not a fan, except for sometimes

Yes, I have owned bank stocks. In fact, I have a small position in Bank of America (BAC) at the moment, on the idea that in a time of rising interest rates banks increase their lending rates much faster than they raise the rates they pay to depositors. So the spread they make widens. This is conventional wisdom without not much more to it.

My biggest issue with bank stocks is that they are opaque, even at the best of times. What they do (apart from their role in helping set overall central government monetary policy) is simple: they take in deposits (i.e., borrow) from individual and corporate customers, and then lend these funds, typically for much longer periods of time, and at higher rates of interest than their deposits, to individuals and businesses. Try to go much deeper–who are the customer?, what are the biggest loans? what are the riskiest/safest?, and there’s virtually no relevant information publicly available.

As a result, professional investors tend to look at bank stocks in an old-fashioned way, that is, based on the company’s per share “book,” or shareholders’ equity, value. But that’s pretty much all a non-specialist in bank stocks can do is.

The idea is this: shareholders’ equity is the accumulated profits of the firm that can be used for future investment. A stock that trades at 1x book is expected to product average profits. One that trades at 2x book is expected to make twice what the average bank can make with its capital. …and so on. At one time, for instance, Goldman Sachs was the star of the brokerage industry and traded at 3x book. As the GS star has waned, that multiple has contracted to 1x.

SIVB

First, remember that while I have been a professional investor for over a quarter-century, I’m not a bank expert. Having said that,

this is a really weird situation. How so?

–in late February, just days before the stock imploded, the company filed its 10K for the 2022 year. Its accounting firm, KPMG, issued the following unqualified opinion of the financial statements contained in it.

“We have audited the accompanying consolidated balance sheets of SVB Financial Group and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.”

There’s more–commenting, as I read it, on the difficulty of assessing the quality of an idiosyncratic loan portfolio, but nothing serious enough to merit qualifying the audit opinion.

—-looking at the financials,

assets

–cash and cash-like securities are $40 billion

–long-term securities, carried at cost, are $120 billion, for a total of $160 billion, or about $200 a share.

liabilities + equity

–deposits are $173 billion, of which $92 billion is non-interest-bearing

–common shareholders’ equity is $16 billion.

The key things to notice here are that the long-term securities (predominantly Treasuries, I think) are not marked to market, and that if marking them to market today resulted in a loss of as little as 15%, shareholders’ equity would be completely wiped out.

—-$200/share in net worth?

Given that large inflows came into SIVB in 2021, when interest rates were exceptionally low, and $80 million+ went into Treasuries that year, it’s difficult to fathom how investors could have overlooked the possibility that that $200 a share in net worth might not be a solid number.

If for most of 2021, as was the case, one would have to reach for a 7-year Treasury to get a yield of 1% and a 10-year to get a yield of 1.5%, the reported interest income for 2022 suggests something like a 50/50 split between the two. If so, this implies a loss of market value of these bonds of around 20% if they were sold today rather than held to maturity.

This isn’t rocket science. It’s just drawing inferences from publicly available government filings. Yes, my numbers may not be 100% accurate, but they suggest that the company could easily have been flirting with negative net worth for some time. If so, management was running a huge risk by not raising capital once it became obvious the Fed was going to boost the Fed interest rates very substantially. And it left itself open to the run on the bank that developed as depositors (belatedly) worked this out.