KRE - What To Do About U.S. Banking Stocks Right Now

2023-03-14 05:20:00 ET

Summary

• One sensible thing might be to simply agree that no one knows and therefore let's be elsewhere.
• Another is to try and understand the basic problem here, the base economic background.
• With that we might be able to find out who is oversold and who isn't sold enough.

There are no specific stocks mentioned here

Well, OK, I'll mention Silicon Valley Bank ( SIVB ) just because that's mandatory right now. But I am deliberately not mentioning one or other of the still-trading (even if with interruptions) stocks because I'm not about to claim sufficient knowledge to know.

Rather, I'm going to describe the basic background problem. With that it's then possible to understand why there is this nightmare of tumbling stock prices right across the regional banks. With that it might be possible to then decide which will survive and which might not. I am not, I repeat, not going to make suggestions either way for specific stocks. This is about the thing I do well, which is the background to events.

So, the problem

Well, the problem at SIVB is that they lost their capital. Which is pretty bad for a bank, obviously. But how did they?

They had an inrush of deposits. OK, that's fine. But not all that many interesting places to lend the money out to. Banking lives off the difference between deposit and lending rates, so that's not quite so good.

So, they lent out those deposits by buying bonds. This isn't quite right, but at this point we can think of a bond as just being a loan out of the bank - the bank buys a bond, it's the same as - for a fixed term. At which point the bank faces two risks. Plus, it faces a decision about them.

One - and one bankers know well - is credit risk. What if the guy who issued the bond goes bust? That did happen in 2008 at a great rate. The other is price risk. If the bond falls in value, then that takes some of the bank's capital with it. And if you've not got enough capital, then you as a bank go bust. Or, possibly worse - because faster - people worry that you might, so they pull their deposits, meaning you're subject to a bank run and so are bust. But faster.

Well, OK. These are manageable. If you are in Treasury notes - so, very short term - your price risk is minimal absent truly hyperinflationary levels of interest rates. If the US Treasury defaults, then we've all got larger problems than which bank to deal with. It's polishing the shotgun while sat atop the canned beans stockpile time.

Ah, but. Everyone else knows that too. So for some time now, T-notes (notes are short term, bills medium and bonds long) have been paying the sort of interest rates that your cat offers if you agree to feed it early. So, the temptation is to move out along the maturity in order to gain more yield.

And that's the problem

Silicon Valley Bank was at the long end of the maturity curve in order to also gain greater yield. Then, interest rates rose. So, the bond prices fell. Enough to wipe out the bank's capital. At which point, the wholesale bank run starts. For depositors over $250k are not insured.

Now for the real problem

OK. So being long maturity has been a bad idea for a bank this past couple of years. Which explains the - umm - fragility of US bank stocks right now. Because we don't know who has been long maturity this past couple of years.

Not knowing isn't quite the problem. Worrying that we might be about to find out is.

The detail of the problem

Banks have two different ways of accounting for their bond holdings. They can have Available For Sale, which means marking them to market. So, losses on bonds as interest rates rise (as we know, prices fall as yields rise) mount up day by day. Or they can Hold To Maturity.

Which makes some sort of sense. A Hold To Maturity loss is more like an opportunity loss than a real loss. Except, well. When the bonds held to maturity are paying less interest than the deposits which fund them, maybe things change.

Maybe, say, all those HTM losses suddenly need to be crystalised. At which point, the bank has no capital.

Ah

Now, this is only one view of what happened at SIVB, but it's a useful one. Because it is describing the background problem. They'd lost the bank's capital by being on a long tenor on bonds at a time of rising interest rates.

And now for the real, real problem

OK, so who else has done this? That's what is collapsing bank stock prices across the markets and country. We don't know who else faces such problems. Those Hold To Maturity losses don't have to be declared as they happen. They're not subject to mark to market. Except in one juddering change, when they might be.

There are rumours out there that there are $1 trillion of such losses inside American banks. Rumours only, I hasten to add. And the stock problem is not just that we don't know whether that is true, but even if it is, we don't know where they are.

As investors, what now?

As depositors we're fine. If the Administration, Treasury and FDIC all tell us that depositors are safe, then they are. But stock, well, that can still go to zero even as that is true. Bonds can also be more than a little weak in such circumstances.

There is a way to try to get a clue. Here's the SIVB 10-Q - on page 13 we get an idea of the holdings of "investment securities". And that's the thing we've got to do. Haul through these filings for each bank and try to work out whether they were long tenor (i.e., long-dated bonds, which then suffer greater price falls as interest rates rise) or not.

Well, you know, good luck. But that is also what all stock analysts in America are trying to do right now - work out who might have lost the bank's capital by chasing yield in long0term bonds and who forsook earnings now for the ability to have any earnings at all in the future.

There's no reason why we're not as good as they are at this same task.

Which is, after all this, the game to be played.

Who?

Who went for yield and thereby lost capital? And who forsook yield to - as it turned out - preserve capital?

That's the explanation for the volatility in US bank stocks right now. Who has rising interest rates killed out, and who hasn't it? The clue to which is in those 10-Qs. Who went for yield and long tenor and who didn't?

Why I'm wrong

Well, I'm not making a prediction accurate enough to be wrong. I am explaining the basic situation as it really is. But that's not enough.

My contention is that some of these worries are overdone. Some of them aren't done enough. Some other banks will be found to have made that SIVB decision. Some others will be thought to have done and won't have.

My view

A sensible and thinking of the pension decision is simply not to play in this game at all. A more fun trader's decision is to try one's luck. Can we spot the solvent banker better than the market or not?

For there will be some oversold - no, I am not going to give examples - just as there will be some under.

The investors' view

We have massive price changes going on. Being on the right side of them will make money. Being on the wrong will lose money faster than near any other investment can. Other than outright fraud, bank runs can - will - lose investor money faster than even burning our own cash notes.

So, no advice on the specifics. Just that explanation of the base and basic problem causing these price movements. Who lost all their money by going long term on bonds in a land of rising interest rates?

Those who did and we don't know they did will see crashing stock prices when we find out. Those we think did but didn't will see recoveries from current levels.

This is not widows and orphans investing. So, good luck.

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