Evaluating the Investability of Banks Amidst Financial Turbulence
Feb 14, 2024
Steve Davenport, Clement Miller
Could your hard-earned money be doing more for you outside the banking sector? That's what Clem and Steve dissect in an eye-opening chat about the investability of banks, especially given the recent tremors felt across financial institutions like Silicon Valley Bank and New York Commercial Bank. We're breaking down the recent bank failures that have sent ripples through the investment community, scrutinizing the resilience of regional bank stocks, and questioning the allure of banking investments in a market that's bursting with other opportunities.
Join us as we peel back the layers of the banking industry's 'black box' with Clem's expert perspective. He brings to the table a wealth of experience and historical data that reveal a stark contrast between the performance of bank ETFs and the S&P 500, prompting us to consider the true value of bank stocks in our portfolios. As we navigate through the complexities of asset liability management, credit quality, and the often opaque inner workings of financial institutions, we unpack the lessons from Silicon Valley Bank's downfall and explore what it really means for the savvy investor seeking resilient and profitable ventures.
Could your hard-earned money be doing more for you outside the banking sector? That's what Clem and Steve dissect in an eye-opening chat about the investability of banks, especially given the recent tremors felt across financial institutions like Silicon Valley Bank and New York Commercial Bank. We're breaking down the recent bank failures that have sent ripples through the investment community, scrutinizing the resilience of regional bank stocks, and questioning the allure of banking investments in a market that's bursting with other opportunities.
Join us as we peel back the layers of the banking industry's 'black box' with Clem's expert perspective. He brings to the table a wealth of experience and historical data that reveal a stark contrast between the performance of bank ETFs and the S&P 500, prompting us to consider the true value of bank stocks in our portfolios. As we navigate through the complexities of asset liability management, credit quality, and the often opaque inner workings of financial institutions, we unpack the lessons from Silicon Valley Bank's downfall and explore what it really means for the savvy investor seeking resilient and profitable ventures.
Straight Talk for All - Nonsense for None
Please check out our other podcasts:
https://skepticsguidetoinvesting.buzzsprout.com
Steve Davenport:
Hello and welcome to Skeptics Guide to Investing. I'm Steve Davenport and in this podcast, clem Miller and I will be briefly discussing a big topic our banks investable. Of course. Last year we saw the failure of Silicon Valley Bank, signature Bank and First Republic. These failures impacted the share prices of many regional bank stocks. This year, we're seeing some continued pockets of instability, most notably New York Commercial Bank. Clem, you usually don't hold any bank stocks in your personal portfolio. Is that because you expect widespread failures?
Clem Miller:
No, the issue for banks is not that a lot of banks will fail. Obviously, there's a mechanism with the FDIC that ensures that banks, or at least depositors, are protected. Also, the FDIC is involved in having larger banks acquire smaller trouble banks. So it's not a question really of bank failures. It's really a question of whether bank stocks are better investment opportunities than stocks that aren't banks. I just happen to believe that bank stocks are not as great an investment opportunity as other types of stocks.
Steve Davenport:
I wouldn't have anything to do with your experience working for banks, would it?
Clem Miller:
No, not at all.
Steve Davenport:
So if the real issue is in who will fail, but whether there are better stocks that you could select for your portfolio, do you have historical data or price performance for banks?
Clem Miller:
Yes, I do so. If you look at US banks, and this is the bank ETF, the one-year total return for banks is minus 10% versus plus 23% for the S&P 500. That's as of yesterday. The three-year total return for banks is minus 1.8% versus plus 31.9% for the S&P 500.
Steve Davenport:
So a huge difference, let's not keep it up with inflation too well, is it?
Clem Miller:
Yes, not at all. And the five-year yes, banks are up 11.37% five-year total return, but this is against 96.38% for the S&P 500. So investing in a bank is just investing in banks is just not as good as investing in the overall market, much less some individual stocks.
Steve Davenport:
I agree that banks haven't been great investments historically. Why do you think that's the case?
Clem Miller:
So investors, really, they look at banks and they say, well, it's hard to understand what's really going on inside a bank. You know it's asset liability management, the rates they're charging, the credit quality of their loans. It's very hard for somebody on the outside to be able to interpret those things. Even the ratios that people use to look at investments are different for banks than they are for other things. So really I think most investors consider banks to be essentially black boxes. That is very difficult to understand, and I consider them to be black boxes too.
Steve Davenport:
Well, it might be hard for many investors to consider them unfathomable black boxes. I think many bank analysts and rating agencies might disagree with you. Why do you even bother to try to analyze banks?
Clem Miller:
So yeah, I mean the thing about bank analysts and about rating agencies is they actually get paid for analyzing banks and in addition to that, Do you think that colors their characterizations?
Clem Miller:
No, I think it's. You know it doesn't color their characterizations, but what it does is it gives the I would say the appearance that banks are just as good an investment opportunity as others, as other sectors, and I just think it's very difficult to analyze what's inside a bank compared to, say, what's in some other industries. The Buffett and Munger and them said you got to understand what stocks are and do and they spent a lot of time trying to get into stocks and to understand stocks and I think even they have said that banks, while some might be good opportunities, they're very difficult to understand.
Steve Davenport:
So I think we need to drill down a little bit on this black box characterization. I imagine one concern you have is a repeat of what happened with Silicon Valley Bank. Can you remind us there?
Clem Miller:
What happened? Okay. So what happened there was that you had a situation, okay. So Silicon Valley Bank had a lot of loans into the tech sector, including venture capital and startups in the Silicon Valley area and by Silicon Valley I don't mean just geographically Silicon Valley, but the whole tech complex and what happened was that a lot of, there was a lot of problems with this sector, which resulted in lots of very well publicized layoffs. A lot of these companies started defaulting on these loans and Silicon Valley Bank had to liquidate some of their investments, that is, their bond investments, in order to cover these defaults. And so, by liquidating these assets, these bond assets, per accounting rules, what they had to do was mark down all the remaining bonds, and when they did that, they fell into a negative capital position and had to be taken over.
Steve Davenport:
Yeah, I think the information moved very quickly as well. I mean, that's what I was amazed at is that people could just go on their phone and click send and that cash comes out very quickly when they get worried. We're now seeing some problems with New York Commercial. What's going on there?
Clem Miller:
So New York Commercial Bank basically has two problems. One problem is that it had a lot of loans into the rent-controlled residential space in New York. Now, this is a problem because a lot of those, a lot of those loans have resets up to higher rates and they just can't the companies that rent these apartments out to the rent-controlled residents they just can't come up with the money to cover the rates on these loans. So, yeah, they're facing defaults on a lot of those loans. Plus, also, commercial real estate on the commercial side is having problems in New York thanks to the hangover from the pandemic, the move to return to office hybrid, you name it, lots of vacancies in office real estate, and that's an area where New York Commercial Bank has a lot of exposure, as do a lot of other banks.
Steve Davenport:
I can understand, lending in the rent-controlled space seems like a little bit of a idiosyncratic issue because that's specific to only a few banks. But I can see where commercial real estate may be a big problem for a larger group of banks. But can't you just look at the balance sheet to figure out their exposure to commercial real estate?
Clem Miller:
Well, you might be able to figure out what the absolute number volume of these loans are dollar value but it doesn't tell you anything about the balance sheet. It doesn't tell you really much about what the true value of these loans are. What's the true value of the collateral underlying the loans? How much will this have to be written down if you've got defaults? It doesn't tell you much about whether they're rolling over these loans and what the terms are of the rollovers. There's a lot you can't figure out just by looking at a balance sheet, and even the notes to the financial statements too, it's hard to figure out.
Steve Davenport:
Some value investors are attracted to banks because of their low valuations relative to stocks in other industries, such as technology or healthcare. What do you make of this argument? Is it good value?
Clem Miller:
Well, one thing that you can look at is, on the positive side, to give banks the benefit of the doubt. You can look at banks' valuations relative to their valuations over time. That's one way you can look at it. But I think it's inappropriate really to look at bank stocks as being cheap just because they're cheap relative to technology and healthcare. That's again because they're black boxes. That's because the opportunities lying ahead for banks are less than those for tech stocks and healthcare stocks. Just because they're black boxes that are more difficult to understand, their valuations are naturally priced down.
Steve Davenport:
They may be cheap, but cheaper a reason I get the banks are highly regulated, but why isn't that a good thing? Shouldn't that make it safe for us?
Clem Miller:
Okay, well, okay. I would say that from the standpoint of a depositor, bank regulations are good, but not necessarily. And from the point of view of society as a whole, bank regulation is good. But the problem is is that regulation is not necessarily good from a shareholder perspective, and this is true in other industries as well. The more regulation you have, the more difficult it is to actually really to actually make money. It has an impact on the bottom line. It reduces the flexibility of management. So what may be good for society is not necessarily good for investors.
Steve Davenport:
Let's imagine for a moment that you're an investor who is less reluctant about bank stocks. Would you be more willing to invest in the big national banks versus the regional banks?
Clem Miller:
Oh, absolutely the big national banks. Big national banks, their exposures are spread out nationally and, in some cases, internationally, and so I think those offer more diversified opportunities than, say, regional banks that are limited to particular geographic exposures, that might have weaker credit quality, weaker economies or even, if they're stronger economies, much more concentrated and reliant on particular industries such as the energy industry.
Steve Davenport:
Let's look at our mailbag. Here's an interesting question From an investment perspective. What do you think is the best bank stock? Mine would. We have two bank stocks, both US Bank Corp and Bank America, and I would probably go with the Bank of America because I believe that one Moynihan has been through a lot and I think that as a leader he understands sending the right messages to markets and also being diligent about how he manages his cost in the bank. I also just like the overall coverage and areas of exposure. I'm not sure I want to be with the investment banking side. I'd rather have people who focus. If I want to own a bank, I want to own a bank that functions mainly as a bank Clem what's yours.
Clem Miller:
So mine is JP Morgan, or I should say JP Morgan Chase, and whatever you think about Jamie Dimon, he's quite a public figure. The fact is that this bank has the lowest short interest ratio of any bank or any, I should say, large or medium sized bank in the United States a listed bank, and that gives me some comfort. And in fact I have held JP Morgan Chase at times, but I've sold it and right now I have no bank exposure.
Steve Davenport:
That's great. Thanks so much for your insights, clem, and thank you to all the listeners for tuning in to our podcast. If you like our content, we would greatly appreciate your liking, subscribing and sharing it with your friends. Again, thanks for being with us.