We have two reports in our El Buen Fin Series, starting with my favorite yield play.

People seeking high yields should buy foreign bank preferred shares, issued at $25 per share, NYSE-traded, and relatively liquid, a special class of American depository receipts.

You should buy despite or rather because of the black label warning. The label reads “nc” which doesn't stand for “non-callable.” It means that omitted dividends are not recuperable in subsequent year, and are “non-cumulative”. In fact, the cheapest foreign bank prefs today are ones issued by banks which had to omit dividends, as they are trading below that $25 issue price. So their yields are higher and the eventual yield to maturity, if the bank pays back the prefs, will also be higher. Those foreign banks which didn't interrupt their payouts usually trade above $25 today because of the still generous yield.

Being non-cumulative allows these preferred shares to count toward a bank's capitalization ratio, a key element in allowing it to do more deposit-taking and lending. The banks offer these preferreds which count toward their capital precisely because they can skip payments in a crisis.

The vehicle was invented by Barclays Bank more than 30 years ago, and quickly copied by other banks in the English-speaking world, and later internationally. The initial offering paid a whopping 11.6% because of a now-ended tax break to UK banks. Their IRS, the Inland Revenue Service, allowed BCS to add back the 15% British corporate tax it paid on the preferred dividend, which boosted the yield without costing the bank any money. The tax break was too good to last.

Now banks have had to invent all sorts of complex hybrids between equity and bonds to boost their capitalization ratio, mostly only for institutional players. The old preferreds however remain around. We recommend a whole host of these preferred ADRs yielding between 4.5% and nearly 7.5%.

During the peak of the global financial crisis, two British banks got into deep difficulty and essentially were bailed out by the government. Royal Bank of Scotland, a heavily indebted bank which had grown by buying highly priced foreign lenders, wound up nearly 82% nationalized by the last Labour government to keep it from collapse for lack of capital.

This caused the European Union to block RBS preferred dividend payments for some of the multiple series of dollar-denominated preferreds it had issued in its own name, and also for one of the banks it had acquired, National Westminister. Some prefs, including Nat West C and certain RBS series, were allowed to continue to pay dividends because of the legal terms of their prospectuses. Others were forced to halt payments for 2 years to prevent distortions in the European banking system because of state-subsidies.

RBS's bad name means that its prefs which never missed a payment still trade at a lower price than those of its wholly owned NatWest sub.

The EU action came under Articles 85 and 86 of the Treaty of Rome which set the European countries on a more capitalistic course. After the RBS dividend blockages, the mounting troubles of banks in the EU led its anti-trust regulators to abandon the penalties for state-controlled bank like RBS. But the damage had been done. RBS had failed to pay the preferred share dividends to the American owners for 2 years. The share price reflected that bad credit history.

We loaded up on the affected series, on the argument that the UK government, owner of the bank, was unlikely to really default. And moreover, before it could privatize RBS, as the coalition Tory-Liberal Democrat government very much wants to do, it would have to redeem the preferreds. But the coalition doesn't want to do so by pumping in more money than the Gordon Brown Labour govt had already given RBS. This impasse makes the highest yielding RBS prefs, the once which had missed payments, a real bargain.