buy bank stocks on the dip

[ChpBstrd]

After the Fed press conference today, the 5yr Treasury is at 4.57%.

That exceeds the *pain* threshold on many commercial real estate deals.  If it closes above this level at quarter end, expect the bond mark discussion for the banks to resume as they report earnings in mid October.   You'll likely see problem loan reserves increase and expenses start to increase, I expect they'll start appraising properties early of the maturity date and increasing reserves on any 2024 maturities.

There was a great Exchanges at Goldman Sachs episode on this earlier this week. I thought the second speaker, Stijn, was fantastic (first speaker was just so-so). highly recommended listening - how big are the losses, what does it mean for each level of the cap structure, how is this similar or different to the S&L crisis?

That was a great podcast, with lots of frightening facts being dropped (how reliable are they? IDK). It really implies we'll have a crisis unless we get falling interest rates ASAP. If offices aren't refilling now - under no-pandemic, full employment, and 4.9% GDP growth conditions - -when will they refill?

And if they'll never refill, who will "lose their shirt" if not banks, REITs, and insurance companies? The ratio of CRE debt to total bank equity startled me: 280% for banks <$10B. And if occupancy is 50% as stated, it seems some properties might have trouble paying even their existing notes at low rates, much less renewal! The potential scale of losses seems to be far greater than the BTFP could patch up.

Left unsaid: If offices really have dropped in value (-40% was calculated by the guest), the size of loan refinancings will also have to drop. For some fraction of landlords this would mean ponying up more cash to fill a negative equity hole at refinancing time, in an era when that cash could earn a good yield, and on an asset that might not even be breaking even now. It could come down to that or foreclosure in thousands of negotiations over the next few years.

[grantmeaname]

I don't know the speaker or his reputation but hopefully the peer review process disciplines what he's saying and he's not totally shooting at the hip.

[Michael in ABQ]

After the Fed press conference today, the 5yr Treasury is at 4.57%.

That exceeds the *pain* threshold on many commercial real estate deals.  If it closes above this level at quarter end, expect the bond mark discussion for the banks to resume as they report earnings in mid October.   You'll likely see problem loan reserves increase and expenses start to increase, I expect they'll start appraising properties early of the maturity date and increasing reserves on any 2024 maturities.

There was a great Exchanges at Goldman Sachs episode on this earlier this week. I thought the second speaker, Stijn, was fantastic (first speaker was just so-so). highly recommended listening - how big are the losses, what does it mean for each level of the cap structure, how is this similar or different to the S&L crisis?

That was a great podcast, with lots of frightening facts being dropped (how reliable are they? IDK). It really implies we'll have a crisis unless we get falling interest rates ASAP. If offices aren't refilling now - under no-pandemic, full employment, and 4.9% GDP growth conditions - -when will they refill?

And if they'll never refill, who will "lose their shirt" if not banks, REITs, and insurance companies? The ratio of CRE debt to total bank equity startled me: 280% for banks <$10B. And if occupancy is 50% as stated, it seems some properties might have trouble paying even their existing notes at low rates, much less renewal! The potential scale of losses seems to be far greater than the BTFP could patch up.

Left unsaid: If offices really have dropped in value (-40% was calculated by the guest), the size of loan refinancings will also have to drop. For some fraction of landlords this would mean ponying up more cash to fill a negative equity hole at refinancing time, in an era when that cash could earn a good yield, and on an asset that might not even be breaking even now. It could come down to that or foreclosure in thousands of negotiations over the next few years.

I used to be a commercial real estate appraiser and appraised several large downtown office buildings. Office is tough. The landlord may end up spending a bunch of money on renovations (tenant improvement allowance) to get a tenant in place. Operating expenses are high and usually included in the lease - so no meaningful ability to pass expenses on to the tenant in a lot of cases. Occupancy was always low in our market - usually about 80% (this was pre-pandemic). I saw office buildings in larger markets selling at 5-6% cap rate with 5-10-year notes and I'm sure all of those are underwater by now.

[ChpBstrd]

After the Fed press conference today, the 5yr Treasury is at 4.57%.

That exceeds the *pain* threshold on many commercial real estate deals.  If it closes above this level at quarter end, expect the bond mark discussion for the banks to resume as they report earnings in mid October.   You'll likely see problem loan reserves increase and expenses start to increase, I expect they'll start appraising properties early of the maturity date and increasing reserves on any 2024 maturities.

There was a great Exchanges at Goldman Sachs episode on this earlier this week. I thought the second speaker, Stijn, was fantastic (first speaker was just so-so). highly recommended listening - how big are the losses, what does it mean for each level of the cap structure, how is this similar or different to the S&L crisis?

That was a great podcast, with lots of frightening facts being dropped (how reliable are they? IDK). It really implies we'll have a crisis unless we get falling interest rates ASAP. If offices aren't refilling now - under no-pandemic, full employment, and 4.9% GDP growth conditions - -when will they refill?

And if they'll never refill, who will "lose their shirt" if not banks, REITs, and insurance companies? The ratio of CRE debt to total bank equity startled me: 280% for banks <$10B. And if occupancy is 50% as stated, it seems some properties might have trouble paying even their existing notes at low rates, much less renewal! The potential scale of losses seems to be far greater than the BTFP could patch up.

Left unsaid: If offices really have dropped in value (-40% was calculated by the guest), the size of loan refinancings will also have to drop. For some fraction of landlords this would mean ponying up more cash to fill a negative equity hole at refinancing time, in an era when that cash could earn a good yield, and on an asset that might not even be breaking even now. It could come down to that or foreclosure in thousands of negotiations over the next few years.

I used to be a commercial real estate appraiser and appraised several large downtown office buildings. Office is tough. The landlord may end up spending a bunch of money on renovations (tenant improvement allowance) to get a tenant in place. Operating expenses are high and usually included in the lease - so no meaningful ability to pass expenses on to the tenant in a lot of cases. Occupancy was always low in our market - usually about 80% (this was pre-pandemic). I saw office buildings in larger markets selling at 5-6% cap rate with 5-10-year notes and I'm sure all of those are underwater by now.

Perhaps everything pivots on occupancy numbers. Here's a source that seems to strongly contradict the 50% number from the podcast, pinning vacancies at more like 10-24%. However the difference seems to be that the 50% number is based on how many offices don't have people working in them and the second number is how many offices aren't leased. I think many companies are still paying leases on offices they effectively abandoned in 2020 or 2021. These companies are perfecting their remote worker management game and waiting on lease expiration to start realizing massive expense savings.

I'll take the next opportunity to drive around downtown during office hours, looking at the number of empty parking spots to confirm or deny this interpretation. I also need to get out in rush hour sometime, to see if it is as bad as I remember it was pre-pandemic.

Landlords might be wise to renew their loans while they still have leases, and banks could be walking into a trap if they're only looking at the business on paper without realizing the office is an empty shell with a year left on the main tenant's lease.

[chasesfish]

I feel like I'm stuck on repeat here...

The office issues are mostly outside of the banks.

There are serious concerns in 4+ story office in central business districts with difficult commutes.  Those are high dollar properties.  Too big for most of the community banks and when permanent loan sizes get above $10mil, the debt migrates out of the banks into the life insurance and commercial mortgage backed securities market.   The maximum exposure here for the large banks are a few pre-2020 construction/rehab loans that had 5yr perm options and will need to be resolved. 

The stuff inside the banks is just not high rise, central business district office.  It is broad CRE that'll be impacted by higher rates reducing values, expense growth greater than rent growth in some property types, and a slowing economy.   Those are managable issues vs. the collapse in downtown, high rise office.

[grantmeaname]

Do you know how much of the dollar value of the office asset class is CBD skyscrapers vs everything else? I live in a midsize city (~#25 in the country) and we have way, way more suburban office park inventory and little downtown inventory, and my part of town 15 miles from the center is full of unleased 4-6 story buildings. Of course it takes many of those to equal one high rise, but I don't think it's as simple as 'bank is exposed to retailers/warehouses, insurance is exposed to office'

[reeshau]

For illustration, here is a slide from the Q3 earnings call for Western Alliance.  They have taken the step to both reappraise their CBD office loans, and move them into a "special mention" category; not yet non-performing, but called out.

At the upper left, you can see that non-owner-occupied office is 5% of total loans.  The CBD category is 3% of this.

[chasesfish]

@grantmeaname - The best answer I can give you is about size of the loans.  4+ story office buildings are expensive.  They are built in areas that aren't cheap and the buildout is expensive.   I'd say the average loan size is almost always over $10mil.   

In this space, banks are really only the construction / turnaround lender.   The permanent debt has always been lower cost and better terms (for the borrower) through the life insurance or CMBS market.

I think there will be some $20bil to $250bil regional banks that have some issues with construction and turnaround loans they did, but I still don't see it being a major issue.

As for how to see this, reeshau posted the WAL earnings supplement.   Every regional bank is posting those and trying to disclose as much as they can about office exposure to protect their stock price.   This is a narrative bank management also believes the market has wrong and is putting out as much data as they can to show how limited office exposure is.   The challenge with the aggregate office portfolio numbers is a $2mil loan to a CPA firm or a dentist who owns their own building is included in the "office loan" classification.

[chasesfish]

More on Office...

Reading Key Bank's earnings report and slides this morning.   Peer Median:  Office loans make up 3.1% of the total loan book.  They defined peers as BAC, CFG, JPM, MTB, PNC, TFC, WFC, and ZION since these banks provided portfolio detail.

As a side note, I bought a few of their prefs, they have been hammered and now yield 9%+ because the bank's margin is down to 2.01% and it'll take 4-6 quarters to work out.

[ChpBstrd]

@grantmeaname - The best answer I can give you is about size of the loans.  4+ story office buildings are expensive.  They are built in areas that aren't cheap and the buildout is expensive.   I'd say the average loan size is almost always over $10mil.   
...
The challenge with the aggregate office portfolio numbers is a $2mil loan to a CPA firm or a dentist who owns their own building is included in the "office loan" classification.

Thanks for the info, @chasesfish. I wonder, though, if there is a hidden assumption in saying local/regional banks don't hold downtown high rise office debt and therefore will be fine. The assumption is that smaller or lower-end properties will do better than the downtown skyscrapers. One of the guests on the podcast posted earlier by @grantmeaname suggested vacancies would be highest at the low end of the market - those ubiquitous little low-rise office buildings and strip malls.

Office has a uniquely pessimistic narrative around our new WFH technologies, but I wonder if other types of CRE are underwater in the sense that their returns are only positive when their debt is below a certain interest rate. To what extent will banks be unable to refinance their own loans by their own standards on warehouses, apartments, clinics, rent houses, storage units, etc?

[Michael in ABQ]

@grantmeaname - The best answer I can give you is about size of the loans.  4+ story office buildings are expensive.  They are built in areas that aren't cheap and the buildout is expensive.   I'd say the average loan size is almost always over $10mil.   
...
The challenge with the aggregate office portfolio numbers is a $2mil loan to a CPA firm or a dentist who owns their own building is included in the "office loan" classification.

Thanks for the info, @chasesfish. I wonder, though, if there is a hidden assumption in saying local/regional banks don't hold downtown high rise office debt and therefore will be fine. The assumption is that smaller or lower-end properties will do better than the downtown skyscrapers. One of the guests on the podcast posted earlier by @grantmeaname suggested vacancies would be highest at the low end of the market - those ubiquitous little low-rise office buildings and strip malls.

Office has a uniquely pessimistic narrative around our new WFH technologies, but I wonder if other types of CRE are underwater in the sense that their returns are only positive when their debt is below a certain interest rate. To what extent will banks be unable to refinance their own loans by their own standards on warehouses, apartments, clinics, rent houses, storage units, etc?

Most CRE loans max out at 70% Loan to Value. Apartments can go higher because of government backed loans from FNMA/FHLMC. So that provides some buffer right there for lenders that the value can fall by 30% on day 1 and they're still not underwater. Presumably many of these loans have paid down at least some principal as well - though not much as amortizations are typically 20-25 years with balloon payments in 5-10 years.

Retail has been suffering almost as much as office. Between big box stores and ecommerce the only viable retail stores are offering services (salons, gyms, etc.) or restaurants. The latter have realized that in many cases it no longer makes sense to have a dining room. A kitchen + drive-thru, delivery, and/or pickup is enough.

I was overseas when COVID hit and didn't come back until Fall of 2020. By then there were a lot of retail storefronts that were closed down that never reopened. Here locally the only thing to backfill many of them were marijuana dispensaries. However, that market is hugely oversaturated and probably 1/4 - 1/3 of those will close down in the next year or two once they realize they're not profitable when a certain amount of demand is spread out among 1,000 stores instead of the 500-700 the market may actually support.

Industrial is doing great though. There will always be a need for a place to store goods and for contractors and other service businesses to work from.

[reeshau]

Actually, retail is doing quite well.

https://therealdeal.com/national/2023/08/21/retail-sector-is-commercial-real-estates-saving-grace/

https://www.wsj.com/real-estate/commercial/a-bright-spot-in-commercial-real-estate-retail-shops-a3ef009e?st=31unuo7qk0ea4xn&reflink=desktopwebshare_permalink

[chasesfish]

Retail space is at an 18yr low in vacancy, CBRE data in this report.

https://chainstoreage.com/available-retail-space-hits-18-year-low

For the most part the product deliveries here slowed after 2007 while population and spending age population kept growing.

I also agree with @Michael in ABQ - It's important to remember the community / regional bank debt is mostly amortizing term debt vs. CMBS that has a lot of interest only.   The loans derisk over time. 

The fear is real in the market.   I just continue to ask myself am I being compensated for that fear with 8-9% preferred stock and some community banks in stable markets trading for 5-6x earnings?   Today I still say yes.

[Michael in ABQ]

Actually, retail is doing quite well.

https://therealdeal.com/national/2023/08/21/retail-sector-is-commercial-real-estates-saving-grace/

https://www.wsj.com/real-estate/commercial/a-bright-spot-in-commercial-real-estate-retail-shops-a3ef009e?st=31unuo7qk0ea4xn&reflink=desktopwebshare_permalink

I stand corrected. I still see a lot of retail vacancies locally - though they tend to be concentrated in the lower quality properties that most surveys don't capture. My first job out of college was compiling retail occupancy data and our cutoff was properties that were over 10,000 square feet - so that excluded a lot of the small retail strip properties with a few suites that most chains and national tenants would avoid.

I've been out of the commercial real estate industry for 5-6 years now and when I left things were ok but the macro trends haven't looked good the last few years. However, a lack of construction + population growth does help when it comes to occupancy and keeping rents from falling.

[reeshau]

Not to rub it in, but I gotcha covered there, too.

Yesterday, in the WSJ:  Strip Malls Are the New King of Retail Real Estate

Says specifically that interest is high in strip malls without a big anchor.  The world has turned upside down.  :)

[Michael in ABQ]

Not to rub it in, but I gotcha covered there, too.

Yesterday, in the WSJ:  Strip Malls Are the New King of Retail Real Estate

Says specifically that interest is high in strip malls without a big anchor.  The world has turned upside down.  :)

I can see the appeal as that big anchor tenant - say Bed Bath & Beyond (before they went bankrupt) would have paid maybe $10-15/SF in rent and demanded a lot of concessions like co-tenancy clauses, not paying their fair share of common area maintenance, etc. Meanwhile, the smaller in-line retail spaces at 1,500 - 4,000 SF would pay $25-35/SF and losing any single one wouldn't cause a potential death spiral like losing an anchor tenant that the other tenants relied on to bring in traffic.

There are only so many tenants that need 20,000 - 50,000 SF spaces. I've seen a lot of former grocery stores and big box retailers turned into trampoline parks, churches, and gyms. None of those are going to provide the same draw that another big box retailer may have provided in the past. And they're probably not going to be paying as high of rent.

Rent for a retailer is ultimately driven by a percentage of sales. An Apple store generates something like $1,000/SF in retail sales so paying 5-7% of that as rent is $50-70/SF which means they can afford to rent the most premium locations. Meanwhile, a local bookstore might generate $100/SF in retail sales so they can only afford maybe $10/SF before the rent is so high that they aren't profitable. This is why every retail owner wants the best national tenants because they can afford higher rent. Also, when they go to sell the property or get a loan, having a bunch of national credit-worth tenants (typically with 5-15-year leases) makes a property more valuable than a bunch of mom and pop local retailers with 2-5 year leases and no credit except the owner's personal balance sheet. And good luck getting money out of a local retail store owner that breaks their lease. Most landlords will just write it off because they know they can never recover enough to offset their time and legal costs.

[ChpBstrd]

Headline:
"Bill Gross Is Buying Regional Banks, Says They’ve Hit Bottom"
Quotes:

The co-founder and former chief investment officer of Pacific Investment Management Co. is buying Truist Financial Corp., Citizens Financial Group Inc., KeyCorp and First Horizon Corp.

On Oct. 30, Gross suggested that regional banks have “extraordinary long-term value,” but was waiting to own some of them at 60% of book value and 7% yields. A week earlier, he said he saw a US recession in the fourth quarter.

In his latest post, Gross added that the best strategy for traders navigating an “uncertain” Treasury yield picture is “to invest in the 2/10 curve continuing to disinvert” and predicted it will go positive over the next six months.

So there's an endorsement of TFC, CFG, KEY, and FHN.

[chasesfish]

Today was a good day.   Long term rates falling boost the prefs 2x, one with the benchmark rate falling, and secondly with the underlying bank's capital improving thanks to less bond marks.

Outside of FHN, not sure why Bill Gross is dipping his toes into the worst franchises vs. just buying KRE.   A few of the bank investors on twitter are making fun of that.   Why own trash companies when you can make the same money on better run franchises

[chasesfish]

The bank bears are somewhere between in hibernation and full migration after today.   The CPI report came in complete goldilocks mode.   It turns out removing a ton of stimulus via paused student loans can dent price increases.

5yr Treasury back below 4.5%

Some level of rate cuts are on the table. 

Shorts on regional banks ran for the exits.

If short/long term yields settle in the 3.5% to 4% range, banks earn back a ton of the bond losses *and* outlook for commercial real estate credit improves. 

We'll know a lot more about rates by mid January.   Two more inflation prints, a December fed meeting, and a bunch of fed speak between now and then.   Probabilities moved from no rate cuts in 2024 to something as early as March.   Enjoy your gains those who went long.

[ChpBstrd]

The consensus is that rate hikes are done. The Fedwatch tool shows an exactly 0% chance of another rate hike, and increasing odds of rate cuts sooner than anyone currently expects. I am with the consensus on short term rates, though it feels uncomfortable to hang out in a herd like this.

I find it interesting that the market's reaction was to bid up banks - KRE rose 7.37% today! I was unaware such a huge risk premium was being assigned to the probability of higher short-term rates, as just last week the Fedwatch tool was only envisioning a 15% chance of a quarter point hike in December or January.

Perhaps the theory on short positions being closed has merit, but most banks I looked at had short interest in the 2% range. Even Comerica and Zions had <9% - less than half what is usually thought necessary to trigger a squeeze. Financial preferred stocks did not participate in the rally like the commons did, as evidenced by PGF's mere +1% move and PFF's +1.3% move. If anyone previously thought banks' survival was imperiled by the risk of one or two more rate hikes, and the CPI report means banks are now safe, shouldn't they be loading up on preferred stock too?

I'm discounting my earlier hypothesis that the yield curve could un-invert on the long-term side. Instead, I'm foreseeing the typical pre-recession pattern. Short term rates will be lowered until un-inversion occurs - and this will occur within a few months plus or minus from the start of recession. This was the pattern after previous rate hiking campaigns, and conditions are bearing an uncanny resemblance to 2007 lately.

The recession will come with credit risks for banks, and there is still a potential housing bubble to contend with, which is why I'm not yet calling a bottom. Instead I'm piling into high-convexity treasuries - 30 year zeros and beaten-down 30's from 2021. Maybe this is the wrong move, and I should instead be locking in yields while they last, but I think long-term rates will continue to slide. A relatively small drop could send such bonds rocketing.

The downside risk is that long-term rates stay the same as short-term yields fall and the yield curve un-inverts traditionally without my hoped-for dip in long-term rates. In the short run, I predict rates could fall if a government shutdown starting next week pinches off the supply of new treasuries. I might reduce or hedge my positions upon resolution of the debt ceiling, because that will let loose another flood of supply.

[chasesfish]

It was the messy middle of banks that skyrocketed today.  KRE holdings plus those more interest rate sensitive like BAC.   A few of my community banks didn't move much.   

The pref market still seems inefficient.   I'm up almost 25% on HBANP while others are in the 5% to 10% range.   Some are just moving with rates while others have having the risk premium repriced.   Hopefully with time both the thinly traded prefs and smaller community banks catch up.

[reeshau]

WAL was up 10%, but still 10% off of late July / early August highs.  Volume 150% of avg daily.  5% short, which comes out to 3-4 days ago volume.

[grantmeaname]

Perhaps the theory on short positions being closed has merit, but most banks I looked at had short interest in the 2% range. Even Comerica and Zions had <9% - less than half what is usually thought necessary to trigger a squeeze. Financial preferred stocks did not participate in the rally like the commons did, as evidenced by PGF's mere +1% move and PFF's +1.3% move. If anyone previously thought banks' survival was imperiled by the risk of one or two more rate hikes, and the CPI report means banks are now safe, shouldn't they be loading up on preferred stock too?

I've never looked at banks specifically, and agree with your overall point, but two things I would note - 1) the best metric for a squeeze is the short interest in terms of typical days' trading volume. Is the interest 1, 3, or 10 days of normal trading. harder metric to find though... 2) dividend paying stocks have a lot more permanent capital from dividend focused funds and retail investors, so you have to mentally haircut their total ownership when thinking about the portion of it that will actually buy, sell, and short based on fundamental news. 2% of the half of a dividend aristocrat that's not dividend focused is really more like 4%.

[chasesfish]

There's an interesting short report that came out against $ABR today.

If you want to see where the high leverage, high risk lending was, look no further than the multifamily mortgage REITs. 

https://viceroyresearch.org/wp-content/uploads/2023/11/Arbor-Slumlord-Millionaires-16-Nov-2023.pdf

How some of these borrowers got this level of debt is crazy.

[ChpBstrd]

There's an interesting short report that came out against $ABR today.

If you want to see where the high leverage, high risk lending was, look no further than the multifamily mortgage REITs. 

https://viceroyresearch.org/wp-content/uploads/2023/11/Arbor-Slumlord-Millionaires-16-Nov-2023.pdf

How some of these borrowers got this level of debt is crazy.

Thanks @chasesfish . That report has some scathing language, lol, and I wonder if the target audience is retail investors who can take short positions. I've been thinking about shorting mREITs for a long time now, but they've held up nonetheless. ABR has actually increased its dividend each quarter this year.

Bulls might retort that:

• 77% LTV is higher equity than almost all new mortgages, so why is that bad? Still far from negative equity.
• The properties won't default even if the cap rate is < the risk free rate because what other choice do the LL's have besides holding out?
• The cap rate is rising with rising rents,
• Housing shortage talk.....
• The housing finfluencers and flipper gurus are probably a red herring argument. How many are we really talking, and are their syndicates really run by inexperienced people?
• If ABR is investing in LCOL area apartments, that's the source of the elistist "slums" commentary. You can find negative reviews anywhere. If anything, ABRs LCOL focus insulates them from a repeat of 2008. If there is a recession, the high end of the market will be moving into the low end of the market.
• Mortgage rates would fall simultaneously with any housing/economic crisis, thus relieving the refinancing issues for ABR at the same time it happens, unless markets completely locked up like in 2008.
• Analysts who follow the company on average predict EPS going from 0.47 in 4Q2023 to 0.48 in 4Q2024.
• We're about to start a rate cutting cycle that will be helpful to ABR and other mREITs.

Overall I don't find these arguments persuasive, just thought I'd get them out there. Others may contribute more arguments.

In the meantime I think ABR and other mREITs are good short candidates. With VIX<14 I'm looking very hard at a bear put spread at 12.5/14 for $0.90 (low imp vol = prices close together across strikes). A 67% return on that spread could also hedge a decent amount of bank stock exposure, methinks.

[chasesfish]

Short reports are always an interesting read.  You know their goal is to hammer down the stock.

The challenge with betting against Arbor is their founder has deep pockets and runs in circles with other deep pockets.   I have it on good knowledge that he has already seeded some rescue funds to buy up the problem assets.  It all stinks in self dealing, but I don't see that group sticking Arbor with such losses it goes to zero.   Their prefs pay +/- 9%, certainly not priced for a zero.

It's a nice short candidate if you can get ahead of a dividend cut.  The problem with that game is paying the dividend out of pocket will kill you until it's cut. 

[Michael in ABQ]

PACWP just paid out their quarterly dividend. 11.5% yield, not bad. Plus 25% appreciation. Too bad I only bought 30 shares.

[ChpBstrd]

I just discovered my tiny local bank will pay 7% APY on my checking account up to $25k if I make at least 30 debit card transactions of at least $5 each per month.

This really tweaks my purchasing calculations and makes me reconsider my go-to 2% cash back credit card. 30 transactions is relatively hard for me to do - I've done 7 so far in November. I could switch exclusively to my debit card and let my credit card balances all hit zero over the next couple of months.

Probably no implications for bank stocks, but I'm impressed we've crossed into the realm when it is technically possible to earn 7% on a FDIC-insured checking account balance. With a bit of adjustment, I could be earning preferred stock-like yields from a checking account. Just taking a minute to wrap my mind around that.

@Michael in ABQ congrats on the PACWP win, and condolences too. In all fairness, I suspect the line just barely held and the timing of the BTFP was a lucky scrape for PACW. A friend lost half his meager net worth on First Republic, which was on the other side of the line.

[chasesfish]

That's a cool customer acquisition strategy.   There was a bank or credit union out of Dallas doing something similar.

We've seen some good moves in long term interest rates and it's reflecting in bank stocks.  There's a few prefs I own that don't have much more steam in appreciation and I might swap them out for some small bank common stock.   Otherwise mostly sitting on my hands for the last month.   

I've seen a few distressed CRE deals, fortunately this 5yr dropping is limiting the variable rate bridge loan bomb for good operators.  Ones who couldn't execute on their business plan are going to exposed, but that happens in any slowdown. 

[ChpBstrd]

I've seen a few distressed CRE deals, fortunately this 5yr dropping is limiting the variable rate bridge loan bomb for good operators.  Ones who couldn't execute on their business plan are going to exposed, but that happens in any slowdown.

The 5y treasury has plummeted from 4.96% to 4.26% in the past month-and-a-half. My outlook is that rate hikes are done, inflation is done, and longer-term yields are heading back to levels seen in early 2023. The FFR will start being cut in 2024 whether we get a recession or a soft landing. The BTFP will be extended at least another year.

The lowest-yielding longest-duration treasuries the banks bought in 2021 are gaining a couple percent per year just from the passage of time, as their maturity dates creep closer. If rates keep falling as I think they will, banks are going to see double-digit percent paper gains on their worst bonds. I'm buying these bonds with both fists.

With that outlook, I have to ask myself if the risks from CRE and mortgages have passed, and if bank stocks have been unfairly punished. 7.5%+ yields are still available on OZKAP, PNFPP, BOH-A, FHN-B or C, GS-A or D, PACWP, TFC-I, ZION-P or O, MNSB-P, and NYCB-U. It would take a major crisis not to lock in a >7% yield, with appreciation potential, out of such a portfolio, and signs seem to be pointing away from a crisis.

Would you agree @chasesfish ? Or are there enough CRE bad operators to say the risk is still very much alive?

[chasesfish]

I agree on locking in the yield.   Getting 7.5% on large regulated banks vs. a 3-4% treasury is and will continue to be attractive. 

You can pick and chose your preferreds relative to CRE risk, the bond banks like BOH, ASB, and TFC just don't have a ton of it vs the good lenders like OZK and PNFP.

[tj]

Commenting to follow...wish I found this thread earlier! Interesting stuff.

[chasesfish]

A few random updates on my holdings.   Given where the 5yr and 10yr bond rates are relative to 9/30, I expect tangible book value to go up quite a bit as some bond marks are recovered plus another three months of amortization in the MBS books.

PNFP has been incredible since March, now up 60%.   Unfortunately with banks they can still only make so much money in ROE, it's nearing the sell level at 160% of Tangible Book Value.   The company operates as close as you'll find to a "growth stock" in banking.  Small dividend, raise/deployed equity in 2017, and continue to offer the best proposition to quality employees in the industry.    This is my only regional common stock and I own a little of their preferreds.

PPBN is the other nice performer lately.  $1bil community bank that was trading at 70% of tangible book value but doing everything right.  They announced a 25% dividend increase and briefly paid 5%, apparently that caused them to get noticed by the market and closed their valuation to 85%-90% of tangible book.   I own two other small community banks in that general area around 85%-90% of Tangible Book that can't seem to get much love from the market (SLBK and BOTJ).   They have both historically returned near 100% of earnings to shareholders via buybacks and dividends, but the sharp bond marks this year for both slowed buybacks.  If those return next year, TBV should grow nicely along with the valuation.

On the large bank side, I still own a bunch of Bank of America.   The doomer posts there of "mark all the loans / bonds to market but not anything else" are running it's course.   The math on how much of their stock they can retire is overwealming as bond prices stop going nuts. 

Almost all of the prefs are up between 5% and 15%.   FHN-F is my largest holding and it's between 11% and 15% depending on the purchase lot / account.   I traded out a couple that were up more as I wasn't getting paid any premium for holding them over BofA or PFF>  The best value I see out there right now for cash flow is AUB-A.   This is a conservative regional bank (to the point lenders don't like working there because they don't take much risk) that bought up rural, low cost deposits all over Virginia and runs a bond book plus loans the money out in Northern Virginia.  The common stock still trades for a premium to book, so I can't find much risk in the prefs.   Pays 8.5% with a 20% upside as it returns to par.

My activist investment in ASRV is still in misery mode.  I've bought anywhere between $4 and $2.50 per share and it's trading for $3.   Bond mark recoveries.   It is a $1.5bil bank with a good non-interest bearing deposit base and a wealth management business, yet it trades for 50% - 70% of Tangible Book Value due to incompetency and an entrenched board.   Instead of accepting help from outside investors, they've spent half of their earnings this year in lawsuits fighting an outside investor preventing him from nominating qualified directors to the board.   This is in the camp of taking my 4% dividend / year and hold out for a management change or sale to finally get the value out of the company.  Holding this also reminds me not to participate in other bank activist campaigns, they're so difficult.

Right now all eyes are on the long term bond rates.   Stay below 4.5% on a five year and the math behind the CRE credit risk is resolvable and bond marks will see recoveries every quarter.   Go back above there, the risk rumblings will return.   

The only value I see out there right now is to find sub $5bil banks with 30% or more non interest bearing deposits trading below tangible book value.  These orgs can make 15%/year in this environment and as long as they return it to shareholders, things will work out.

[ChpBstrd]

Great insights @chasesfish .

Right now all eyes are on the long term bond rates.   Stay below 4.5% on a five year and the math behind the CRE credit risk is resolvable and bond marks will see recoveries every quarter.   Go back above there, the risk rumblings will return.   

5-year treasuries are currently at the bottom of the still-inverted yield curve, at 4.14%. A couple of months ago, it looked like the yield curve could un-invert from the long-term side rising, which would be a historical first. But now it looks like the run up in long-term yields was maybe an anomaly, and not enough market participants believe the Fed's "higher for longer" narrative. I've made several percent in the past month and a half, riding long-duration, high-convexity bonds upwards as yields plummeted. I still think they'll head back down to where they were last January.

Perhaps we are at the bargaining stage of grief, where investors are trying - and failing - to convince themselves of outcome narratives which have never happened before in history, such as a yield curve un-inversion on the long side, or a soft landing after 525bp in rate hikes? I still think the traditional recession + un-inversion on the short-term side is the most likely scenario, though the timing is unknowable, as the 2023 predictions thread painfully illustrates.

One might notice a contradiction in my general avoidance of financials and my base case that long-term treasury yields are heading to 4% or lower. If long-term rates (and inflation) are going lower, then CRE will be fine, bonds will go back up, and banks might be fine - right?  I think bond-heavy banks with lots of NIB deposits represent a leveraged bet on rates falling, because their paper losses are factored into their low stock prices.The wildcard is defaults and worries about defaults. If recession is the most likely scenario, financials are usually not where one wants to be at this pre-recession stage in the market cycle. Back up the truck to financials right after recession.

Of course, I've been wrong about financials for 6+ months now, preferring to avoid risks while capitalizing on my interest rate thesis with bonds directly. I still think risks are there even if they haven't materialized or never materialize. This cycle has been a weird one, though, with GDP flying upward in the face of rate hikes like we haven't seen in decades, and different areas of the economy seemingly going through asynchronous mini-recessions every few months. In Spring it was banks. In summer, energy. This fall it was transports. It hasn't been a traditional everything-slows-down situation because long-term rates stayed so low the damage to companies was limited. 

[chasesfish]

@ChpBstrd

Interesting commentary.

To me, the treasury markets are screaming at Powell that we're in a 3.5% Fed Funds world if and he wants to hold it at 5.25% saying "we aren't sure enough yet"

The employment market is rolling over, the job openings report was lighter than expected, along with deflation hitting certain segments like consumables and apartment rents.   The housing issues are turning regional again, reacting to supply, demand, affordability, and migration....like housing always has.  Services / wages are still sticking and the blue collar boom due to the population demographic change is going to stick around, but we're talking about a 2-3% inflation world, not 5-8%.   Will keeping them high for four more months vs. eight more months kill the economy?   Probably not.  He's never committed to deflation to return to 2019 prices.   

My somewhat outlandish prediction is that OPEC decides to do a repeat of 2014 and just go wide open on the oil taps to crash the price of oil for 9-12 months to try to fight US production and get their pricing power back.  That type of deflationary pressure will get rates down faster.   

[ChpBstrd]

Yes, if history is any guide, the Fed will not lower rates until recession is imminent. The first day of yield curve inversion has historically predicted recessions within a range of 0-24 months, but when the Fed starts cutting rates - well, that event means a recession is starting within a few months if it has not already started. Rate cuts are a more solid recession indicator than the yield curve, IMO. They have always arrived too late to salvage the situation in the past, and JPow does not strike me as the most forward-thinking or reactive personality to occupy the Chair.

It is ironically the depth of the yield curve inversion that has been saving us from recession so far, IMO.



Overnight rates may be high, but if you get out to the 3-5 year range or beyond, there's a major discount. For example, five year treasuries are at a roughly 100bp discount to one year treasuries, and I would expect a similar discount at each level of creditworthiness.

I would expect companies to start taking on more duration to obtain the discount, rather than relying on commercial paper or money markets. This would, in theory, drive volume to banks, which are in turn motivated to use lending profits to repair their bond portfolios or at least buy time. The yield run up of the 3rd quarter, which is being followed by a yield reprieve, may convince some borrowers that locking in a rate for the next few years is a good risk-weighted decision. Or maybe it's the only way to stay profitable?

The mortgage market is going through a drought, so I'd expect banks are being forced to increase their exposure to loans and bonds in the 3-10 year range. At the same time, banks are deterred from tapping short-term markets because of the inverted yield curve. They're probably limited from selling longer-term bonds because of risks to their ratios. 

These incentives would seem to herd banks into a situation where they have fewer types of investments funded by increasingly expensive deposits and BTFP loans. Meanwhile the yield curve inversion and risks of taking on long-term debt would herd them into simply earning credit spreads instead of term spreads. 

These speculations aren't based on data, and are probably wrong, but I'm mostly curious to learn how they're wrong. How are banks getting around these constraints and growing earnings?

[sayonara]

PTF

[daverobev]

Any suggestions for good prefs at the moment? I've a little cash, thanks to Macy's takeover offer (a little being operative here).

[tj]

Any suggestions for good prefs at the moment? I've a little cash, thanks to Macy's takeover offer (a little being operative here).

Just a note re: your signature, the IBKR is 1% on up to $100k not $1million, unless things have changed!

[daverobev]

Any suggestions for good prefs at the moment? I've a little cash, thanks to Macy's takeover offer (a little being operative here).

Just a note re: your signature, the IBKR is 1% on up to $100k not $1million, unless things have changed!

You're trying to tell me that... 1% of $1 million is... not... $1000. Eh.

When did I last change this signature, holy moly.

[chasesfish]

Just a few random updates...

I sold the rest of my PNFP common stock.  The last lot had a 100% gain, great company but the market is way ahead of itself IMO.   That probably means it'll go to $100.

I don't see any great bargains in prefs right now, not enough meat in anything over just buying the index.  (PFF or PFFD)

I added to one of my small bank holdings today.  $10.20/share with a tangible book value between $12-$13.   Competent lenders and the book value gains another $5/share as bond losses are recovered, which should get a nice boost with how rates are holding.   That's the only spot I'm finding value, $1bil banks with >30% non interest bearing deposits trading below tangible book.   You have to hunt to find them.

[chasesfish]

A few more thoughts on this thread...

The panic "dip" looks over.   There aren't any additional interest rate triggered failures and investors have mostly figured out the risks that could blow out commercial real estate are mostly outside of the banks.

The fed has shown they are not closing banks based on bond marks alone without a deposit run and the ones with the largest uninsured deposits either failed (FRC), merged away (PACW), or took the margin hits and fixed that issue ($WAL).   If you didn't have a deposit run, feds viewed the bond losses as not systemic, mathematically recoverable with time, and didn't require additional capital to be raised ($BOH).

What does this mean?   Banks are moving from trading based on Price to Tangible Book Value back to Price to Earnings.  Working through their bond portfolios, working through problem loans, they are all now an earnings story.   Bought a bunch of long duration bonds a few years ago?  Your earnings will drag.   Got a little aggressive in commercial real estate lending?  You'll take some earnings hits as you move what would be net income into loan loss reserves.   Banks will probably struggle to post positive loan growth in 2024 as commercial real estate transacts out to the permanent market. 

For me, this has been a fun ride.  As usual, I wish I would have risked more but I'm careful not to risk money we have and need for retirement for excess returns we don't need and sold a couple of positions too early.   

I'm 16.5% invested in financials as follows:

BAC:  3.79%
Small Banks:  6.61%
Prefs - Individual / Funds:  6.06%

I think these have 20-50% more gains, but in my mind I expect a couple years.  BAC and the small banks  probably trade for 8-10x forward earnings, only pay 20-40% of their earnings in a dividend, and have the rest to retire shares or fund growth.   The market may also come to this conclusion and price the remaining 20% to 50% gets priced in quickly.

[ChpBstrd]

@chasesfish , very interesting ideas.

This may sound odd but it sounds to me like this would be a good time to start a bank. You’d not be encumbered by bad bond/mortgage bets or exposure to CRE price depreciation. Such a bank would in theory start out with less baggage, have more remaining runway if things went sideways, and so might be valued higher by investors. Perhaps the banks buying growth fall into this category too.

[chasesfish]

@chasesfish , very interesting ideas.

This may sound odd but it sounds to me like this would be a good time to start a bank. You’d not be encumbered by bad bond/mortgage bets or exposure to CRE price depreciation. Such a bank would in theory start out with less baggage, have more remaining runway if things went sideways, and so might be valued higher by investors. Perhaps the banks buying growth fall into this category too.

Your thought process is correct. 

Personally I think the money is in doing what Bank OZK did on a smaller scale.   Come into a little / old community bank, capitalize it, and go and buy a bunch of$1bil banks.  The difference in multiples between what a $1bil bank trades for and a $10bil bank is significant.   You have to figure out how to be either a preferred acquirer or a semi-feared acquirer to make it happen.

The bank I started my career with made tender offers for mutual S&Ls in the 1980s.   Imagine being a depositor / borrower and getting a letter saying you can sell and get $8,000 in stock.

[ChpBstrd]

I've noticed the BTFP seems to be making a lot more loans in December, after many months of slow growth. As of 12/20 about $20B worth of new net loans had been made, compared to about $1B through all of October.


Maybe there is a lag effect, but this strikes me as odd because interest rates have been plummeting since mid-October. That is to say, I would have expected banks to use the BTFP to borrow against their treasuries in July-October, as they were getting beaten down by rapidly rising interest rates. Why did banks wait until December, when their bonds and presumably ratios had recovered from most of the damage? Deposits have been stable and flat for months.

10-Year Treasury Yield, for reference:


Is there something out there causing banks to fear another set of runs? Were lots of banks forced to mark-to-market or move assets to available-for-sale accounts in the 4th quarter? Did the market for CDs or other bank deposit products dry up? Or was it simply that the BTFP rate (4.84% today, as opposed to about 5.5% for one year CDs) was suddenly lower than what people were demanding for time deposits?

[reeshau]

There was a lot of coverage of the repo market rates spiking in December to 5.4%.

From https://www.reuters.com/markets/us/us-short-term-financing-rate-spikes-dealers-close-books-2023-2023-12-27/

"Because large dealer banks are offering less intermediation at year-end, cash in money market funds could not make its way to hedge funds and other cash borrowers. Increased usage of the Fed's reverse repo facility, through which money market funds lend to the Fed, was evidence of money market funds wanting to invest cash but lacking private counterparties, [Steven] Zeng said.

Cash flowing into the Fed's reverse repo (RRP) facility jumped to $793.9 billion on Dec. 26 from $772.3 billion as of the end of last week.

'It's year-end coming and bank balance sheets and window-dressing are preventing the money market funds from taking cash to banks,' said Scott Skyrm, executive vice president of Curvature Securities. 'If it wasn't year end ... a lot more of that RRP cash would be flowing into the repo market.'"

Is this possibly two sides of the same coin?

[chasesfish]

@ChpBstrd There's some type of arbitrage at play with the BTFP facility.

Someone posted screen shots of Andy Beal's bank being $10bil of the usage.

[ChpBstrd]

@ChpBstrd There's some type of arbitrage at play with the BTFP facility.

Someone posted screen shots of Andy Beal's bank being $10bil of the usage.

Is it as simple as:
1) Borrow against the bank's treasuries portfolio at 4.85%
2) Use the funds to buy another bank's CD or t-bills at 5.5%
3) Earn a risk-free net interest margin on the difference?

The BTFP FAQs (question D.2) says the interest rate is set as "the one year overnight index swap (OIS) rate as
of the day the advance is made + 10 basis points".

If we use SOFR as the OIS, it looks like the BTFP rate should have been about 5.32% + 0.10% = 5.42% in early December. Yet the Federal Reserve's discount window clearly says 4.85% tonight, and not much has changed, so that approach must be wrong.

Perhaps it is more valid to use the 1 year treasury rate as a proxy for what someone would pay for a one year swap. As I click through the dates on UStreasuryyieldcurve.com, it appears that in early December the one-year treasury rate fell more than 10bp below what banks could earn with something like a 6 month T-bill. For example:

December 4, 2023:
6-month yield = 5.41%
1-year yield = 5.1%

December 20, 2023:
6-month yield = 5.33%
1-year yield = 4.88%

Today's one-year treasury rate was 4.8%, which is within compounding rounding to the quoted 4.85% BTFP rate minus 10bp.

So even if a bank had to pay 10bp over the 1-year rate, they could still earn an extra 20-30bp of risk-free annualized yield for the next 6 months, just in exchange for clicking buttons. The ROI improves if you consider they're borrowing at full par against treasuries that have lost value. There are no prepayment penalties for BTFP loans, so this is basically a risk-free carry trade against the US government, or a handout of free money to banks.

As we get closer and closer to the market's expected dates of rate cuts, the yield curve between the 1Y treasuries and shorter-duration t-bills could get even steeper. This would incentivize even more money to flow into this carry trade. Other than injecting a few bucks into bank earnings, I don't see any major effects on things like inflation or bank stability.

Is this a good summary of what you had in mind @chasesfish ?

[chasesfish]

Thanks for the math behind it, that makes sense.

Word is the facility should spike a bunch more this week from banks doing this but not wanting all the borrowings to show up on the year end financials. 

[ChpBstrd]

OK, this news shocked me:
https://www.bloomberg.com/news/articles/2023-12-26/fed-likely-to-end-bank-funding-program-in-march-says-wrightson

They're winding down the BTFP in March. That means we'll be back in an environment where bank runs are plausible. And long-term interest rates are higher now than they were a year ago when banks were failing due to bond losses causing bank runs. Overall it strikes me as a horrible idea not to let this program run one more year, given all the risks and additional damage to bank bond portfolios, but it seems this is the world we live in.

I expect this will set off a small rush by banks to leverage any remaining treasuries not yet already pawned in the BTFP, prior to the window closing. They can park the proceeds in one-year or shorter instruments for the next 12 months and buy themselves some insurance in case we have another liquidity crunch in 2024. Aside from this one-time cash infusion, I think the BTFP will cease contributing to money supply in the second quarter.

Will post more thoughts in the inflation and interest rates thread, but IMO this development raises the risk profile for bank stocks. The Fed wants banks to use the discount window and standing repo facility instead of the BTFP, because the Fed wants to evolve these into policy tools. Plus BTFP arbitrage gives the Fed a bad look.