Blain’s Morning Porridge – April 25th 2023: Bad Banks, Bad Management, Twitter and Blain’s Rules on Bank Investment.  

“You cannot trust bankers to control themselves. They are like heroin addicts.”

This morning: First Republic’s numbers show how close it came to failure – it’s a saga of stale management and bad banking, but reinforced by the pace of rumour and sigh on social media. Will it happen again? Blain’s Rules on Bank Investment may help you avoid the bad’uns..

Yesterday’s numbers from close-to-failed US bank First Republic were… interesting. Its’ customers pulled over $100 bln in deposits in the wake of the deposit-flight runs on Silicon Valley Bank, Signature Bank and Credit Suisse in March. The $100 bln amount looks better than it actually is after Wall Street Banks put $30 bln of their own money into First Republic to stem deposit flight in the wake of SVB’s failure. The stock is down 90% since March, and crashed another 20% in post market trading last night. Ouch!

First Republic is now desperately reinventing itself, slashing costs and headcount, while considering “strategic options”, which in US banking parlance means it’s a fire-sale. The numbers show its paying between 3-5% on its emergency loans from the US authorities; the Fed and FHLB, but is only making 3.73% on its lending book – meaning… effectively its running at a loss with its cost of funds exceeding its loan income! Unsustainable.

Its business model has been exposed as hopelessly stale – relying on uber-wealthy depositors to fund the bank effectively for zero during the years of ultra-low interest rates. Its management was broken and out of touch – an 80 year-old CEO who was allowed to hang-on too long, and a successor pushed out as “toxic” or for the crime of being female and foreign according to what you read.

The bank failed to spot the world had changed. When rates rose, these depositors sought returns on their money and left the bank. As a trickle of funds left, it became a torrent. First Republic nearly went the same way as SVB. Would anyone have been really that surprised? Swift action by the Fed probably saved a number of banks – effectively unlimited deposit guarantees, but the other side of that coin is bad banks are bad banks, and preserving them just diminishes the quality of the banking gene pool.

Capitalism thrives and stays healthy on failure weeding out bad stock…

According to the WSJ, First Republic was the envy of other banks for the service it provided its client list of wealthy tech dudes. When money was plentiful and cheap the Tech lords who sipped its’ champagne were happy to leave their dosh in deposit accounts paying the square root of zero. It’s mortgage business basically gave free money to its rich clients, including Mark Zuckerberg. (Who would have thought Zuck needed a mortgage? Time to sell Facebook?)

But, what suddenly triggered the deposit run on SVB?

Many point to Silicon Valley start-up financiers and leaders freaking out on Twitter and other social media about getting their large, uninsured deposits out. Effectively it was little different to the little boy in Mary Poppins demanding his penny back, triggering a run on his dad’s Bank – except this time it happened at pixel-speed across the global twitter-sphere in seconds. Even the UK’s flawed Emergency Phone Alert System (tested on Sunday with varying success) could not have spread the word so quickly.

Elon Musk will be perversely pleased its Twitter that’s getting the credit for nearly wrecking the global financial markets…

In the aftermath of the SVB debacle, Janet Yellen commented: “No matter how strong capital and liquidity supervision are, if a bank has an overwhelming run that’s spurred by social media so that it’s seeing deposits flee at that pace, a bank can be put in danger of failing.”

Just how fast social media caused the tumble to be has been examined in a new paper from a group of academics: “Social Media as a Bank Run Catalyst”. Containing many insights into the downright bleeding obvious, the paper “shows” how it was Twitter et al that fuelled the speed of the banking crisis. The run-risk factors that sank Signature and SVB, market-to-market losses on bonds and deposit flight, were “amplified” by Twitter accounts – say the authors. Their conclusion is when banks are in crisis – experiencing run-risk events – negative tweets translate into immediate stock market losses, and can be reinforced by keywords related to contagion.

One of my coveted “No Sh*t Sherlock” awards is winging its way to the authors of the paper even as you read this…

However, the paper highlights some interesting trends around the social-media fuelled destruction of banking value. The team delved into the twitter records going back months, marked tweets as positive/negative, and who was doing the tweets, particularly if the tweeter was in the start-up community. At the hight of the crisis, the intensity of negative twitter comments was felt within moments on the stock price of the bank. Equally important, negative tweets going back months meant banks seeing high twitter activity experienced the steepest losses during the run period.

Basically, the message is the more the market and customers – via social media – is talking about a bank’s potential problems, the more susceptible that bank is to a social media induced crisis in a “run-event-period.” Also, the longer such fears are implanted in the market the deeper that crash may be – although the market was surprised at the speed of the collapse of SVB, it had been festering on twitter for months before it happened.

That’s interesting… is there an algo that can tell me what banks/stocks are being talked about positively or negatively? That’s what Twitter once was.. The research team go on to suggest deposit flight and stock price are correlated. Really? Who knew…

What lessons can we take from this? Its good old fashioned management failure that lies at the root of the March market liquidity debacle.

Back in September 2022 we had something similar in the UK when the stupendously incompetent, but fortunately short-lived Liz Truss government torpedoed the UK gilts markets. Collapsing Gilt prices spawned the Liability Driven Investment crisis as leveraged gilts trades caused triggered margin calls, nearly sinking the market. This morning the FT outlines how the FCA (the UK regulator) will now demand tougher stress tests to correct the “significant deficiencies” it found after the crisis.. Oh dear.. regulating to solve the last crisis seldom avoids the next..

There are some clear lessons from the March Liquidity Crisis and the LDI crisis, but the key ones for investors remains understanding exactly what it is you are investing in.

To help you predict where the next crisis will come in banking (because it surely will) here are Blain’s Rules on Bank Investing: some basic rules when it comes to investing in financial institutions:

• Buy dull, boring, predictable banks doing banking in a dull, boring, predictable way that don’t feature front-page-of-the-FT risk for repeatedly getting it wrong – and don’t feature in the Twitter-sphere negative news lists.
• Quality of management: Good banks replace good managers with better managers. Bad banks tend to replace bad managers with even worse ones.
• CAMEL-L: understand the bank’s Capital, Assets, Management structure, Earnings, Liquidity and Liabilities.
• Business – look for diversity and their degree of inter-connectedness – how reliant on the rest of the banking system are they. Who is their regulator. How systemically vulnerable are they.
• Don’t trust anything. Take a slide-rule to their accounts and look at the notes on held-to-maturity assets.
• Who are their clients?
• If these check out, then, and only then, start to think about buying the stock or bonds.

In the next few months I am going to talk to as many banking analysts as will speak to me to expand on this, and present a list of banks to buy/sell/avoid..

Five Things To Read Today

FT                    Wall Street wavers ahead of Big Tech earnings

BBerg              Big Swings in One-Day Volatility Index Leave Traders Bewildered

WSJ                 First Republic Lost $100 Billion in Deposits in Banking Panic

Thunderer       Withdrawals of £55 bln forced Credit Suisse to seek rescue from UBS

Guardian         Finance Companies “may make $30 bln” by delaying debt relief for five countries

Out of time and back to the day job…

Bill Blain

Strategist – Shard Capital