Jack Hough 7-9 minutes
By one measure, bank stocks have given up a quarter-century worth of gains. Is that a buying opportunity for contrarian investors, or a sign that the group is broken?
Caution abounds, particularly on midsize banks, following a string of failures there, including a Twitter-fueled deposit run on Silicon Valley Bank. “There’s not a great place for regional banks, we think, in portfolios now,” says Brad Neuman, director of market strategy at Alger, a money manager.
One bank analyst points to a feedback loop between share price movements and bank strength. “When people see the stock prices go down, they get concerned about their deposits,” says David Konrad at Keefe, Bruyette and Woods.
On Wednesday, when UBS Group , the Swiss bank, initiated analyst coverage of U.S. mid-cap bank stocks, it titled its report “No Man’s Land”—a reference to the group’s limited appeal. Unrelated to that report, shares of UBS (ticker: UBS) were tumbling at the time, pulled lower by a much more dramatic decline for compatriot Credit Suisse CSGN –24.24% Group (CS).
Credit Suisse is an asset manager and Wall Street investment bank that has struggled for years with poor financial performance and scandals. New management is working on a turnaround. Saudi National Bank, the Swiss bank’s biggest shareholder, has expressed confidence in the plan, but says it won’t go above its 9.9% stake. On Tuesday, Credit Suisse said customer outflows had slowed. Wednesday’s stock plunge seems unlikely to inspire confidence.
Silicon Valley Bank operated for four decades as a banker to customers known for their risk-taking: venture capitalists and start-ups, including, in more recent years, crypto entrepreneurs. Ironically, it was brought down by an ill-conceived bet on mortgage securities and Treasuries, assets typically prized for their safety.
When interest rates were near zero, and tech firms were riding high, SVB collected many more billions of dollars in deposits than it could prudently lend. So it bought bonds with pristine credit quality, and to pick up extra yield, it went long. Then inflation roared, and the Federal Reserve aggressively raised interest rates—something that makes existing bonds less valuable, especially long ones, but only to holders who plan to sell.
SVB planned to hold its bonds until maturity. But with tech now slumping, some of its customers needed to take out cash. The bank announced it had sold bonds at a loss, which was interpreted as a sign of weakness. Word spread, including among venture capitalists and their portfolio companies, setting off panicked withdrawals. The bank failed in little more than a day.
Investors who’ve heard so much about bank stress tests and strengthened balance sheets since the global financial crisis 15 years ago were left wondering: Where were the early warning signs? In hindsight, they were on Wall Street and Twitter.
SVB Financial Group shares (SIVB) had been in free fall since October. In February, Byrne Hobart, the author of the Diff, a widely followed newsletter on tech and finance, tweeted that SVB was “technically insolvent” if its bond values were adjusted for unrealized losses, but also that “I don’t expect a bank run,” given the remaining stock value.
Companies that fall into distress can sometimes issue new shares to raise cash, so a high stock market value can give depositors confidence not to flee. In SVB’s case, the stock value ultimately evaporated, and the depositors ran.
SVB was the second-largest bank failure in U.S. history. It helped set off the third; within days, Signature Bank (SBNY) also folded. Regulators quickly announced that deposits for both would be protected even over the FDIC insurance limit of $250,000 per depositor and account. This was meant to cover company payroll accounts and prevent panic from spreading to other banks among depositors who are over the limit. It has set off lively debates over bailouts, moral hazards, and needed reforms. Meanwhile, a fresh downturn in bank stocks on Wednesday suggests that risks remain.
So back to the starting question: Is the slide in bank shares an opportunity for stock market daredevils? On one hand, rattled investors have been piling into Treasuries, pushing prices higher there, which is helping to offset paper losses of the type that doomed SVB. On the other hand, the KBW Nasdaq Bank Index was recently trading at 1998 levels, raising the question of whether investors can do without banks altogether.
Konrad at KBW, the firm for which the bank index is named, says niche banking has become riskier. Part of the problem with SVB is that its depositors looked the same and left together. But not all banking looks riskier. Large banks have been gaining deposits from customers leaving smaller ones.
Konrad points out that JPMorgan Chase (JPM) has an amount of cash on deposit with the Fed that, taken on its own, would equal one of the country’s largest banks in size, and that JPM still earns high returns on the capital it puts to work. His favorite stocks now include U.S. Bancorp USB –5.52% (USB) for its fee income and diversified funding base, and Morgan Stanley (MS), which has a lucrative asset-management business.
Neuman at Alger tends to favor growth stocks. Examples in other industries include CrowdStrike Holdings (CRWD), a cybersecurity company; Intuitive Surgical (ISRG), which makes medical robots; and Impinj (PI), which makes radio frequency tags for merchandise. Asked about banks, he says that large ones will continue gaining on small ones because of their technology advantage, but that he prefers payment networks and financial technology companies to either.
The newly launched coverage of 19 midcap banks at UBS includes five Buy ratings—the firm points out that this 26% favorable rate compares with one of 60% at its peers. Its highest-conviction Buys are Western Alliance Bancorp (WAL), New York Community Bancorp (NYCB), and Webster Financial (WBS). Its highest-conviction Sells are First Citizens Bancshares (FCNCA), Texas Capital Bancshares (TCBI), and Cullen/Frost Bankers (CFR).
In general, UBS writes that banks look cheap relative to earnings, but that alone isn’t a reason to buy them, and that deposits and loan performance are likely to be worse than The Street expects.
Write to Jack Hough at email@example.com