2023-03-14 07:00:00 ET
Summary
- SVB's epic two-day collapse has caused terror in financial markets and sent bonds on their 5th best two-day run in history.
- The Treasury, FDIC, and Fed have now created a plan to backstop all US deposits at FDIC-insured banks. The risk of a GFC level collapse has fallen to basically zero.
- But world-class banks that have nothing to do with SVB's problems have also sold off, including three of the world's custodial titans.
- These are banks that are 134 to 239 years old, with A to AA-rated balance sheets, and 82nd to 95th percentile global risk management according to S&P.
- All three offer Buffett-like 18+% annual return potential over the next few years from their 25% to 39% historical discounts. If you want a safe 3+% yield and the banks likely most immune to this crisis, these three are it.
This article was published on Dividend Kings on Monday, March 13th
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The nature of black swan investing risk is that news can break that surprises everyone and sends stock prices crashing, even for some of the world's best companies.
This can create life-changing opportunities for those with the right temperament and tools to recognize safety and quality, and value when it's most in focus.
The Silicon Valley Bank ( SIVB ) crisis unfolded at warp speed in the last few days, creating incredible fear and opportunities.
- Regional banks fell 12% last week.
- 16% at one point
On Thursday, March 9th, regional banks had their 15th worst day in history.
Fears of another financial crisis sent bonds on their 5th best two-day rally in US history and stocks down about 3%.
So let's review what caused the crisis, why it's likely now over, and three incredible banking bargains you can safely buy just in case it's not.
What Caused The SVB Crisis
My, how the mighty have fallen. SVB was a bank that boomed following the post-Pandemic stimulus-induced speculative bubble and then imploded spectacularly in a matter of days.
At its peak, it was a $45 billion bank worth $755 per share, and now on Monday morning, shares are trading pre-market at $44.
- a 94% decline
- on its way to a 100% loss
What caused this epic and furious collapse? It's quite the story.
After the unprecedented crisis caused by the Pandemic, in which the world's governments essentially shut down the global economy, the US government worked with the Federal Reserve to throw nearly $10 trillion in stimulus at the US economy to prevent a depression.
This resulted in an estimated $3 trillion in excess consumer savings from stimulus checks. The Fed's $5 trillion in money printing also found its way into the banking system via increased deposits.
Silicon Valley Bank was founded in 1983 and became the Goldman Sachs of startup tech and venture capital.
In a world of zero interest rates and free money, with record tech IPOs and VC funding for almost any tech company with a bright idea (or even just any idea) for growth, SVB boomed.
In 2020 and 2021, SVB saw its deposits more than triple to a peak of more than $170 billion.
Due to stricter banking regulations about bank capital reserves after the Great Financial Crisis, SVB put many new deposits into bonds, $21 billion.
With rates at zero and bond yields at record lows, SVB made a big mistake in that many of those bonds were longer-duration rather than short-duration T-bills.
- it also used much of these deposits to make loans to VC-backed startups
SVB was likely betting on lower forever interest rates, and when the Fed sent rates soaring due to the highest inflation in 42 years, it created a massive unrealized loss in its $21 billion bond portfolio.
But here is why SVB failed so quickly and suddenly in the last week.
About 60% of its deposits are from venture capital and startups. These are mostly money-losing tech companies—those who have struggled so much since rates went through the roof.
What do companies losing money but were showered with cash following the Pandemic stimulus binge do? Naturally, they use their bank deposits to stay afloat and keep the lights on.
This means that for over a year, SVB has faced a steady exodus of deposits requiring a certain amount of cash on hand.
Early in 2023, SVB was forced to sell a large chunk of its treasury bonds, which have an average yield of 1.76% and are about 14% underwater. It sold those bonds to free up cash to keep paying depositors the money they were withdrawing.
This created a $1.8 billion loss that it attempted to plug that hole with $2.25 billion in stock and preferred stock sales.
That created a panic among many of its larger customers because SVB's shares were down over 50% from their highs. Whenever any company sells shares after they are cut in half, it reeks of weakness, and banking is an industry 100% dependent on trust.
- SVB's CEO coming out and asking customers to "remain calm" and that there was no need for panic only fueled the panic
Many VCs, such as Peter Thiel, told their companies to pull their deposits out of SVB just in case. They did so in a big way. On Thursday, March 9th alone, $42 billion in deposits fled SVB, or 25% of its deposits, leaving them with a cash balance of -$1 billion.
With shares falling 60% on March 8th and then another 60% on March 9th (an 84% decline in two days), management had to cancel the planned stock sale.
What does a bank with -$1 billion in cash and customers still fleeing do? They tried to sell themselves. The trouble is that SVB was the 18th largest bank in the country, with numerous businesses such as wealth management.
It takes weeks of due diligence, even months, to comprehend a bank like this. No bank was willing to take on such a risky acquisition in just a few hours, so the FDIC and California banking regulators were forced to shut SVB down and put it in receivership.
What The Government Did To End The Crisis Before It Got Started
SVB's problems are specific to its unique business model and shared by almost all other banks.
The problem of bond losses after the worst year for US bonds in history has left the banking industry with $620 billion in paper losses on its bond portfolio.
And thanks to regulations, much of the record new deposits and Fed money printing ended up on bank balance sheets as bonds.
- Where else could banks put trillions of new dollars?
This means that if every bank in America had to sell all their risk-free bonds immediately, many would be insolvent. That includes giants like Bank of America ( BAC ) and JPMorgan ( JPM ).
- if every customer demands all their money back at the same time no bank on earth would survive
- it's the nature of fractional reserve banking
But Wall Street wasn't worried about the four giant money center banks, which are systematically important and too big to fail.
It was worried that companies would flee regional banks, creating runs that would lead to a cascade of bank failures, as we've seen already.
- Silvergate ( SI ) has failed - almost pureplay crypto bank
- Signature Bank ( SBNY ) - failed on Sunday (25% crypto assets)
- Silicon Valley Bank (60% VC bank)
Now it's important to note that almost no other bank was so heavily betting on speculative parts of the economy as these three. However, First Republic ( FRC ), Zions ( ZION ), and PacWest ( PACW ) were at high risk of runs.
The trouble isn't with traditional bank runs by scared consumer deposits. Grandma's money is safe at the local bank thanks to FDIC insurance on $250,000 per account.
And most people know this. But the trouble is with uninsured deposits, over $250,000.
For example, the small businesses that employ 50% of Americans must keep their money somewhere.
While some spread all their deposits across dozens of banks to keep it all FDIC-insured, most keep their cash in one or two banks.
Twitter
Some Wall Street legends, such as Bill Ackman, warned that the government had until Monday to prevent a bank run which could see many businesses pull their cash from regional banks and send it to the four money center giants that everyone knew would never be allowed to fail.
Imagine you're a small business with $10 million at your local bank. Why take the risk, even a small one, that your money could be lost and your business bankrupted overnight when you can set up an account at JPMorgan?
There are 3,400 FDIC-insured banks and similar institutions (like credit unions) in the country, and the government has stepped in to protect them by ending the bank run before it started.
The government first made the logical decision to coordinate complete deposit protection for SVB and all US banking customers.
The days of companies worrying about more than $250K in cash at any bank potentially vanishing forever are now gone.
Bubba Gump Shrimping company (a restaurant at the Mall of America) can now keep its money at the local Huntington Bancshares ( HBAN ), and so can my sisters, without fear of losing their savings.
This is a 100% logical hole in the banking system that has now been plugged in.
- No American or business should ever worry about any deposits held at an FDIC-insured bank.
- Where will the money come from to rescue SVB's customers and those of Signature Bank?
- Who will have access to all of their money on Monday, March 13th?
The FDIC's insurance fund is $122 billion and funded by insurance fees it charges its member banks.
That's more than adequate for the $20 billion in insured deposits at SVB but not enough for the full $171 billion in deposits.
Treasury is setting up a $25 billion backstop to help ensure that no customers at SVB or Signature lose any of their savings.
FDIC funds don't come from money printing but insurance fees paid by the banks (and indirectly their customers).
- it's how all insurance works
- losses are paid for by participants that don't fail
The Fed is also creating a new lending facility to provide all the emergency funding
The Fed will offer 12-month emergency loans with risk-free bonds (US treasuries and government-insured mortgage bonds) to any bank needing them.
They can get face value for their bonds, and the interest rates are SOFR + 10 basis points.
- not "free money"
In other words, despite what some say on social media, nothing about these emergency actions is a "bailout."
The Anti-Bank Bailout: This Time Is Nothing Like 2009
Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law." - Treasury Department
In 2009 big banks that had made reckless subprime loans were saved by taxpayers, and most of their executives kept their jobs, and some even got million-dollar bonuses.
This time the executives are all losing their jobs, and their shareholders are being wiped out. Most bond investors are also likely going to suffer large losses.
There is no moral hazard here in my view.
The Pandemic created a need for emergency stimulus.
The government responded, and banks had to take on massive deposits and put those somewhere.
Regulations meant a lot of it had to go into bonds.
Interest rates had to rise to fight inflation (mostly created by the Fed and US government stimulus).
Any bank faced with a run would become a forced seller of risk-free bonds and could fail, even if its business and lending were sound.
Let me be very clear. This is NOT a bank bailout. This is arguably a bailout of your local bank to fix the mess the government created out of necessity from the Pandemic.
The bailout is for you, the customers of America's 3,400 local and regional banks.
Your small business deposits, as are your regular personal savings, are now safe.
The Fed isn't going to "turn on the printing press" again, as 100% of the new lending facility is covered with real assets.
- It's not QT
Thousands of businesses that would have been forced to close because their savings were wiped out have been saved.
A financial contagion has very likely been averted. The actual crisis lasted about five days and resulted in three bank failures.
As Ackman says, more banks will fail, and a few do each year. But the doomsday predictions of permabears like Robert Kiyosaki?
You can safely ignore the forecasts for 60% to 90% market crashes that people like this have been predicting for well over a decade and always will.
3 Blue-Chip Bank Bargains Likely Immune From The "Crisis" Just In Case It's Not Over
What if you don't trust me, the media, or the government? What if you're still worried about financial contagion from the SVB crisis?
After all, while the risk to depositors is likely gone, that doesn't mean that bank shareholders aren't at risk. Signature Bank, SVB, and Silvergate stockholders will be wiped out entirely.
What if your banks also succumb to the same fate?
Well, there is a kind of bank that has no exposure to the SVB crisis, and those are also on sale.
Custodial Banks: The Plumbing Of The Global Economy
Custodial banks like Bank of New York Mellon ( BK ), State Street ( STT ), and Northern Trust ( NTRS ) are banks with the largest and most diverse assets on earth.
Bank | Assets Under Custody (Billions) | Credit Rating | 30-Year Bankruptcy Risk |
Bank of New York Mellon | $44,300 | AA- stable | 0.55% |
State Street | $36,743 | A Stable | 0.66% |
Northern Trust | $10,264 | A+ Stable | 0.60% |
Total | $91,307 | A+ Stable | 0.60% |
(Source: FactSet Research Terminal)
The custodial banking giants are the bank of banks. Where do BlackRock, State Street, and Vanguard hold their money for ETFs? Where does Fidelity keep your IRA and 401K investments? These banks are even more important than the money center banks like JPM and BAC.
These banks generate most of their revenue from custody fees as well as asset management fees for the world's richest clients.
- ultra-high net worth individuals
- pension funds
- sovereign wealth funds
Do you think sovereign wealth funds and pension funds are going to try to pull their hundreds of billions out of these banks due to the failure of SVB?
Do you think Yale's endowment is worried about the safety of its investments custodied at banks like this?
As one example, the Bank of New York Mellon was founded in 1784 by Alexander Hamilton, the first Secretary of the US treasury.
- it's 239 years old
- and one of the oldest banks on earth
If this bank ever goes under, the world has likely ended, and you'll be too dead to care about money.
What about State Street? It was founded in 1792, and Northern Trust was founded in 1889.
- STT is 231 years old
- NTRS is 134 years old
Why are these some of the safest banking bargains on Wall Street right now?
While they didn't sell off as hard as regional banks or financials in general, the custodial banking giants did fall 7% to 10% last week.
They are all in bear markets and attractive bargains for those seeking safe yields and good long-term growth prospects.
Long-Term Consensus Return Potential
Investment Strategy | Yield | LT Consensus Growth | LT Consensus Total Return Potential | Long-Term Risk-Adjusted Expected Return |
State Street | 3.2% | 10.8% | 14.0% | 9.8% |
Bank of New York Mellon | 3.1% | 10.1% | 13.2% | 9.2% |
Northern Trust | 3.5% | 9.2% | 12.7% | 8.9% |
S&P 500 | 1.8% | 8.5% | 10.3% | 7.1% |
(Source: DK Research Terminal, FactSet)
Bank of New York Mellon: Arguably The Safest Bank You Can Buy Right Now In My Opinion
Further Reading
Summary Facts
- DK quality rating: 77% very low risk 12/13 Super SWAN custody bank
- Fair value: $63.18
- Current price: $47.31
- Historical discount: 25%
- DK rating: potential strong buy
- Yield: 3.1%
- Long-term growth consensus: 10.1%
- Long-term total return potential: 13.2%.
State Street: The Growth King Of Its Industry
Further Reading
Summary Facts
- DK quality rating: 74% very low risk 11/13 SWAN custody bank
- Fair value: $108.01
- Current price: $79.87
- Historical discount: 26%
- DK rating: potential strong buy
- Yield: 3.2%
- Long-term growth consensus: 10.8%
- Long-term total return potential: 14%.
Northern Trust: One Of The Safest Banks You've Never Heard Of
Further Reading
Summary Facts
- DK quality rating: 81% very low risk 12/13 Super SWAN custody bank
- Fair value: $140.11
- Current price: $84.92
- Historical discount: 39%
- DK rating: potential very strong buy
- Yield: 3.5%
- Long-term growth consensus: 9.2%
- Long-term total return potential: 12.7%.
Bottom Line: The World Isn't Ending, And These Blue-Chip Bargains Are A Great Way To Profit From This Fact
Let me be clear: I'm NOT calling the bottom in BK, NTRS, or STT (I'm not a market-timer).
Even Super SWAN quality does NOT mean "can't fall hard and fast in a bear market."
Fundamentals are all that determine safety and quality, and my recommendations.
- over 30+ years, 97% of stock returns are a function of pure fundamentals, not luck
- in the short term; luck is 25X as powerful as fundamentals
- in the long term, fundamentals are 33X as powerful as luck
While I can't predict the market in the short term, here's what I can tell you about STT, NTRS, and BK.
These are the world's three largest custody banks, with A or even AA-rated balance sheets and exceptional risk management, according to S&P.
- STT: 95th global percentile
- BK: 92nd global percentile
- NTRS: 82nd global percentile
If any banks are immune to the SVB fallout, these three probably are.
And that's why, with 25% to 39% discounts to fair value and 9% to 11% long-term growth outlooks, and safe to very safe 3% to 3.5% yields, I'm so confident in recommending these three world-beater banks today.
For further details see:
Profit From The SVB Crisis With 3 High-Yield Blue-Chip Bank Bargains