DPST - DPST Is Dangerous Right As Banks Move To Shore Up Reserves

2023-03-10 08:04:50 ET

Summary

• The news in banking is that SVB Capital had to sell securities marked for sale in order to shore up cash balances, as well as issue new shares.
• SVB finances venture, so this is another negative indicator for the VC space.
• More importantly, it is a signal that we are in the same universe of fire-sales and equity raises in at least the marginal side of banking, with some contagion risk.
• Investors should look over their banking investments to watch for a safe amount of reserves.
• With DPST exposed to regional banks that are especially dependent on their NIM, with deposit betas also high on top of signs of bank weakness, DPST is to be avoided.

First and foremost, Direxion Daily Regional Banks Bull 3X Shares ( DPST ) is a leveraged ETF. These securities are engineered in such a way that make them highly speculative, and investors must do their own due diligence to understand these risks which are in relative terms, exceptionally high. We have a section in this article that provides some initial information to consider regarding these risks.

However, in particular, DPST is exposed in that regional banking is highly dependent on net interest margins and income (NIM and NII), and the ETF takes the changes in the underlying regional banking index and magnifies those returns for each independent day by 3x. Because of sales of assets by some banks now, and the need to raise capital to shore up reserves against eroding risk-weighted assets, the risk is especially pronounced for regional banks, if the higher rate environment begins to affect their stability due to high deposit betas. Overall, a bullish and leveraged instrument on regional banking is ill-timed, especially when panic can create issues for banks.

Note on Leveraged ETFs

Because they reset daily after mimicking changes in the index that day by a 2x factor in the case of DPST, there is the problem of value erosion. While a 1% rebound after a 3% drop isn't so bad for the underlying index, having a 6% drop and a 2% rebound is more of a problem. There is a reason why Warren Buffett's #1 rule is, don't lose money. If you lose money, you have less to recover with, meaning for every drop you need a bigger percentage recovery to bring you back to square 1. If an asset drops 33%, you need an almost 50% recovery to recover. If an asset drops 50%, you need 100% recovery to breakeven. Even if the next day is a bigger rebound than what you lost the previous day, with leveraged ETFs it is still less helpful even if the recovery gets doubled because more money was lost the prior day.

If you don't fully understand these risks, do not proceed with a leveraged ETF. They are best used over short durations because of value erosion. They are highly speculative burst instruments.

Links for reference on these risks:

• The Lowdown on Leveraged and Inverse Exchange-Traded Products
• Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors
• Regulatory Notice 09-31 | FINRA.org

Trouble With Banking

Banking had a bit of a rout these days and it comes first off the news that SVB Financial ( SIVB ) has had to sell some held securities at deep losses to raise some reserves. SIVB is particularly exposed to venture capital , where portfolio companies of VCs have been instructed to move money away from SIVB due to bank-run risks. Venture exposure means SIVB would be first in line in terms of seeing some struggles from a higher rate environment and tighter financial conditions for cash burning SIVB loan portfolio companies.

But the issue goes beyond that, and it's the simple fact of duration gap in banking portfolios.

Duration gap is the concept that assets are longer duration than liabilities for banks. They basically have to be, as this risk transformation is one of the main purposes of banks. But when rates rise the net value of banks becomes eroded.

Another factor, deposit beta , is also critical in determining how aggressive this erosion is. Deposit beta is the rate at which increases in Fed funds reference rates converts into rising deposit rates. If the beta is high, net value of banks comes down faster with rates, and conversely interest income and margins too. Deposit beta is higher than expected right now, and could come up a lot more since deposit betas are substantially lower than Treasury yields, which is not sustainable.

Larger banks have more ancillary services to make money off, including just straight fees, but also asset management and other associated businesses that can shore up the equity in banks against duration risks.

Regional banks are more exposed than larger banks as they depend more on this fundamental function of taking on duration risk and adding value to the economy in that way. Their assets, while not as exposed as SIVB which serves venture, are more exposed than many other institutions, and they'll have higher deposit beta since they have less ancillary services with which to compete for depositors. So the concern in markets is the flood gates may be opening.

Bottom Line

We think that contagion risks are quite low. SIVB is a little less than 1% of the US' total banking assets. Most of the assets are with large institutions that have safer balance sheets and conditions with respect to duration gap. Regional and community banks have shrunk in importance, also in part due to consolidation in banking over the last 30 years. But the unknown risks in the banking world need to be heeded carefully by investors.

The problem is panic is a contagion too, and as far as it concerns SIVB, the risks are higher than the average investor expects. Solvency risk is real if confidence starts to decay . This can happen to any bank where their financial condition comes into question. Do not underestimate the danger of a bank run, and these could begin in regional banks in principle if deposit beta and loan quality starts to become a problem. Thankfully, rates of financial in businesses remains pretty low.

However, the market may not notice this, and panic would be very bad for DPST if speculation mounts over bank balance sheets, where in the case of some fire-sales, would become less valued and may require more equity. Deposit betas are also a continued problem since rates are likely to go up a bit more and to stay higher for longer. As markets catch onto this general reality about rates, they will also punish regional banks especially hard. Moreover, the concerns around regional banks specifically, which DPST tracks, is quite justified even without actual contagion. It's just the strata that regional banks find themselves in with respect to the rate environment. Overall, stay away.

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