Because of the massive share dilution and major ownership by each country's government, many investors are hesitant to put money into the stocks of Royal Bank of Scotland Group (NYSE:RBS) and National Bank of Greece (UNKNOWN:NBG.DL). But we're going to look at another way to invest in the recovery of these banks while being more insulated from share dilution and future recapitalizations.
RBS: discount and a yield
With government ownership of more than 80%, RBS is something of an unsolved problem for the British government. All of this has cast a cloud of uncertainty over the bank -- depressing the value of RBS-related securities. In addition, the common stock pays no dividend, so investors need share-price appreciation to see a return on their investment.
However, there is an alternative for those bullish on RBS but still wanting to collect a dividend. RBS preferred shares currently pay substantial yields north of 7% annually, as well as trading at a discount to liquidation value. One example is RBS Preferred N Shares (NYSE:RBS-N) with a yield north of 7.5% and a more-than 15% discount to liquidation. Fortunately for U.S. investors, RBS has many different preferred shares listed on the NYSE, giving you a wide choice in selecting the right investment.
RBS preferred shares will not only allow the holder to collect a high yield, but they also stand to benefit from a decision on how the government will address the RBS situation going forward. If RBS is moved back toward privatization, the appetite for RBS preferred shares may increase as government control is loosened and private investors have a better look at what the future of RBS will entail.
National Bank of Greece: half-price sale
Unlike RBS, which has numerous varieties of preferred shares listed on the NYSE, National Bank of Greece only has its Series A Preferred Shares (NYSE:NBG-A). Also unlike RBS, the dividend on these shares is currently suspended as the Greek bank tries to preserve capital.
But buyers of National Bank of Greece preferred stock are compensated through a 50% discount to liquidation value. This discount is built in to reflect the state of Greece's economy, the bank's uncertain future, and the lack of a dividend.
However, when compared to common shares of National Bank of Greece, the preferred shares offer substantially less risk while still giving investors the opportunity to double their money and begin collecting a dividend if the bank is seen as more stable. Additionally, the preferred shares avoid much of the recapitalization risk by avoiding the share dilution aspect of raising capital by issuing new shares.
Although RBS shares offer investors a solid dividend until the bank can turn around, National Bank of Greece preferred shares require long-term patience in holding for a recovery in the Greek financial system. But one bright spot for National Bank of Greece preferred shares is that for the Greek bank to pay dividends to common shareholders, it must first reinstate the preferred stock dividend. If Greece can recover and investors begin to pressure for a dividend, preferred shareholders are first in line.
Most preferred stocks act much like bonds that have less upside potential but pay a consistent dividend. But in the cases of RBS and National Bank of Greece, preferred stock carries a major upside as well. Investors looking to invest in European banks while collecting a dividend or reducing recapitalization risk should take a look at the preferred shares of RBS and National Bank of Greece.
Alexander MacLennan is long $7 January 2015 National Bank of Greece calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days.