally separate from loan losses, recession, etc. Recapitalizations galore. But I have not looked superclosely at the issues, or at STD in particular. For me the whole sector in that region is an avoid. I simply have no edge. Nice contrarian article.

  • Report this Comment On June 07, 2012, at 6:47 PM, awallejr wrote:

    <<Yes. Echoing others. I'd put $10K in NLY before I put $1 in a spanish bank lol>>

    That's my point.

    This article isn't about Alex advising people to buy STD as a spec play, this is just a continuation of his crusade against NLY and AGNC. He argues how STD is highly speculative and then makes a Monty Python argument basically saying see since STD is speculative and not a worthy Graham and Dodd pick therefore NLY and AGNC are as well.

    It is apples to oranges here, but I will say it was at least a clever attempt.

  • Report this Comment On June 07, 2012, at 7:00 PM, ETFsRule wrote:

    Dross: yes, the person you quoted is accurate. This is also explained here:

    http://www.fool.com/investing/international/2011/01/27/how-f...

    I'm not sure how you would go about "selling rights" as Teacherman mentioned, but it could involve jumping through a lot of hoops. I suspect that it might not be worth it anyway. There is no guarantee that you will break even each time you buy & sell your shares.

    If the company pays a quarterly dividend, and this causes you to buy and sell your shares 4 times a year, then you are potentially losing the bid/ask spread 4 times, plus commissions. Not to mention, your "rights" could trade at a discount to the actual stock price - after all, why would anyone want to buy your rights unless they stood to make a profit?

    This would likely cause you to lose more than the taxes on the 17% dividend (~3.4%/year).

  • Report this Comment On June 08, 2012, at 7:55 AM, dross203 wrote:

    Thanks all for help clearing up my question. Very insightful help.

  • Report this Comment On June 08, 2012, at 11:41 AM, BellemonteCo wrote:

    This is a horrible article. It should not appear on the Fool, where people turn for sound financial information. There is absolutely no safety in this dividend.

  • Report this Comment On June 08, 2012, at 12:03 PM, deadbrokedad wrote:

    I hope the author is watching Today's news on CNBC. Seems the whole world expect Spain to go crawling to the IMF for money to prop up its failing Socialist system this weekend. Couple that with the near failure of the #3 state bank and watch the Spanish bank runs come Monday just like the Greeks have already done.

    Me, I'm staying with the US Gov't backed paper that supports the Top-of-the-line mReits. Cha Ching, Cha Ching all year long, all last year too. Like having the same license to steal that the Fed has.

  • Report this Comment On June 08, 2012, at 1:13 PM, Threedollarbill wrote:

    I've learned to beware the high yielding stocks, they seem to be high for a reason: risky. I much rather own a stock with a way lower yield, a bit of growth, less risk than a high yielding one, and one that's domestic right here in the USA. I'd prefer: JNJ, WMT, MCD, MO, T, VZ, just about any of these any old day. This article is waaay to risky.

  • Report this Comment On June 08, 2012, at 7:15 PM, eremmell wrote:

    Cool! I'm happy to read all of the uninformed negative comments here, as I'm quite long STD/SAN! Of course that means that this is a contrarian pick. I expect to see STD up around $9/share by the end of 2012. Yes, they will continue to pay the EUR 0.60 dividend. If you research this bank in some amount of depth, you will find they are being thrown out with the bath water. Especially now that we hear that this weekend Spain will ask the EU to bail-out their banks (and the EU will accept ... they are just waiting to be asked directly by Spain). STD of course needs no bail-out. If EU agrees to bail-out Spain's banks this weekend, I expect to see a 10% pop in STD early next week ... continuing upwards through the next quarterly dividend.

    BTW, I'm also quite long ABX.

  • Report this Comment On June 08, 2012, at 7:47 PM, eremmell wrote:

    I tried to post a comment here, it has been 30 minutes and it still doesn't show up.

    Anyways, I'm happy to see the negative sentiment towards STD as I'm long quite a lot on that stock (as well as ABX). Contrarian play. If the EU bails out Spanish banks this weekend, you can expect to see STD pop 10% early next week and continue rising up through the next quarterly dividend. STD will continue to pay the EUR 0.60 dividend. No worries, this stock will get up close to $9/share by the end of 2012.

  • Report this Comment On June 14, 2012, at 3:11 PM, SpaceVegetable wrote:

    This one has been on my watch list for a while. They have more than just Spain in terms of exposure. They bought Soveriegn bank here in the US a couple years back, so they're getting revenue from a lot of different places.

  • Report this Comment On June 14, 2012, at 3:17 PM, thisislabor wrote:

    @turfscape,

    you know what I want to be exposed to?

    how about just the truth on how the company sits, not on whether or not it is going up or down.

    let me decide that for myself thank you very much.

    also, I hate posting this up here in the forum because you all readers seem to think you can still predict a stock's price movements.

    you can't predict the market!!!!

    so don't try to!

    but you can describe it as it is... but you can't make any judgements on where any given stock is going.

  • Report this Comment On June 14, 2012, at 3:19 PM, thisislabor wrote:

    dross203,

    your non-refundable credits typically rollover to the next year. i forget if the foreign tax credit does or not off the top of my head though..

  • Report this Comment On June 22, 2012, at 1:21 PM, TMFAleph1 wrote:

    “It’s a double whammy and a little unsettling for the repo market to no longer have SOMA lending as a backstop,” said Michael Cloherty, head of US interest rate strategy at RBC Capital Markets.

    'Operation Twist' threat to bond trading, Financial Times, Jun. 21, 2012

    http://www.ft.com/cms/s/0/a8e4fc4c-bba8-11e1-90e4-00144feabd...

  • Report this Comment On June 22, 2012, at 5:32 PM, TMFAleph1 wrote:

    "As a reminder, there has been abnormally low liquidity, reflected in offer-to-cover ratios, in the recent auctions for some of the Treasuries that the Fed purchases as part of the program. Other strategists have also pointed out that the Fed has a dwindling supply of sub-three-year Treasuries to sell, which among other things might exacerbate future strains in repo markets."

    RBC: Problems with extending Twist... not fixed by extending Twist, FT Alphaville, Jun. 22, 2012

    http://ftalphaville.ft.com/blog/2012/06/22/1056421/rbc-probl...

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