How to play banks
My strategy for investing in bank stocks; from core overcapitalized community banks to volatile regional banks
Yesterday was a wild ride. The bank stocks I bought the day before all skyrocketed. Pre-market I was up a ton. By midday most of the banks I bought were up 30-50%. One went up 75% at the peak. As mentioned in the Telegram, I decided to cash out on most of the banks. My plan was to hold the names for a longer period of time. But when equity prices re-rate this quickly, something I was not expecting, it was time to take some profits.
I continue to hold smaller positions in PacWest Bancorp (PACW), Western Alliance Bancorporation (WAL) and Ponce Financial Group (PDLB). All three of these are trading meaningfully below tangible book value. PacWest and Western Alliance are extremely volatile names and I think will be good trading vehicles to play volatility. Ponce is especially cheap as it is meaningfully below tangible book value and received significant ECIP funds (read here for more information — seriously take a few minutes and read that link. It is fascinating and something I plan to write about in the coming days).
The extreme volatility with banks is fascinating. As interest rates rise, security portfolios fall in value from bond prices falling. The drop in bond values doesn’t show up in traditional income statements but shows the loss in other comprehensive income — a line below GAAP net income. The loss in the securities portfolio then impacts shareholders equity, or book value, a key valuation metric that bank investors use when valuing a bank.
To make matters worse, when interest rates go up banks are forced to raise their internal rates on deposits, pressuring net interest margins. If banks are unable to compete with risk free treasuries, now yielding something like 4.5%, then depositors will take their cash and move elsewhere. This becomes a double edged sword. Your assets to offset your liabilities (deposits) have decreased in value from rising interest rates and your deposits are fleeing to other sources such as treasuries, making some banks at risk of running out of money should a run on a bank occur.
Finally, with rising interest rates, bank demand for originating new loans has slowed down considerably. Net interest margins are going to get pressured and GAAP net income will likely fall. Shareholders equity will continue to decrease as long as the Federal Reserve is tightening. And if rates go meaningfully higher from here, depositors will likely look to put their idle cash to work in risk-free treasuries and call it a day. There are real problems with banks and Mr. Market showed his distaste for the sector over the past week. I am expecting this extreme volatility to continue and I want to take advantage of it.
My goal over the next few months is to identify core bank stocks that are extremely cheap, asset heavy and will likely survive a prolonged downturn. These core stocks will probably be the small community banks with rock solid balance sheets, mutual conversions and ECIP beneficiaries. Ponce Financial is one that comes to mind that could be a core position. Along with William Penn Bancorporation (WMPN). Or even Citizens Bancshares Corporation (CZBS) that has a market cap of $89 million and $109 million of cash at the holding company level, essentially valuing the bank with a negative enterprise value. Even better, the bank could earn $15 million this year and has generated earnings every year since inception.
Larger regional banks like the ones I highlighted in this article will be more of trading vehicles for me. The regional banks are more liquid than these tiny community banks that no one has heard of. Speculators will take them for a spin and anyone who has guts to catch falling knives will do very well for themselves when mean reversion kicks in. I think the best way to play these volatile regionals is to buy the ones that are trading significantly below book value along with insiders buying in the open market. As I wrote yesterday, there was an insane amount of insiders buying stock in the open market of beaten down bank stocks. It seemed like a layup mean reversion play to me.
Fortunes are made in the worst of times. We are headed into an era of uncertainty. I’m guessing more banks go under over the next few months which will drive volatility in the sector. As the core overcapitalized names get cheaper I will continue to build positions. When volatile regional banks drop too low, I will be there for the mean reversion play.
Banks have always been one of the most boring sectors of the stock market. But now they are front and center on Wall Street. The bank group I created in the Telegram Channel is now the most popular chatroom we have. If these things get extremely volatile I would be the WallStreetBets crew finds out they exist — then things will get even more interesting.
If you want to keep up with the development on banks consider becoming a paid subscriber to Grit Alpha. As a paid subscriber you get access to all of my research and stock ideas, along with membership into the Telegram Group with hundreds of active investors.
I will be posting in the Telegram Group today highlighting the bank stocks I will buy. Credit Suisse (CS) is blowing up pre-market with the stock down 26% as of this writing. Rumors are flying that the bank lost 1/4 of their deposits in the past quarter. Things in the financial system are breaking. It will be another wild day today of extreme volatility. Markets are crashing and I am here for it. Time to make some money.
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