buy bank stocks on the dip

[SilentC]

@ChpBstrd I was catching up on this thread and thinking about OZK up until the last post.  I’m under qualified to answer but the asset side seems ok and they apparently are not seeing deposit flight at 3/31 and at a deep discount to book.  It would seem like their sr. secured position in non-crazy projects should end well.  I am afraid of all the prefs at the is point, taking equity risk without as much upside.  I also think there will be more pain so you probably don’t need to show up early.

[chasesfish]

I posted this somewhere else yesterday and I'll reiterate it here

What does it take for a bank to be investable today? 

1)  Do they have an old deposit franchise?  We're talking 50+ years.   This is where low cost "core" deposits come from.   35 years was not enough for $FRC

2) Are the competent lenders?   Are most of the deposits loaned out?   Are they known to be reasonable in the deals they will / won't do in market?   $SVB did credit no one else did

3) How is their securities book?   Many old deposit franchises + competent lenders were left with excess deposits to put somewhere. 
Many reached for yield and now have losses not reported in earnings but showing up in Other Comprehensive Income (OCI).  $FFIN and $BOH wrecked the stock of premier deposit franchises because of this, but still aren't cheap enough to buy.

4) What is their stock trading for compared to Tangible Book Value?  It's tough to justify paying a premium (more than tangible book) for any bank in this environment.   Sorry $CFB, I can't pay 2x book, even if you're a superior franchise.   Many of the banks I find under $10bil that pass the first three tests still trade at 1.3x or more price to book.  At that premium, you can just own $BAC and get a TBTF bail with the #1 retail deposit franchise in the US.

It's surprising how few meet all four of these guidelines when you get over $10bil.   I should probably add the regionals in California also carry the risk that regulatory agencies in that area have proven to pass on enforcement. 

[chasesfish]

@ChpBstrd - BankOZK is scary to be an equity investor in if you believe there are credit risk issues.   Their reputation in the industry is doing commercial real estate deals other banks won't, especially when it comes construction. 

The prefs are probably okay, the bank has a lot higher capital ratio than others.

[RobertFromTX]

@ChpBstrd - BankOZK is scary to be an equity investor in if you believe there are credit risk issues.   Their reputation in the industry is doing commercial real estate deals other banks won't, especially when it comes construction. 

The prefs are probably okay, the bank has a lot higher capital ratio than others.

Back in 2015ish, our CEO, in mentoring us younger lenders, specifically used OZK as an example of what we were NOT going to do with our loan portfolio.

[chasesfish]

All banks should be as forward as MTB with loan and deposit portfolio data.   Nice early to mid quarter update

[SilentC]

Is there anything they are specifically doing “wrong?”  My thought is they aren’t earning an insanely high NIM/portfolio yield so it would seem they aren’t veering into hard money type lending, claiming to have 60% type LTV at completion on construction projects and balancing the higher risk with running lower leverage/double digit TCE %.  Thanks.

Edit- talking about OZK

[chasesfish]

39% of Bank OZK's loan portfolio is in Construction & Development loans.   Go to Page 8 of their press release. 

They are the most exposed to a commercial real estate downturn and leasing grinds to a halt, these projects sit empty and only generate expenses. 

[ChpBstrd]

@ChpBstrd - BankOZK is scary to be an equity investor in if you believe there are credit risk issues.   Their reputation in the industry is doing commercial real estate deals other banks won't, especially when it comes construction. 

The prefs are probably okay, the bank has a lot higher capital ratio than others.

Back in 2015ish, our CEO, in mentoring us younger lenders, specifically used OZK as an example of what we were NOT going to do with our loan portfolio.

Thanks @chasesfish and @RobertFromTX , this is the type of information not accounted for in efficient markets theory and not as visible in financial statements.

Still, I'm torn.

On the one hand, 8.4% yields are only available during times of stress and scary news. I could have retired three years ago had I locked in a preferred-heavy portfolio during the COVID crash and pivoted to a normal portfolio a few months later. The only way to lock in such returns is to have an iron stomach during the tough times.

On the other hand these insights from experienced people suggest my perceptions of OZK are inconsistent with the reality of OZK. I knew they were growth oriented, but it's starting to make sense that growth comes from going where others fear to tread.

Then there's this: https://www.gsb.stanford.edu/faculty-research/working-papers/monetary-tightening-us-bank-fragility-2023-mark-market-losses

The paper attempts to mark-to-market the assets of the US banking system. Then it calculates an equilibrium at which point it makes sense for uninsured depositors to make a run on the bank, and applies that equilibrium to US banks to see how many are at risk of runs.

Quotes from the paper:

The market value of U.S. banking system assets is $2.2 trillion lower than suggested by their book value. Interestingly, SVB does not stand out as much in the distribution of marked-to-market losses, with about 10% of banks experiencing worse marked-to-market losses on their portfolio.

...even if only 10% of uninsured depositors decided to withdraw their money, we would have 66 banks failing with about $210 billion of assets. If 30% of uninsured depositors ran instead, which is close to the share of withdrawals just preceding the shutdown of the SVB, we would have 106 banks failing accounting for $250 billion of assets.

We find that 10% (20%) default rate on CRE loans – a range close to what one saw in the Great Recession
on the lower end – would result in about $80 billion ($160 billion) of additional bank losses. While these
losses are an order of magnitude smaller than the decline in bank asset values associated with a recent rise
of interest rates, they can have important implications. An additional 285 (578) banks with aggregate assets
of $700 billion ($1.2 trillion) would have their marked-to-market value of assets insufficient to cover the
face value of all their non-equity liabilities. Even if half of uninsured depositors decide to withdraw, the
losses due to CRE distress would result in additional 21 (58) smaller regional banks at a potential risk of
impairment to insured depositors (over what we discussed in Section 4).

Additionally, the paper finds that the places with factors associated with LCOL areas (low education, low income) are actually at more risk of impaired deposits than wealthier areas (Appendix, figure 8). This debunks my idea that LCOL area banks will again be a refuge as the HCOL banks collapse along with their bubble real estate. It might also be an artifact of the way interest-rate losses are known, but real estate has only started to fall, and maybe LCOL areas had a more bond-centric asset mix.

So overall this investment has lost some key rationales, and the evidence has made me wonder if I'm on the wrong side and should be shorting the financial system instead of grabbing for yield. I looked into using puts or short spreads on OZK to hedge my OZKAP risk until December, but it was too expensive to justify in a world of 5.2% FDIC-insured CDs.

I put in a high sale order on my OZKAP as a way to "break the seal" on mentally accepting the losses, while I think and research further. The next step is to reduce the ask price. Thanks to all who offered insights, and keep them coming!

[chasesfish]

Bank preferreds are challenging me right now.  Maybe I'm too bruised from FRC.   The banks I'd go for that are bruised but I don't think are at risk just don't seem cheap enough.

I like HBAN-P, but what yield is high enough to hold it and let it grind out a few years?   

I do like that the price will increase as credit spreads improve and rates fall. 

[SilentC]

39% of Bank OZK's loan portfolio is in Construction & Development loans.   Go to Page 8 of their press release. 

They are the most exposed to a commercial real estate downturn and leasing grinds to a halt, these projects sit empty and only generate expenses.

I get that, and I’m not long or short OZK.  Somehow in the GFC this business model did not unravel.  Anecdotally I’m looking out a 30th floor window now and I see at least as many cranes today as I did in January/pre-SVB.  I’m not saying it’s not scary but they also aren’t one of these banks with $30bn book sitting on $17bn of HTM losses trading at 1x book either.  I’m not sure which is a worse position, having a lot of floating rate exposure to risky loans or a lot of interest rate risk and being 20x levered on “real” equity.

[chasesfish]

Bank OZK did a great job coming out of the GFC.   They were a small bank located in a geographic area (Arkansas) that didn't get hit like the rest of the sunbelt.   They raised capital and became a preferred acquirer of failed banks.   Picked up a bunch of good deposit franchises for pennies on the dollar.

The knock on Bank OZK is the loss-share acquisition strategy meant two things:   They weren't able to keep the good business loans because of the loss share restrictions, and all the talent they kept only knew how to do real estate lending.   They had a bunch of deposits that needed to be loaned out and they can either 1) call a bunch of real estate people and get the money out the door in 6-18 months or 2) buy securities.

Moving core commercial lending is a decade long game, not something you can do with as quickly as they wanted to grow.

They'll probably be fine, lots of capital can offset all that risk.  I just don't see the bank as investable at these prices. 

[chasesfish]

Tuesday evening update:  It looks like the market has decided to try to death spiral PACW.

We'll see if their depositors stay or go

[ChpBstrd]

The Stanford paper I posted earlier has all but convinced me this is not over, and that my OZKAP trade is on the wrong side of the situation. As they say, if you wouldn’t buy it again, you should sell it.

I flipped from long to neutral/short on stocks in early 2022 but months after the top, and taking those losses was the right call in hindsight. This is looking a lot like a combo of the 80’s S&L crisis plus a pending 2008 real estate crisis, so the signals are pointing me to a bear spread against XLF.

[Michael in ABQ]

Tuesday evening update:  It looks like the market has decided to try to death spiral PACW.

We'll see if their depositors stay or go

I guess I should have sold those preferred shares when I was up a couple of dollars. Oh well, it was only a few hundred dollars worth. I'm guessing they won't be paying out a dividend June 1st as scheduled.

[Weathering]

Bank preferreds are challenging me right now.  Maybe I'm too bruised from FRC.   The banks I'd go for that are bruised but I don't think are at risk just don't seem cheap enough.

I like HBAN-P, but what yield is high enough to hold it and let it grind out a few years?   

I do like that the price will increase as credit spreads improve and rates fall.

I’m in HBANP since $16.30/share (just before the latest ex-dividend date). It rose to $19.60/share but as of today is back below $17/share (maybe lower tomorrow based on the market). 7% current yield (in an industry that is diversified from my other holdings) is good enough for me to hold forever. If it climbs above $21/share then I’ll consider selling to invest elsewhere.
But, I would feel safer if I owned the senior, unsecured bonds instead - except their yield is <5%

If HBAN were to merge, or be acquired, who would it be with?

[ChpBstrd]

If HBAN were to merge, or be acquired, who would it be with?

This question gets to the heart of the matter. All banks are in a precarious position today because getting themselves into that position was the only way to survive the ZIRP era. Almost no banks have a few billion in unneeded extra cash sitting around to buy another company, and they are less inclined to spend what money they have in compounding their risks. Even JPM will run out of capacity before this is resolved.

There are no similar-sized banks coming to rescue banks that get into trouble because this is a systemic crisis, not a matter of a few “bad” banks suffering from mismanagement.

As the FDIC and administration move past the denial phase, I think they’ll start liquidating banks instead of offering them on a fire sale to mega banks like JPM. They’ll cite antitrust law. If they allowed all the big banks to take over the little ones, we’d be in duopoly territory before we knew it. Then anything not TBTF might be too small to survive.

[daverobev]

https://finance.yahoo.com/news/pacwest-explores-options-amid-stock-211105457.html

Good grief. Down to $3 a share.

Edit https://finance.yahoo.com/news/pacwest-moves-calm-market-60-053127958.html

“The bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news,” PacWest said in a statement dated Wednesday. “Our cash and available liquidity remains solid and exceeded our uninsured deposits.”

Should have said that bit first!

[chasesfish]

Good morning!   Some random thoughts...

For those waiting for blood in the streets, that PACW report looks like it's here.   They released all the financial data through Tuesday vs. a news report.   The data says they're fine, but can sentiment cause a bank run?

We're getting to that 2008 type news cycle that looks like:

Bank needs to take strategic action because of a bad funding mix (shrink or raise outside money)
Costs of shrinking the bank is impossible (sell loans at a discount when there aren't other bank buyers, can't raise equity)
News story hit about the bank taking strategic action
Depositors flee, accelerating the need for Step 1

Each bank being attacked by this news cycle is stronger than the last bank.  Eventually one will break this cycle, but yikes.

I like HBANP, I'd hold and enjoy the dividend.   If it's in a taxable account, you can use this opportunity to harvest a loss in one name and buy another name's preferred.   I know and worked for one of the Huntington execs that's under consideration as the next CEO.   They've made a lot of good moves over the past four years to become a modern bank with a diversified loan book. 

FHN looks incredibly attractive this morning.   Merger called off with TD Bank.  Not unsurprising, TD can't pay that price with the cost of capital today and regulators aren't going to approve a merger any time soon.  That's a premier deposit franchise and great loan book headquartered in one of the best markets in the country (Tennessee).   Tangible Book Value is $10.89/share before they get paid $200mil for the merger breakup.   Premarket has it opening at $8.05 (??).   SNV is a similar institution with more CRE exposure trading at a premium to tangible book still.

[SilentC]

Bank OZK did a great job coming out of the GFC.   They were a small bank located in a geographic area (Arkansas) that didn't get hit like the rest of the sunbelt.   They raised capital and became a preferred acquirer of failed banks.   Picked up a bunch of good deposit franchises for pennies on the dollar.

The knock on Bank OZK is the loss-share acquisition strategy meant two things:   They weren't able to keep the good business loans because of the loss share restrictions, and all the talent they kept only knew how to do real estate lending.   They had a bunch of deposits that needed to be loaned out and they can either 1) call a bunch of real estate people and get the money out the door in 6-18 months or 2) buy securities.

Moving core commercial lending is a decade long game, not something you can do with as quickly as they wanted to grow.

They'll probably be fine, lots of capital can offset all that risk.  I just don't see the bank as investable at these prices.

This is good color, thanks, and agree on valuation I read in another forum it was well below tangible book and that was wrong.

[ChpBstrd]

Bank OZK did a great job coming out of the GFC.   They were a small bank located in a geographic area (Arkansas) that didn't get hit like the rest of the sunbelt.   They raised capital and became a preferred acquirer of failed banks.   Picked up a bunch of good deposit franchises for pennies on the dollar.

The knock on Bank OZK is the loss-share acquisition strategy meant two things:   They weren't able to keep the good business loans because of the loss share restrictions, and all the talent they kept only knew how to do real estate lending.   They had a bunch of deposits that needed to be loaned out and they can either 1) call a bunch of real estate people and get the money out the door in 6-18 months or 2) buy securities.

Moving core commercial lending is a decade long game, not something you can do with as quickly as they wanted to grow.

They'll probably be fine, lots of capital can offset all that risk.  I just don't see the bank as investable at these prices.

This is good color, thanks, and agree on valuation I read in another forum it was well below tangible book and that was wrong.

Two additional notes from someone who lives near lots of Bank OZK branches and their HQ:

1) In 2004-2008, real estate prices didn't really go up any faster than 2-3%/year in OZK's lending area. Both the boom and the bust occurred in coastal states and very large metro areas. I remember it was weird to watch the news talking about a crisis that wasn't visible in the real world anywhere around us. In the 2018-2022 boom however, dirt-low interest rates and unemployment lifted RE prices everywhere. A house I sold in 2018 for $210k now has a Zestimate(r) of $292k. Some neighbors who bought at $122k in 2020 are now listed for $150k. D-neighborhood houses in my city that were worth $50k a few years ago are now selling for $100k. Thus I'm reluctant to say this time is exactly like the boom/bust of 2004-2008, because the current boom has affected places that were once unaffected. It's still cheap to live here compared to most places, but housing costs as a percentage of income have risen recently in a way they never rose before. A 20% decrease in RE values would only put us back on trend at this point so it's very possible.

2) Bank OZK was well-positioned in the GFC because their geographical area dodged the RE boom/bust and because unemployment in AR went from 5.5% in 2007 to only 7.9% in 2009. National unemployment started at 4.4% in 2007 and rose to 10.0% in 2009. Everyone else's GFC (5.6% increase in national unemployment) was a mild recession in AR (2.2% increase in AR unemployment), because AR had a relatively low concentration of cyclical tech, real estate, and financial industries. Thus, banks here didn't experience loan losses on the scale of other places. OZK took advantage of the situation to grow while other banks were in survival mode, but in doing so they grew into areas that were arguably more cyclical, like Florida.

Thus it is not clear whether OZK will be the next OZK in terms of emerging relatively unharmed from the chaos and expanding aggressively to become a six-bagger six years after the crisis. Other small Southern banks like SBSI, RNST, SFNC, or RF could be considered candidates to repeat the play, but there's no guarantee their loans won't tank this time due to fast RE appreciation in recent years and a longer way for employment to fall.

Just to continue the comparison: The unemployment rate in AR is currently 3.0% which is lower than the 3.5% national rate and far lower than the 4.4% rate in bubble-zone California. This is a reversal of the pre-GFC setup, and suggests AR could swing more dramatically in unemployment this time. It also suggests a lot of marginally employed people are enjoying car loans, mortgages, and HELOCs courtesy of their local banks. Meanwhile, local businesses with bank loans are unable to grow due to a hard limit on the number of people looking for jobs. Their commercial debts might be more risky than the booming economy makes them appear.

[SilentC]

Good points ChpBstrd.  One bit of food for thought, no one knows how bad CRE gets but rough math - they have tangible equity ex the preferreds of 3.75bn.  Commercial loans of 17bn.  Assuming a 10% default rate and 50% loss on the defaults, that would reduce equity value to 2.9bn.  Market cap is 3.7 or about 1.3x tangible.  You can argue about what an ok multiple is but they have traded much higher than that at times.  Conversely a BAC type bank is too big to fail, if you marked to market their HTM losses is trading at almost 3x tangible excluding prefs (if I’m calculating that right).  With OZK you have the deposit flight risk (not too big to fail) and the risk that severity or default rate are a lot higher, and with a BAC you are hosed if rates stay higher for longer and you earn your 2% +/- coupon on 800bn notional value of MBS and treasuries while cost of deposits and debt rises well above 2%.  The rate risk is actually really scary to me, maybe moreso than the credit risk.

[chasesfish]

Update from the day.

Opened a sizable enough position in FHN, got in at $9.50

Added more $PNFP below $45

Decent size position in HBANP at almost an 8% yield. 

All of these banks like loaning money at variable rates. 

I digested a ton of FHN information today, their combination of deposit base, loan mix, and bond book management is the best I've seen outside of M&T and in a much better market.   FHN's loan book yielded 6.04% in the second quarter, they can handle the increase in funding costs even if some deposits move to money markets and they have to replace with 5% money.   

Word is the regulatory issues were on TD Bank's size.  I think it's a screaming buy below $11.  TBV was $10.89/share and that's before the $225mil boost to capital they'll get due to the merger breakup.


It's like we've entered the point in the cycle where any bank that can't defend their stock via buybacks (basically prohibited if TCE falls below 7% of total assets), the shorts are attacking them and dropping news stories trying to create a deposit run / asset sales.   Any bank above 7% can burn the shorts by repurchasing shares at a steep discount. 

[ChpBstrd]

@chasesfish I like what you're doing with this screening process.

Flipping the script: What do you think are the worst banks which are not yet in the headlines? And what do you think about a plan to buy and hold the keepers while shorting the worst banks as a short-term hedge?

So far, we've been talking about impaired securities, but I suspect the really vulnerable banks are the ones with a heavier mix of loans. These are much harder to liquidate than treasuries or MBS and cannot be used as collateral for home bank loans. Perhaps the size of the run they can deal with is a function of how many treasuries they can sell before becoming illiquid. So even a bank with good ratios could be vulnerable if it has only a thin veneer of treasuries atop a bunch of less liquid assets.

I got rid of my OZKAP today for about a $4,500 loss, minus a dividend I have coming. Even worse - in an IRA. I have very mixed feelings about it, but that paper plus a recent poll showing 55% of Americans are concerned about their deposits convinced me the bank runs could continue to expand.

[reeshau]

@chasesfish , a question:

Looking at FHN, I see their ROAA is barely above 1%.  So, OK.  And below tangible book, anything can be a bargain.  I know people are looking primarily at safety, but several of the companies you have mentioned are mediocre, though not bad on ROAA.  Are you not really considering that?  And if so, is that a tactical choice, or not something you go for?

I have two former bank examiners in my investing network, and for years that is their primary filter.

[chasesfish]

Premarket activity on the banks says the shorts don't want to go into the weekend hodling at these prices.   $WAL coming out and threatening legal action for false stories was a solid denial.   It would be better for them to have > 7% TCE and defend their stock through repurchases, but that's the second best method.   Maybe we'll look back and call this the bottom.

@ChpBstrd - I've played a little with shorting banks, but I struggle shorting stocks.  It's more like gambling and my compliance manager (spouse) doesn't like it.  $FFIN at 3.5x book and Triump Financial would be my favorite shorts right now. 

Sorry to hear about your Bank OZK prefs, I know I bashed on OZK but that criticism was focused on the common, the institution has such high capital ratios the prefs were the way to go in that institution.   If you bought KRE with the money you'll earn those losses back over time.   It's splitting hairs, I prefer HBAN's prefs for the corporate loan book and size, but there's a case to be made fto be in OZK instead for the geographically desirable deposit franchise and higher capital ratios. 

@reeshau ROA....that's a good question.   Peer ROA runs +/- 1% for an average bank.   If a bank has 8% Tangible Common Equity, a 1% ROA equals a 12.5% return on equity.   Well run, efficient banks can generate a little higher return on assets and get to a 15%+ return on equity.   The question to me is if one is an outlier, then why?   Here are some current quarter numbers on stocks I've mentioned.

FHN:  1.3% current ROA.  Why?  They accepted 0.8% when the bank had a lot of excess deposits and stayed short in the borrowings.  The low cost deposits + variable rate lender took their medicine last year.   

MTB:  1.4% ROA.  Same story as FHN, they took their medicine and only had a 0.94% ROA in Q1 of 2022 by staying short in the bond book. 

SMMF:  Outlier here 1.5%+   Why?   Rural deposit base that was able to fill the hole in a big market (Washington DC) CRE lending at premium prices, but that will decline some over the next year as deposit rates are up and they are full on new loan originations.

PNFP:  1.26% ROA.   Great markets, variable rate lender, hire the best lenders, founder run.   ROA will revert closer to median due to their deposit book.  Younger bank = higher cost of funds. 

PKKW:  1.09% ROA (had to hand calculate this from the call report, their press release for Q1 isn't out).   Bank is selling for 80% of book value, lower cost of funds, and is still beating peer average even with a drag from their bond book. 

ROA matters, trends matter, and why the ROA is what it is matters.   Banks average 1%, well run banks can stay above average.  I think two things matter more than ROA, the price you pay for that ROA and ensuring the bank is competent at lending so you don't get wiped out b a credit risk event. 

As a side note, you can still make money in a low ROA bank if the price is right.   I own some $ASRV, a 0.6% ROA bank that's trading at 60% of book value but sits on a rural 100yr old deposit franchise.   The 0.6% is always because of "one time" things, but if they keep having "one time" issues, are they one time?   An activist is rattling their cage a little bit and the 62yr old CEO will eventually retire, but I can be paid a 4%+ dividend to wait as long as I buy it right. 


Lastly - I mostly invest between Pennsylvania and Texas.   This is for two reasons, I worked in these markets for a predecessor of $TFC for 16 years.  I know these markets and have an idea of who's competent and who's not based on my time in the business.

Secondly, $TFC is top 5 in deposits in along the East Coast from Virginia to Florida and the bank is a complete trash fire right now.  The companies taking their best customers / market share are doing well.   This is both a disappointed ex-employee with where the company has gone, but also math.  $TFC doesn't bring on new loan customers, barely services existing customers, and the consequence is the core customers are slowly replaced with bonds and specialized lending.  They sit on one of the most valuable deposit franchises in the country and basically don't make new loans to businesses and often don't do the minimum required to keep customers.   

PNFP, SCOF, SNV, UCB, and FHN are all natural beneficiaries of this dysfunction and generally well run banks.   I've picked up some PNFP and FHN, but I have not been able to buy the other three below tangible book (yet).   Southeast deposit franchises carry a premium to market. 

[bluecollarmusician]

I just wanted to chime in here, as I have followed this thread with interest.  Watching the moves in the market has been a bit like a soap opera.

I really appreciate the input here from those of you knowledgeable about the sector.  I was watching financials closely in 2007-2008.  In the end I pulled the trigger a little too late on a position I have held in BAC since then.  I have been a fan of regionals (always) from a customer perspective, and have been waiting for a point to enter pretty much since then.

Long FHN, and also for fun picked up a few HBANP

[ChpBstrd]

@chasesfish thanks for your perspective and for sharing your research! To be clear, I was shaken out of OZKAP primarily by the research paper and secondarily by the consistent insights I found here and elsewhere. Plus, holding a position in a semi-risky bank heavily invested in CRE prior to the Fed's next rate cuts is inconsistent with the macro thesis I'm gathering from all my other sources. It didn't make sense to think one way and invest another.

With FRC, the preferreds seemed to offer a safety and dividend excuse to dip a toe into the risk, but due to the macro situation they went to pennies along with the commons.

I'm sure OZKAP will go up 20% now that I'm out ;) , but all signs suggest we might be in for a culling of banks on the scale of the S&L crisis. That risk may never materialize, and OZK may be one of the survivors if it does. Still it makes sense to avoid such a risk when reasonable returns are available in safe assets. Outside of safe assets, I've found multiple avenues to research getting the same income I bought OZKAP for, while avoiding the banking sector.

I might pick up OZKAP again closer to the next ex-div date, if the panic continues, if they show signs of resilience, and if rate cuts start to be considered by the Fed. For now, Fed officials consider rate cuts out of the question. Bond markets, however, foresee 75bp in cuts later this year. Perhaps they foresee banks falling like dominoes this summer, in alignment with the Stanford paper? For now, Fed officials are publicly bewildered by these market predictions. JPow at his Wednesday presentation essentially said Fed officials were surprised by the bank failures, and are still treating them as one-off events.

Rate cuts are the only thing that can save the entire banking sector all at once, so if that's what is needed that's what we will eventually get after many more months of pain. Even then, the rate cuts may not help much if banks have been forced to sell their treasuries and MBS to pay depositors, or if the rate cuts encourage prepayments of the higher-rate loans they're making today. Incidentally, I'm aligning myself with my own preaching by taking pot shots at bear spreads on KRE.

[Weathering]

I was too early in my HBANP purchase (net $16/share) but instead of harvesting the tax loss I added HBAN senior unsecured bonds (2025 maturity) at a 7.9% YTM in an inherited IRA. The new bond purchase is equal to 35% of my HBANP position, so I’m not doubling down just adding some.

[SilentC]

@ChpBstrd you are probably right that rate cuts save the sector, but if it’s done prematurely without obvious improvement in inflation trajectory you could possibly see long rates go higher as a vote that inflation is not being cured and will be persistent.  You could also see MBS spreads widen as mortgage production goes up (assuming more housing transactions done at lower interest rates) without incremental demand which would negate some of the benefits to bank HTM portfolios.  Even if the Fed went out and said it was going to cut rates 200bps over the next 12 months it might not be a solve-all.  Definitely open to thoughts on this.

[chasesfish]

Two morning updates:


PacWest Preferred owners just won big.   Common stock dividend cut to a penny, but preferreds continue.


Now that the "fat pitch" is probably over, I'm going to stick with small bank investing.   There's just stupidly cheap opportunities on great deposit franchises in the billion dollar bank range.   Buying a 12-15% ROE business at a discount to tangible book is just a nice long term game. 

[daverobev]

Two morning updates:


PacWest Preferred owners just won big.   Common stock dividend cut to a penny, but preferreds continue.


Now that the "fat pitch" is probably over, I'm going to stick with small bank investing.   There's just stupidly cheap opportunities on great deposit franchises in the billion dollar bank range.   Buying a 12-15% ROE business at a discount to tangible book is just a nice long term game.

What are your thoughts on PacWest now, risk vs reward? Are they going to get de-banked like FRC was?

[chasesfish]

@daverobev There will be people who make big money on this if PacWest doesn't have to dilute common shareholders.

Personally?  Not for me.  I can buy a smaller community bank generating a 15% return on equity at a 20-25% discount to book value.   These banks also have another mathematical 40-60% gain in equity over the next five years through their bond portfolio.    Those look like 80-100% wins over the next five years without the level of risk. 

[daverobev]

@daverobev There will be people who make big money on this if PacWest doesn't have to dilute common shareholders.

Personally?  Not for me.  I can buy a smaller community bank generating a 15% return on equity at a 20-25% discount to book value.   These banks also have another mathematical 40-60% gain in equity over the next five years through their bond portfolio.    Those look like 80-100% wins over the next five years without the level of risk.

Thanks. Well, I have a couple of orders for PACWP, we'll see if either of them fill... if I'm throwing good money after bad.

[SilentC]

@daverobev There will be people who make big money on this if PacWest doesn't have to dilute common shareholders.

Personally?  Not for me.  I can buy a smaller community bank generating a 15% return on equity at a 20-25% discount to book value.   These banks also have another mathematical 40-60% gain in equity over the next five years through their bond portfolio.    Those look like 80-100% wins over the next five years without the level of risk.

Let me know how you are thinking about this, but what I struggle with is that these banks will not earn a mid teens ROE for the next few or maybe several years if rates don’t fall significantly.  I didn’t look hard at Pinnacle but they are trading around tangible and holding mortgages and CRE loans.  If rates don’t change a lot their deposits continue to get a lot more expensive … they don’t have a lot of no interest paying deposits so their deposit cost could get into the high 2s or 3%s even if the Fed cuts rates significantly so they are earning essentially nothing or negative on their mortgages.  Then on their CRE they have elevated credit losses for 2-3 years.  I’m not sure this is a layup yet, if the earnings are going down it will be hard for the stocks to go up.

[ChpBstrd]

@daverobev There will be people who make big money on this if PacWest doesn't have to dilute common shareholders.

Personally?  Not for me.  I can buy a smaller community bank generating a 15% return on equity at a 20-25% discount to book value.   These banks also have another mathematical 40-60% gain in equity over the next five years through their bond portfolio.    Those look like 80-100% wins over the next five years without the level of risk.

Let me know how you are thinking about this, but what I struggle with is that these banks will not earn a mid teens ROE for the next few or maybe several years if rates don’t fall significantly.  I didn’t look hard at Pinnacle but they are trading around tangible and holding mortgages and CRE loans.  If rates don’t change a lot their deposits continue to get a lot more expensive … they don’t have a lot of no interest paying deposits so their deposit cost could get into the high 2s or 3%s even if the Fed cuts rates significantly so they are earning essentially nothing or negative on their mortgages.  Then on their CRE they have elevated credit losses for 2-3 years.  I’m not sure this is a layup yet, if the earnings are going down it will be hard for the stocks to go up.

I wasn't asked, but my thought is similar to yours @SilentC : Banks will spend at least the next couple of years struggling to raise cash and not doing much lending. The first punch was rising interest rates, which decimated securities portfolios. The next punch will be rising defaults, driven by rising unemployment and bankruptcies in 2024. A third punch could occur if there is a big drop in the value of collateralized assets like real estate. The order in which punch 2 and 3 occur is debatable.

It's a game of picking the bottom. Bank stocks and preferreds will start rising as soon as the future looks brighter than the present, even if there is a lot more pain and stress ahead. In early 2009, investors in banks like MTB, CBS, and USB could see daylight ahead and then the stocks rocketed upward for a decade. On the flipside, a lot of banks never fully recovered, like HBAN, RF, and NYCB.

The first problem is the formidable task of picking the bottom. The second is picking which banks will double or triple in the next 5 years versus which banks will suffer through the recovery. As in 2008, it'll depend on what's in their portfolios. In the example of OZK in 2008, they apparently had real estate loans in an area that didn't crash, personal loans in an area where unemployment didn't get too high, and sticky deposits from less-cyclical consumers and businesses.

I'm not sure how to pick a bank that will have a similar portfolio today. Banks with lots of small retail depositors and short duration securities look good now, but how much will those accounts shrink when unemployment rises? Also, when evaluating book value, we run into the same problem investors faced in 2008: discerning the actual value of the assets!

Deposit flight is a big problem because it forces banks to lock in losses on securities before the securities can recover from rate cuts. A bank with a high-duration securities portfolio might be a poor performer now, but if they can hold onto their portfolio through the recession, they might be a winner. I'm having a hard time determining this too.

[chasesfish]

@daverobev There will be people who make big money on this if PacWest doesn't have to dilute common shareholders.

Personally?  Not for me.  I can buy a smaller community bank generating a 15% return on equity at a 20-25% discount to book value.   These banks also have another mathematical 40-60% gain in equity over the next five years through their bond portfolio.    Those look like 80-100% wins over the next five years without the level of risk.

Let me know how you are thinking about this, but what I struggle with is that these banks will not earn a mid teens ROE for the next few or maybe several years if rates don’t fall significantly.  I didn’t look hard at Pinnacle but they are trading around tangible and holding mortgages and CRE loans.  If rates don’t change a lot their deposits continue to get a lot more expensive … they don’t have a lot of no interest paying deposits so their deposit cost could get into the high 2s or 3%s even if the Fed cuts rates significantly so they are earning essentially nothing or negative on their mortgages.  Then on their CRE they have elevated credit losses for 2-3 years.  I’m not sure this is a layup yet, if the earnings are going down it will be hard for the stocks to go up.

I can tell you exactly how I'm looking at this.  I only want to own banks that have an asset mix advantage or a liability (deposit) cost advantage.

Pinnacle (and First Horizon) have an asset mix advantage.   The banks both have 6%+ loan yields on their book for Q1, so they aren't saddled with a bunch of legacy fixed rate loans.   Neither have much in the way of securities losses.   I'd recommend going through Pinnacle's slides contained here.

https://s25.q4cdn.com/259938676/files/doc_financials/2023/q1/1q23-Earnings-Call-v-1-3.pdf

Pinnacle's issue is it's deposit mix.  They must go out and get money at 5% for every incremental new loan they make.  The bank was earning 15%+ ROE at a 3% net interest margin and they're still running 3.4%.   They were fortunate not to be saddled with the securities portfolio of others as well.

I also know a lot about PNFP because of a number of former coworkers that are there, including one of the Chief Risk Officer's lieutenants.   That bank moves in line with the corporate goals, hires the best professionals in most market, and doesn't take stupid credit risk.   Most good community banks I look at are sitting on a 4.8% loan yield and PNFP is at 6%

The smaller banks I'm playing with I'm taking an asset mix risk, they're locked into low yielding securities and a high 4% rate loan book.   They have 100+ year old deposit franchises and ran 35% non-interest bearing (0% cost) deposits.

Banks typically make more money thanks to higher overall net interest margin when rates are high.   The speed at which these rates have increased have helped some (PNFP) and hurt others (FRC).

[reeshau]

WAL doesn't have the history @chasesfish is looking for, but it's loan profile is similar.  The HFI loan portfolio was 6.28% as of Q1.  HFS, of course marked-to-market, is not far behind at 5.9%.

[ChpBstrd]

PACW made the interesting move of (1) saying we're not experiencing deposit flight, and (2) cutting their common dividend. Investors applauded both pieces of information, sending PACW up 82% on the deposits news on Friday, and then another 3.6% on the dividend news Monday. Some may see a contrast between "everything's fine" and "cut the dividend" but I think the dividend cut is the right move. In this kind of crisis, there's no substitute for equity cash to ward off the bank runs. Other banks should have cut their dividends long ago.

EWBC, on the other hand, announced a dividend hike a couple weeks ago.

I can't help but wonder whether these dividend decisions reflect management's sentiments, and may indicate behavior behind the scenes. Maybe PACW is battening down the hatches to prepare for an economic hurricane, while EWBC is nonchalant?

[reeshau]

I can say I was happy that WAL declared their same dividend.  It was about a week overdue; I asked IR about it 2 Fridays ago, and they said the board meeting was about a week behind last year.  (Not attributing it to anything)

I don't blame PACW for reducing the dividend; they are on the market's front line, and I think you're right that capital preservation is the right move, but better than cutting the dividend entirely.  But for anyone else, a dividend reduction or cut definitely runs counter to the "all's well" messaging, and would be interpreted badly.

[chasesfish]

Regarding the dividend question:

PACW was still under 7% Tangible Common Equity to Total Assets and is in the news story.   They need to survive and time is their friend.   Interesting nugget on WAL.  Good for them.   They can replace deposits with 5% money and survive with a positive NIM.   

A positive spread = path to survival.   A bank can make terrible bond book and loan pricing decisions if they sit on an old and low cost franchise...

and a bank can deal with a crappy funding mix if they earn a decent loan yield

[ChpBstrd]

At the risk of inhaling the fumes and damaging my brain, I hopped over to WallStreetBets yesterday to see what they thought about the PACW dividend cut. Sentiment was unanimous that it meant PACW must be the next FRC.

So I sold the apes a few 4-day put options with extreme IV, driven by last week's volatility.

I'm up 47% as of now, even with PACW down for the day and lower than where I sold the put. Goes to show in cases like this volatility > delta, but try teaching that to an ape.

[chasesfish]

At the risk of inhaling the fumes and damaging my brain, I hopped over to WallStreetBets yesterday to see what they thought about the PACW dividend cut. Sentiment was unanimous that it meant PACW must be the next FRC.

So I sold the apes a few 4-day put options with extreme IV, driven by last week's volatility.

I'm up 47% as of now, even with PACW down for the day and lower than where I sold the put. Goes to show in cases like this volatility > delta, but try teaching that to an ape.

Lol

PACW has weekly options now.

[ChpBstrd]

@chasesfish I know it's about 20x bigger than the banks you're focusing on, but what do you think about Regions Financial (RF)? 

I was shopping their bonds maturing 5/18/25 (CUSIP: 7591EPAQ3) with a yield to worst of 7.377% and I was also looking at their preferreds with similar yields in the 7-8% range. Moody's (report attached) had the following nice things to say about them back in September 2022:

The company's enhanced risk management infrastructure has led to a reduced commercial real estate concentration and controlled loan growth compared to competitors...
...
Regions' risk management infrastructure is positively influencing the company's strategic decision making. This has led to the decrease of historic asset concentrations in commercial real estate (CRE) and home equity. Its CRE and home equity exposures were 92.9% and 56% of tangible common equity as of 30 September 2022, respectively, which are relatively low among the large US regional banks. As evidence of risk management effectiveness, we observed Regions' decrease in CRE loan balances in 2017, which was management's direct response to overly loose credit conditions. Given the enhancements in Regions' risk management infrastructure and the conservativeness it has shown in reducing its CRE growth, we expect that it will avoid outsized asset concentration risks.
The relatively modest size of Regions' energy exposure ($1.6 billion or 1.7% of loans as of 30 September 2022) also illustrates the effectiveness of risk management oversight in avoiding asset concentrations. At the end of 2015, Regions' direct energy loans equaled $2.5 billion or about 23% of its Moody's tangible common equity, which was less than most other regional banks that, like Regions, are operating in U.S. energy producing areas...
...
Regions has benefited from its interest rate hedging program put in place in 2018, which has supported its loan yields, and its robust low-cost deposit base. We expect Regions' net interest income margin to grow over the next 12-18 months as a result of further expected interest rate hikes, loan growth and relatively low, though increasing, deposit betas, which indicates the extent to which interest rate increases are passed on to depositors.

Additionally, per their April 21 earnings call...

Approximately 70% of our deposits are retail deposits. These deposits tend to be granular and less rate sensitive. In fact, approximately 90% of these deposits are insured.
...
Hedges added to date create a well-protected net interest margin profile through 2025.

They've set 10% as a goal for CET1 ratio, raised that ratio to 9.8% (20bp increase) in the first quarter, and anticipate 20-30bp improvement per quarter. This addresses the biggest drawback noted in the Moody's report, so they could theoretically see an upgrade to "A" in certain scenarios. Buybacks have been suspended and they've established multiple sources of emergency credit lines.

Based on just these two sources, this sounds a lot like the "mythical unicorn survivor bank run by preppers loaded for bear, but with their stock/bond prices nonetheless beaten down" that we've been looking for.

They feature low rates of uninsured deposits, low CRE and home loan concentrations, an interest rate hedging program that is probably more sophisticated and cost-efficient than what smaller banks are running, an appearance of longstanding conservative lending practices, and despite all this caution they've been generating a 1.45% ROA and 13.6% ROE despite the last 14 months of chaos.

Your take?

[chasesfish]

I haven't looked that closely at Regions.   Decent bank, hosed the shareholders with dilution in 2008.   I briefly had a good dude as a boss boss who saw his early retirement wrecked in RF stock, so I might be biased.

Bonds / Prefs?  You'll be in good shape with RF.   Decent risk people in the bank now too, they aren't out there on the risk spectrum anymore after nearly losing the franchise. 


Today's purchase?  BOH preferred stock.   BOH-A.   Operate in a four bank oligopoly with nowhere for local business deposits to go.   Mathematical problems in their bond book because they've always had a lot more deposits than loans because of the state's wealth and lack of lending.   I was a long time holder of their common stock but sold out in December because of the coming reckoning with their equity.   Yield is improving slowly with rising rates because they're almost all demand deposit accounts.

Prefs are thinly traded, it was a 200mil issuance originally, 8.5% yield, got most of my $10,000 order filled around $12.60

[ChpBstrd]

Operate in a four bank oligopoly with nowhere for local business deposits to go.   Mathematical problems in their bond book because they've always had a lot more deposits than loans because of the state's wealth and lack of lending.   I was a long time holder of their common stock but sold out in December because of the coming reckoning with their equity.   Yield is improving slowly with rising rates because they're almost all demand deposit accounts.

Great timing on the BOH sale last December! I took a look at BOH's CD rates as a proxy for their oligopoly status. Can confirm - they're only paying 3.75% for a 12 month term, compared to lots of other FDIC-insured CDs on the mainland being offered for 5.1% right now! They don't seem to be reaching for deposits.

That said, who can't simply click some buttons to buy a higher-yielding CD on the mainland through their brokerage? In terms of the 44% of their deposits which are uninsured, who can't simply move funds to a money market account?

Also, I'm a bit wary of Hawaii because of the high levels of real estate speculation and price appreciation. Seems like buying BOH would be like taking on much of the potential downside for loans in one of the frothiest markets on Earth.

[chasesfish]

I think $BOH learned from frothy home equity line lending last cycle.   I don't go much further than "more people than houses" when thinking about that market.   Land on lava rock is incredibly expensive to develop.    Don't get too aggressive on hospitality or condos and it'll work out.   I'm also surprised people don't click "buy" on CDs online, but it is what it is.   


The only other banking update I see right now:   Insider purchases are coming through fast and furious on all size banks.  Open market purchases from executives and directors, not just stock vesting.   Blackout periods ended for all of these buys after earnings were reported over the last three weeks.   They may not be right, but most insiders are increasing concentrations at these prices.   Higher rates, especially if they stabilize for a year, is better for banks.   Insiders also have good view into the credit risk at their institutions.    The alternate argument is this is tunnel vision, which I would also be suffering from.

[reeshau]

PacWest is down as much as 25% pre-market, as it has pledged an additional $5.1B in assets to the Fed discount window.  According to reports (there is no press release on this) The bank said deposits dropped 9.5% over May 4-5.  The bank now has $15.1B in liquidity, and $5.2B in uninsured deposits.

This is in contrast to their statement, released on May 4, saying "The bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news."

[reeshau]

WAL has released a deposit update today, given the excitement around PACW.  WAL was down 10% pre-market, but looks like facts are winning today, and it is up a bit.

Stable Deposits: Total Deposits were approximately $49.4 billion as of Tuesday, May 9, with quarter-to-date deposit growth of $1.8 billion from $47.6 billion as of March 31 and higher by approximately $600 million from $48.8 billion as of Tuesday, May 2, the date of our last deposit status release. Insured deposits were approximately 79% of total deposits as of Tuesday, May 9 compared to 68% as of March 31. Readily available liquidity is approximately double the amount of uninsured deposits as of May 9. The increase in deposits amidst heightened market volatility and challenges at competitors exemplifies the strength and resilience of the Bank and its customer relationships. Our $2 billion quarter-over-quarter deposit growth rate guidance is unchanged.

[ChpBstrd]

PacWest is down as much as 25% pre-market, as it has pledged an additional $5.1B in assets to the Fed discount window.  According to reports (there is no press release on this) The bank said deposits dropped 9.5% over May 4-5.  The bank now has $15.1B in liquidity, and $5.2B in uninsured deposits.

This is in contrast to their statement, released on May 4, saying "The bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news."

I agree, it is a contradiction in sentiment. As soon as the bank said they were fine and they were cutting the dividend to be extra-fine, the actual bank run started.

Maybe the lesson is to not be in the news at all, even if you have good news to announce. Apparently, a lot of PACW customers got spooked by seeing their bank in the news alongside mentions of First Republic, Signature, and SVB and thought for the first time "my bank is in question?". Perhaps we'll see less transparency about day-to-day deposit flows going forward.

Those PACW short put options I was bragging about earlier are now at $0.325 compared to $0.075 yesterday. I was paid $0.331 for them, so amazingly I'm still slightly in the green with a day and a half to go! I figure the sort of volatility that would get me assigned on Saturday morning would be the same volatility that would allow me to write a very expensive ITM call on Monday morning.

[chasesfish]

Two updates today: 

Bought some FHN Prefs - 8.39% yield on the Series F issuances.   Unloaded a share of my AZO at an all time high.  If you've followed my posts, I like the lowest stated fixed rate coupon on these so I can pickup the most convexity when the credit spreads narrow and if rates drop.

One of my community bank holdings dropped their annual meeting deck from this week.   51% demand deposit accounts at 0% interest.   Last cycle their funding cost peaked out at 0.75%, right now they're at 0.90% with a slightly higher fed funds rate than 2007.   Their business is loaning on real estate in a college town with a landmark state university.   Last cycle charge offs peaked at 0.50%.   They were heavily invested in bonds, so there's a 60% increase in tangible book equity that happens over the next five years as the book rolls over.    I do know one thing, loaning money on an 8 unit student housing building or a retail center in a university downtown where there's a P5 sports program is not a difficult business. 

The "death of college" need not apply if we're talking about a large enrollment state school with a D1/P5 sports program.