ZION - KRE: Searching For Margin Of Safety

2023-03-14 07:00:00 ET

Summary

• SPDR S&P Regional Banking ETF is holding a diversified 143 regional bank stocks.
• KRE lost over a quarter of its market cap, caught by the Silicon Valley Bank failure.
• I attempt to find a bottom and contemplate a few ways to profit from this.

Situation Overview

Following my previous update on the Silicon Valley Bank issue during the weekend, KRE's market value has decreased by over 25%. The reason for this decline is widely known, and I won't delve into the specifics covered by numerous headlines and articles. Essentially, KRE's net asset value per share (NAVPS) dropped due to the failure of Silicon Valley Bank and Signature Bank, resulting in the worthlessness of their equities. This contagion risk led to a sell-off of other regional banks.

I am among the more optimistic individuals for a couple of reasons. Firstly, the banks that have failed are not the typical regional banks that cater to local economies. Silicon Valley Bank caters to the technology, biotechnology, and venture capital sectors, and its bank run was caused by sizeable deposit redemptions from knowledgeable investors. Signature Bank and Silvergate Capital had a significant focus on cryptocurrency. It's worth noting that none of these banking failures have a direct impact on Main Street and the real economy. Secondly, the newly established Bank Term Funding Program provides banks with one-year funding on a collateralized basis. Furthermore, the collateral, such as US Treasuries, agency debt, and MBS, will be evaluated at par rather than at market value. This allows banks to raise short-term liquidity without the need to sell their portfolio securities at a loss, which was a significant trigger for Silicon Valley Bank's failure. Consequently, given the distinctive characteristics of the failed banks and this new funding program, I believe that the majority of regional banks will be alright.

KRE NAVPS

As I am considering going long on KRE, I want to be aware of the potential risks involved. Thus, I decided to calculate KRE's NAVPS. To obtain the necessary information, I downloaded KRE's holdings from their website and used Google Finance formulas to create a spreadsheet . To simulate the worst-case scenario, I set the price of some of the holdings to zero.

• Silicon Valley Bank ( SIVB ) is a zero for sure.
• Silvergate Capital ( SI ) is also a zero.
• First Republic Bank ( FRC ) is in significant liquidity trouble, I assume it will fail as well.
• I then zeroed out four other banks with a high percentage of uninsured deposits: Comercia ( CMA ), Synovus ( SNV ), Zions ( ZION ) and Western Alliance ( WAL ).
• (let me know in the common box which one I should zero out)

After accounting for the 42 million outstanding shares, my calculated adjusted NAV is roughly $1.75 billion or $41.73 per share. To prepare for the possibility of the surviving banks experiencing further trading declines, I applied an additional 10% discount. As a result, I am confident in a worst-case NAV of $37.5 per share.

Game Plan

As my approach involves taking a directional bet, my objective is to have positive delta exposure to KRE. While outright purchasing KRE presents a ~17% downside, the risk/reward ratio does not appear to be particularly favorable. Personally, I am more at ease buying calls and selling some puts to offset some of the premium costs (and to capitalize on the heightened volatility). Additionally, a covered call strategy may also be worth considering. More daring investors may want to consider selling puts with a strike price near my worst-case scenario. Regardless of the strategy employed, I am confident in having a hedged long exposure to KRE.

The primary risk is clear: a series of regional bank failures. However, I consider this to be an improbable event. If the number of failed banks does increase, I anticipate the Federal Reserve to take drastic measures.

Conclusion

This trade is not for the faint-hearted. There is a possibility of a significant tail risk in which regional banks experience a domino effect of failures. Nevertheless, given that the current bank failures were due to extraordinary circumstances and that the Federal Reserve has already devised an effective solution, I believe the issue will be contained. I intend to include KRE in my portfolio, and there are various methods to execute this strategy creatively.

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