This Week in Banks: A Comeback
"Don’t call it a comeback. I’ve been here for years. I’m rocking my peers. Puttin’ suckers in fear. Makin’ the tears rain down like a monsoon. Listen to the bass go boom. Explosions, overpowerin"
Summary
LL Cool J said it best in “Momma Said Knock You Out”, don’t call it a comeback. Banks bounced. Interest rates leaked higher. 2s & 10s almost un-inverted. Mega inversion on the short end. Ockham’s Razor. Rates down winners. Two CRE doom REITs beat. And financial conditions bucking the trend, which may not be your friend.
Bank Bounce Back
Banks dusted themselves off with a rally back after last week's slide.
The big banks put on a bit more of a show than their smaller counterparts. I’m told size isn't everything, but in this case, it seems to have helped. Maybe they've got better shock absorbers, or maybe they were hit worse last week. My sense is this had more to do with a push into large caps again after the great Yen carry trade unwind of August 1st and 2nd. Money flowed back in up in cap just as quickly as it flowed out.
Speaking more to that – while the banks were busy patting themselves on the back, the NDX and SPX were already halfway down the block. And while it is clear that nothing “fundamental” changed over the past couple weeks, that didn’t stop the world from selling stocks.
The question we all have to be asking ourselves is, were a handful of data points on inflation and employment enough to completely change the momentum on the “strong economy” narrative. Were we all asleep? Was bad data there all the time? Or is this just another head fake like Bloomberg’s 100% recession call in 2022?
As you can see, the sell off last week was not because your banks suddenly reported bad results (bank earnings were largely a beat) but because the market (i.e. the machines & HFs) violently sold cyclicals. I mean violently. Like worst day for cyclicals relative to defensives since 2020 and 2009. These past couple weeks felt historic, because it truly was historic for bank investors. Long live the VIX I guess.
Morgan Stanley piggybacked this with some commentary showing how the deterioration of macro data lately has led the way for the rally in defensives over cyclicals. Banks being a version of “levered beta” means that when the broader market starts to price in a recession, they will catch a cold. This realization can hit hard, but the sooner you embrace it, the better a bank investor you will be.
The punch line to all of this being, banks as a whole are fairly valued given the uncertainty on the future state of the economy, but cheap if you believe there will be no recession. And to boot, banks with more "credit leverage” i.e. higher loan/deposit ratios should exhibit more volatility going forward. Be mindful of the credit risk you own in banks.
Financials Scoreboard for the Week
XLF was up 45 basis points from 8/4 to 8/9.
FIS (congrats to those that followed FIS Position Started) posted strong earnings and continued execution, plus who doesn’t love a $3b buyback authorization. They’ve had relative alpha on the year relative to other bank fintech companies. The key in this one working out again was, a) they were seen as a disaster because of WorldPay, the CEO pretty much had to take drastic action, and the early read on execution (at the time) was good. A higher price changes the logic going forward, but it still makes sense to me.
Looking at XLF YTD there have been some insurance names that are absolutely on fire. This is part of the reason why many banks have been selling their insurance arms to take a mulligan on their underwater bond books. These underwater bond books of which are ironically much less underwater now. Maybe it would’ve paid to wait? But on the insurance companies, the run makes me wonder if/when those industries can be hurt by the ripple effect of more catastrophes and higher premiums that are in the news.
Interest Rates Leak Higher
On the week yields sold off a good amount. 5s were up about 35bps, and maybe we’re getting de-sensitized after the mega rally last week.
We all know yields play a fundamental role in the economy. They set the baseline for financing costs across the board and are crucial in valuing future cash flows. They also impact the valuations of a very in the news asset class - real estate. Finance 101 teaches us that if you take a big, long stream of cash flows (like a CRE loan) and discount it at a lower rate, it’s worth more.
What’s more, the 5-year Treasury yield breaking through 4% in the last couple weeks is a key psychological level for market participants. It's not just a number; it's a signal that can influence sentiment and decision-making. And perversely, more investors probably Google’d “fixed income” this week than in November of 2023 when 5s were at 5%.
The 5-year UST is especially important for banks since they tend to price longer fixed rate CRE on 5-year treasury rates or 5-year swaps rates. To hit this point home. In November of 2023 when inflation was ripping, and the market was pricing in 8 cuts (just like today ironically) a fixed 5-year CRE loan would have been swaps +250 for the wise lenders or maybe tighter for the ones cheating on price.
CRE Loan Rate in 11/2023 = 5.00% + 2.50% = 7.50%
CRE Loan Rate in 8/2024 = 3.75% +2.50% = 6.25%
Remember, not only will lower interest rates raise valuations and lower LTVs, but as interest rates decrease and loans can be re-financed into lower rates, the loan's debt service payments decrease lifting the DSCR, as more income is available to cover the lower payments. So, this 5-year rally is a big tailwind to the CRE industry, sorry doomers. And while it may be painful on go forward bank NIM or NII, for now this is a tailwind to the sector.
And here’s some fun trivia for you. Since 2000 do you know what the “average” 5-year yield has been?
About 2.68%. Kind of makes one wonder if we can’t go down more. This past rally has probably added about 50-100 basis points of TCE accretion to bank balance sheets (for the bond heavy ones) with the fading away of AOCI. That should also be a tailwind for the sector.
On a different set of rates, 2s to 10s almost un-inverted last week.
Econ 101 teaches us that the 2-year to 10-year Treasury spread is a key economic barometer. It reflects market expectations on growth, inflation, and monetary policy. More slope typically means an easier environment for financing and better profits for banks. This is what people are predicting would happen under a Trump presidency. Being the extreme version of a capitalist, he knows that borrowing short to lend or acquire long assets is a great strategy to create value for himself (barring a bankruptcy here or there).
An inverted yield curve, where short-term rates exceed long-term rates, has historically signaled potential recessions. However, it's not a precise timing tool and we’ve been in the longest inversion ever (I think). Environments like this suck for people that mismatch where they borrow and where they invest.
And while 2s to 10s are close to un-inverting, the shorter part of the yield curve is near all-time highs in inversion again. 3-month to 5s are around 156 basis points of inversion and have been for quite a while. If history below is any guide this curve tends to overshoot the other way once the trend breaks.
When you zoom out over time this looks like a cycle-based pendulum, swinging from very inverted to very un-inverted (aka sloped). The average going back to the early 1980’s is 57 basis points of slope between the 3-month and 5-year, although we are usually only there in passing. A reversion to slope (without a recession) would be a huge tailwind to the banking sector.
Winners & Losers in Big Banks
GS was the big winner on the week in big bank land & STT the biggest loser.
No major commentary here other than that I think in general larger banks are more fully valued than their smaller counterparts. WAL in the high 60s is interesting to me. FCNCA is interesting up to about 2200 even though it’s not in BKX. And I am about to do something silly and look at CMA because the news on them has been so horrendous, that it makes my ears perk up. I have not heard anyone say one nice thing about Comerica. If you can find them for me, please hit me up.
Winners & Losers in Regional Bank Land
ABCB or Ameris was the big winner this week.
Ameris has transformed from a small community bank into a significant regional player through strategic M&A. Key acquisitions include Atlantic Coast Financial Corporation (2018), enhancing its Florida presence, and a major merger with Fidelity Southern Corporation (2019), nearly doubling its size. In 2020, Ameris acquired LION Financial Group, boosting its SBA lending capabilities. These moves have expanded Ameris's footprint across the Southeast, diversified its services, and grown its assets to over $20 billion. Pretty impressive and living in a great geographic footprint.
I have a few thoughts on ABCB or Ameris. First, they’re not a super grower despite the M&A. In my Relative Growth Score ranking they’re probably in the 30th or 40th percentile. They have not grown top line or bottom line at a super high level, but have grown TBV/S at an impressive clip
They’re currently “fairly” valued in my opinion. 12x forwards is not out of line nor is it super cheap. A re-rate would be nice, but there’s probably no catalyst for that other than Trump being re-elected with a Republican type of sweep, a lowering of tax rates, or a resolution of recession fears. None of which they control.
Estimates for ABCB have been readjusting higher like much of the bank world. And EPS has grown in the mid to high single digits over a longer time frame, but that has been largely M&A related as we’ve pointed out. “Not that there’s anything wrong with that” it is more challenging in certain environments. Think about RNST a $17 billion asset company trading around 133% of TBV having to raise excess equity to acquire FBMS recently. Note: as I say this, I bet Ameris working on an M&A deal to shut up.
The question for a bank like ABCB is, at a P/TBV of 163% and at a size of $20b with a track record of growth through M&A, what do you do now? Your currency isn’t lights out, there are limited targets (see RNST & FBMS deal), and so how do you go into the next wave of growth? Can you do it without the big deal or do you just become “average” as a friend likes to say.
Losers & Winners in Small Banks
These are all smaller market cap banks under $1b so they can bounce around pretty wildly.
It’s always a good day (even when it’s a bad day for them) when I can highly Crazy Woman Creek Bancorp, since they probably have the best name out there.
KRNY is an interesting name to me in a world where rates down mean CRE banks outperform. They are trading at 62% of TBV, have a 110% L/D ratio, and have about 500% RBC in CRE loans. To be clear I am not buying, but this is a type of bank that could “outperform” if CRE banks catch a lower rates bid.
But for me rather than a KRNY, I’d much prefer to buy a similarly cheap bank, with a lower L/D ratio, and less CRE. When you think of this you can think of a bank like FMBL. FMBL has discount of 46% of TBV, a 76% Loan to Deposit ratio, and a 330% CRE to RBC ratio. All things equal, this should mean less moving parts to go right for you in order to win. As a bank investor I would focus on factors like this. Go down in credit risk works almost all the time (except wild bull runs like 2021/2022).
In fact, the next time you’re trying to buy a bank with lots of moving parts I want you to think about this guy.
This is William of Ockham a prominent 17th century philosopher. And he’s got a great problem-solving principle about life (and bank investing). He lived during a time of intense philosophical and theological debates in European universities. He was a key figure in the philosophical school of nominalism, which questioned the existence of universal concepts. Many of the heated debates centered around complex theological questions, often involving intricate arguments and assumptions.
Ockham was kind of the OG antagonist of complexity and challenging the status quo. Later on, people studied him and broke down his theory calling it, “Ockham’s Razor”
The tenets of his theory are:
Simplicity: It favors simplicity over complexity when considering competing hypotheses.
Parsimony: It suggests we should avoid making unnecessary assumptions.
Not Absolute: It's a guiding principle, not an immutable law. The simplest explanation isn't always correct, but it's often a good starting point.
The formal version of it is "Entities should not be multiplied without necessity." But the more modern interpretation is, “Among competing hypotheses, the one with the fewest assumptions should be selected.” So it goes, simpler is better, the simplest explanation is often the correct one, and steer clear of complexity.
Or as a new favorite quote goes, “it is vain to do with more, what can be done with less”.
A Couple REIT Beats
Getting back out of the 17th century, everyone knows that REITs are companies that own, operate, or finance income-producing real estate across various property sectors. They allow individual investors to earn dividends from real estate investments without directly buying, managing, or financing properties themselves. REITs are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends. This structure offers investors a way to access real estate returns with the liquidity of publicly traded stocks.
In general REITs finance themselves short and invest in long assets. Just like banks with a touch more leverage.
And notably this quarter and pretty quietly I’d say were the fact that two prominent REITS in the Commercial Real Estate world posted pretty decent if not strong results.
Vornado Realty Trust is a prominent REIT primarily focused on office and retail properties in New York City. It owns and manages millions of square feet of Manhattan office space, including several iconic buildings. The company also has significant retail holdings and investments in other markets. Vornado's performance is closely tied to the health of the New York City real estate market, particularly the office sector. As with many office-focused REITs, Vornado has faced challenges in recent years due to changing work patterns and economic uncertainties affecting urban office demand.
Vornado’s beat had a handful of positive points:
They re-signed Bloomberg as a tenant at 731 Lexington (was known already)
Their total occupancy was up 10bps vs. an estimate of down 160bps.
They sold part of 666 Fifth Avenue to Uniqlo for $350mm ($20k/sq foot) which JPM estimates is a cap rate somewhere in the 4s. This was a big surprise to the Street.
Street estimates are being adjusted higher inferring that NYC is back, baby. But you New Yorkers aren’t calling it a comeback, you’ve been here for years.
Simon Property Group is the leading retail REIT in the U.S., owning and operating premier shopping destinations globally. With a portfolio of high-quality malls, premium outlets, and lifestyle centers, Simon has demonstrated resilience in a changing retail landscape. The company is known for its strategic adaptations, including property redevelopments, tenant diversification, and investments in digital initiatives. Simon's financial strength, consistent dividend growth, and ability to evolve with market trends have positioned it as a bellwether in the retail real estate sector. Despite e-commerce challenges, Simon continues to leverage its scale, premium locations, and innovative approaches to maintain its market leadership.
Simon’s beat also had a few key points:
Domestic NOI growth of 5.1% in the quarter.
Mall & premium outlet occupancy was 95.6%.
Traffic at malls up 5% this quarter.
The consumer (at least the high end one) is still spending despite fears of a recession that seem to make their way into people’s heads. Nothing but good numbers here. Can the consumer keep consuming? It feels that way right now.
TIL JPM Can Be Wrong
Last week I posted a graphic from JPM about the Nasdaq bank index performance after a rate cut. A friend and great X follow (Follow Captain George North) pointed out that the data from JPM appeared to be wrong (shocking I know).
The updated bank performance following a rate cut is below.
Looking at this data the last two rate cut cycles were not kind to banks. Although once the 2020 rate cut cycle eventually took hold, banks did outperform. I kind of throw out this analysis even though it’s fun to look at. Today is different than yesterday.
PS - Seriously follow my friend.
Financial Conditions
Financial Conditions Indexes (FCIs) are composite measures that provide a snapshot of overall financial market health and economic climate. They combine various indicators such as interest rates, credit spreads, equity prices, and exchange rates to gauge the ease or difficulty of obtaining financing. FCIs help economists, policymakers, and investors assess current economic conditions, predict future activity, and inform monetary policy decisions. A higher FCI typically indicates tighter financial conditions, while a lower value suggests easier conditions. These indexes offer a timely, comprehensive view of how financial markets are impacting the broader economy.
Basically, they’re a way to check the vibes of a market.
Vibes high = financial conditions easy.
Vibes low = financial conditions tight.
To quote Buffett (okay paraphrase), when the vibes are high be fearful, and when the vibes are low be greedy. Maybe that’s why he’s been selling his AAPL & BAC at record paces?
Here is the weighting of the BFCIUS Bloomberg Financial Conditions Index. You can see that it’s a bunch of things that are proxies for risk being on or risk being off. And then below is the important graphic. This is that indexes view of how high or low the economic vibes have been. And then below that the BFCIUS going back to 2021.
2021 was a big year for stocks and was full fiscal and monetary stimulus times.
2022 was the year of a tight financial conditions index (along with tough returns).
2023 was kind of a regime shift from tight conditions to easy and a rally.
And 2024 has been a pretty long interrupted streak of easy and big returns until lately.
This recent about face has been abrupt, and so has the bounce back. But if this signals a regime change then it should factor into your investing frameworks.
Zooming out, you can see that we’re still historically easy. But maybe headed towards less easy. Again, when seas in risk appetite change it should change how you invest.
And one more point. Financial Conditions Indexes (FCIs) exhibit reflexivity, akin to George Soros's theory. They don't just measure market conditions; they influence them, creating self-reinforcing cycles. As FCIs indicate tighter conditions, market reactions can further tighten the environment, reinforcing the initial reading. The upcoming election is set to amplify this reflexivity, introducing greater volatility into FCIs. This volatility isn't mere noise; it reflects genuine uncertainty about future economic conditions. The interplay between FCIs, market reactions, and real economic impacts will likely intensify, making the financial landscape more dynamic and unpredictable in the coming months.
My takeaway would be summed up by Soros himself, I don’t know what’s going to happen but the way to make money is to harness reflexivity before it happens. “Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”
Summing It All Up
The economic landscape is murky, and I've scaled back my exposure accordingly. I’m still long banks and financials (I rarely am net short). But this isn't the time for heroics. I'm focusing on quality (for the most part) - companies with rock-solid balance sheets and durable competitive advantages. They're the ones that'll weather the storm, whatever comes. Or rather, if that comes.
On banks, lower rates could be a tailwind, but let's not kid ourselves - a recession would change that tune really quick. It's a nuanced play, not a blanket bet.
Despite the uncertainty, I'm not blind to value. There are individual names out there that look compelling. It's about being selective, not cynical. The market's inefficiencies always create opportunities for those willing to dig deep and think independently.
Remember, it's not about being bullish or bearish. It's about being right. Stay nimble, stay focused, and keep your powder dry for when real opportunities present themselves.
Volatility usually picks up in election cycles. And volatility usually picks up in the fall.
Keep your head right, your emotions cool, and your mind open. There will be opportunities. We’ll find them.
The best is ahead,
Victaurs