A Stock Stronger than Silicon Valley Bank?

Last week, Silicon Valley Bank collapsed, due to a run on the bank where depositors attempted to withdraw more money than the bank had available in liquid assets. Its collapse sent shock waves through the US markets, causing the S&P 500 index to drop nearly 5% on the week. Yet despite the size and speed of that collapse -- and the short-term impact it had on the market, there’s good reason to believe its demise may very well create opportunities elsewhere in the industry.

You see, Silicon Valley Bank had been a big player when it came to financing for high-tech venture-capital-backed firms. Because of that, it was in a fairly unique position among banks in that it had a lot of big deposits that were technically controlled by businesses that absolutely needed that cash to stay afloat. That situation put it in a more precarious position than it otherwise might seem, and once the run started, it quickly spiraled to the point where the bank needed to be placed into receivership.

It’s a crisis that should be contained

Silicon Valley Bank’s collapse was stunningly swift, and that spooked investors in other banks and financial stocks. While a bank run can tax the reserves of any institution, the reality is that the Silicon Valley Bank collapse is not likely to spread into an overall systemic meltdown of the total US banking sector.

This is because Silicon Valley Bank faced some very unique risks due to the client base it served. With so much of its new money dependent on venture capital, it was hit disproportionately hard by the slowdown in that industry. Since many of its depositors were companies that needed to preserve the cash they had previously raised, they were particularly skittish when it came to the risk of losing access to that cash in a bank run. As a result, that bank was particularly exposed to the risks of a bank run.

Banks with a more diversified client base, a higher proportion of smaller depositors better covered by FDIC insurance, or where their depositors tend to generate rather than consume cash are far less at risk. Indeed, according to the FDIC itself, there have been a total of 562 bank failures in the US since 2001. Regulatory changes since then have made bank failures less likely, also cutting down the risk to the overall system from the failure of even a fairly big bank like Silicon Valley Bank.

What does the opportunity look like?

On the flip side, JP Morgan Chase (NYSE: JPM) looks to be in a far stronger position than Silicon Valley Bank. JP Morgan Chase has over $3.2 trillion in assets and $269 billion in Tier 1 capital. Tier 1 capital is money available to the bank to cover its operations in the event of unexpected losses. 

It’s probably because it’s in such stronger shape that JP Morgan Chase’s stock held up fairly well last week, dropping only around 7% on a week that was catastrophic for its weaker brethren. Still, that 7% drop means that it’s now available on the stock market at around 11 times its expected earnings. That’s a fairly reasonable valuation for a business that’s still expected to post profit growth over the next several years.

And indeed, the next several years could very well be great years for any banks that make it through the current economic situation. One of the key reasons that Silicon Valley Bank failed is because it held a lot of long-term bonds as its assets. 

The problem with long-term bonds -- even ones that eventually pay off at maturity -- is that their market value tends to drop when interest rates rise. When Silicon Valley Bank announced that it needed to raise cash, the losses it was forced to book on its bonds due to that bond price swing was a huge driver of the bank run that caused its collapse. 

There are two things to remember about that price movement: First, the decline happens because the interest payments on newer bonds at higher rates come with higher cash interest payments. That makes them better assets to hold than the original, lower-rate bonds. Second, if rates reverse and start to drop, bond prices will reverse and start to rise.

As a result, any bank that makes it through the current rising rate period is setting itself up to thrive. It can benefit from both the higher rates it can get on its own lending or future bond holdings and from a potential rebound in bond prices if interest rates ultimately decline.

The fact that even far stronger banks like JP Morgan Chase saw their stocks drop on the week means that fear might be creating an opportunity. Sure, the near term may very well be rocky if other banks face challenges as well, but if the stock market is going to offer up bargains among the survivors, why not consider buying their shares?

At the time of publication, Chuck Saletta owned JP Morgan Chase bonds.

Sources – EasyResearch, Yahoo Finance, New York Times, Bloomberg, Time, LA Times, JP Morgan, Tech Crunch. FDIC, Wharton, Bank Data, Investopedia, Fortune

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