Update: Crypto Fraud Crumbles as Bank Stocks Surge

November 10, 2022 | Watching the collapse of the FTX crypto fraud pyramid, we are reminded that most financial stocks trade on tangible book value (TBV). When there is nothing tangible, well, then there is probably little value. Occasionally value hides in plain sight, waiting for the accountants to fashion a new rule and recognize same for GAAP purposes. The gain-on-sale income from mortgage servicing assets, for example, is a case in point.

But in the instance of crypto fraud (or what our pal Nouriel Roubini wonderfully dubbed “shitcoins”), the value was only in the eye of the credulous in finance and the media. News reports suggest that FTX Chief Executive Sam Bankman-Fried misappropriated billions in investor funds, which he lent to his Alameda Research firm to the tune of about $10 billion. We have a couple of questions.

Consider two examples: Silvergate Capital (SI) and Signature Bank (SBNY). We warned our readers that these two crypto banks would soon come to a bad end. Back in February of this year, we profiled the former mortgage bank from Costa Mesa, CA (“Profile: Silvergate Capital Corp (SI)”).

The fate of the remarkable but tiny SI is a matter of indifference to us compared with SBNY, a $118 billion asset regional bank with a proud legacy that stretches back decades to paramount private banker Edmond Safra and Republic National Bank. We wrote in July:

A year ago this week, we warned our readers that the Fed’s “pivot” away from encouraging inflation would result in lower valuations for crypto tokens and stocks, especially the aspirational stocks that followed the crypto upsurge.

Crypto has gone from a sort-of juiced up equity strategy to a distressed credit story in just hours. But now that the collective idiocy of crypto and, yes, blockchain too are hopefully falling by the wayside, let’s take a look at how financials are navigating the world of rising interest rates.

Roaring Financials

Over the past month, our bank surveillance group has rallied on hopes of moderating inflation, with Raymond James Financial (RJF) leading the group higher. The basic explanation for this rebound is twofold.

First, the higher-beta stocks in technology and new media are getting hammered, forcing managers to seek shelter in less volatile names in order to preserve and protect that all-important assets under management (AUM).

Second, the banks are seeing expansion of new interest margins even as the FOMC pushes ahead on interest rate hikes.

We expect to continue to see improvement on the lending/NIM side of the equation, but the market side of the universal banks will continue to suffer weakness in absolute terms and in YOY comparisons. Loan growth will likely slow in 2023 as the economy slows, but notice that the Fed is now being criticized by both Democrats and Republicans.

The table below shows our bank surveillance group as of the market close yesterday sorted by price-to-book value. The numbers are hardly distressed and are, in fact, quite normal. JPMorgan (JPM) at 1.5x reported book value is hardly cheap.

Bank Surveillance Group

Sources: Bloomberg, Yahoo Finance

But with the huge swings in interest rates and asset valuations, the real question is what is true book value, net of mark-to-market adjustments c/o the FOMC and underwater loans and securities. Piper-Sandler writes: "GAAP Equity has been negatively impacted as rates have risen. Unrealized losses in AFS securities are included in AOCI (and therefore GAAP Equity), and as bond losses remain unusually large, the hit to equity is likewise bigger than anticipated for most financial institutions."

While the fundamental view of financials may be neutral to slightly negative in the next year or so, don’t expect Buy Side managers to be shy about buying banks regardless of the outlook for earnings. So long as credit costs remain muted, the appetite for bank stocks should only grow as investors become convinced of an approaching pause in rate hikes by the FOMC.

If credit expenses continue to rise, however, then the bull thesis around bank stocks may start to weaken appreciably. Not only are the equity market valuations of banks and nonbanks overstated coming out of QE, but credit costs remain far below average levels, suggesting that a mean reversion will occur recession or no, simply because of the reset in the floor for interest rates. We temper our generally positive view of lenders with the knowledge that there is no free lunch and that state TBV may fall just as it rose in 2020-2021.

Next week we will be reporting on the discussion at the the 8th annual IMN MSR East conference in Lower Manhattan. What does or does not happen to the value of mortgage servicing rights (MSRs) in the next year will be top of the agenda. We have more questions than answers, sorry to say. Click this link to read our latest column in National Mortgage News.

The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.