Shulmaven Way Ahead of the Fed on Silicon Valley Bank Failure

Why did it take more than a month for the Fed's autopsy of the Silicon Valley Bank (see below) when this blogger had it figured out as early as March 11, 2023?

From the "Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank April 2023," Released April 28, 2023

"1. Silicon Valley Bank’s board of directors and management failed to manage their risks;

 2. Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity; 

 3. When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough; and 

 4. The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach."

From Shulmaven March 11, 2023 Shulmaven: Random Thoughts on the Economy and the Stock Market - No. 3

* Last week a black swan flew over the markets in the form of the failure of the Silicon Valley Bank (SIVB) with assets of $211 billion, making it the second largest bank failure in U.S. history. Although shorts were hovering over the stock for awhile, the suddenness of the collapse shocked the markets. The failure was the result of two cardinal sins of banking: 1) like an early 1980's S&L the yield on its assets were far below its funding cost due to the rapid rise in interest rates and 2) like the Texas banks of the 1980s its assets and deposits were concentrated in one industry; oil in the case of Texas and technology in this case.

Thus far, unlike in 1984 when the FDIC bailed out all of the creditors of the Continental Illinois National Bank, with $40 billion in assets and the it being the 7th largest bank in the U.S., Silicon Valley depositors above the $250k insurance threshold (87% of the deposits) will have to wait in line to get paid out of the receivership. Thus there are more than a few companies that will not be able to meet payroll. Just to note the Continental Illinois bailout gave rise to the term "too big to fail."

From Shulmaven, March 18,2023 Shulmaven: Random Thoughts on the Economy and the Stock Market - No. 4

*- This episode represents a complete failure of the bank regulatory apparatus in that Silicon Valley's 86% deposit growth in a year represented an unmistakable yellow flag. Further, the bank invested those deposits in long duration assets which should have been viewed as a per se violation of safe and sound banking practice. That would have triggered either the closing of the bank or the firing of its officers. I can't wait to hear the testimony of the regulators from the FDIC, the San Francisco Fed and the State of California testifying before Congress.

And don't forget Shulmaven April 2, 2023 Shulmaven: Winter Comes to the Bank Stocks

My guess is that when the Federal Reserve adopts new stress tests it will include the hitherto omitted interest rate risk as a key criterion. If that criterion were included it is highly likely that at minimum BAC would be prohibited from buying back stock and increasing its dividend. In fact the Fed might require the bank to cuts its dividend and increase its equity capital. Why? On a mark to market basis BAC currently has book equity capital/assets ratio amounting to a meagre 5.4% compared to its accounting book value of 9.0%. 

My Amazon Review of Tara Zahra's "Against the World: Anti-Globalism........."

The Revolt of the Masses

 

University of Chicago history professor Tara Zahra describes a world of growing trade protectionism, rising anti-immigrant sentiments, growing antisemitism, the rise of right-wing populist demagogues, and the fear of a global pandemic. This sounds all to familiar, but she is not discussing the world of today, but rather the inter-war period of 1919-1939. The primary difference is that the wheels have yet to fall off the global economy.

 

In the halcyon era for the global elite before World War I, all was right with the world bringing ever-growing prosperity for those plugged into the global economy. However, just as today many were left behind and there resentments were smoldering beneath the surface and when World War I upset the global apple cart, those resentments exploded which in its extremis brought fascists to power, especially in Germany and Italy. In central Europe, the dependence on imported food brought with it massive starvation as the allied blockade starved out the population. Hence, after the war the goal was to become initially self-sufficient in agricultural commodities and later, as was the case for Germany, to go as far into autarky as possible. Along the way, according to Zahra, democracy fell by the wayside.

 

What Zahra has ignored in this important book is that it was not only the elite who benefited from globalism but is was also the rising middle-class in all of the countries that the global economy touched. And when the global economy started to circle the drain in 1929, it was the middle class that went down with it planting the seeds of the authoritarianism that was to come. She also ignored the role of left-wing populism in reinforcing the power of the right. The fear of Bolshevism pushed many otherwise sensible conservatives into the hands of the far right.

 

The way out of the deglobalization trap, was, according to Zahra, was a form of global Keynesianism, where each country would prop domestic demand, making it easier to accept imports from the outside. Throughout her book, Zahra humanizes what happened with vignettes about leading industrialists and liberal-minded internationalists. In many ways this is a scary book, because it seems that history is rhyming in its own way today.

For the full Amazon URL see: Revolt of the Masses (amazon.com)

My Amazon Review of Daniel Gordis' "Impossible Takes Longer: 75 Years after....... "

 Israel@75

Daniel Gordis, the American born Israeli Distinguished Fellow at Jerusalem’s Shalem College, has offered up an examination of where Israel has succeeded and failed through the lens of its 1948 Declaration of Independence. It is important to note here that although there is much history in his book, it is not a history of Israel. He simply asked whether or not Israel would today be viewed as a success or a failure in the eyes of its founders.

Today’s Israel would give immense pleasure to its Zionist founders. Instead of the cowering Jews of the shtetl, the average Israeli stands upright and, although not quite “the light unto the nations” and not necessarily loved, it is respected in the international community. Indeed, Israel has become a regional superpower with a vibrant culture and a buoyant technology driven economy. It is a country that stops work on Yom Kippur and even among secular Jews it has the highest birthrate in the industrialized world.

The country has grown from the 1947 partition lines of 660,000 Jews and 600,000 Arabs to country of seven million Jews and two million Israeli Palestinians. People today forget how close run its survival was in 1948 and that the vote to declare independence passed by a thin 6-4 majority. Gordis also reminds us that the founders created an ethnic democracy, not a liberal democracy. Afterall, Israel is the Jewish state. And in 1948 its goal was survival, not prosperity. It certainly has survived and thrived.

 

Nevertheless, the founders would be surprised to see that Mizrachi Jews now account for a majority of the state’s Jewish population, a group that was then and still today that is looked down upon by the Ashkenazi elite. The founders hoped that American Jews would move to Israel in substantial numbers. This, as we know, did not happen. To American Jews, America is the new Jerusalem.

 

The 1948 vision of Israel society was that of a state-centered socialism. That lasted for Israel’s first 25 years, but as that the bureaucracy ossified, in fits and starts Israel became a market economy with a very unequal distribution of income. Nonetheless, the social safety net is propped up by a strong universal health insurance system.

 

The founders would be surprised to see that the tensions between the Israelis and Palestinians continue unabated. After 75 years there is still no end in sight. Gordis supports a two-state solution, but that remains far off in the distance. The founders couldn’t imagine that Israeli troops would be deployed outside of the 1948 lines for so long acting as occupying troops. Perhaps even more shocking to the founders would be the power of the orthodox Haredim in today’s government and how far right leaning it is. Remember that in 1948 the Israeli right was just as secular as the Israeli left.

 

Although not present at the signing of Israel’s Declaration of Independence and hardly in the leadership, it was Menachem Begin, heir Vladimir Jabotinsky’s Revisionism, who was most clear-eyed about Israel’s future. To the Revisionists the antagonism coming from the Arabs would be long lasting and that ultimately Israel’s economy would have be organized along capitalistic lines if it were to succeed.

 

As an aside after reading this book and Walter Russell Mead’s “The Arc of a Covenant,” I can’t help but thinking had the U.S. Congress not passed the Johnson-Reed Immigration Act of 1924, there might not be an Israel today; many of the Jews of Europe would have ended up in America, not Israel. (See: Shulmaven: My Amazon Review of Walter Russell Mead's "The Arc of a Covenant: The United States, Israel and the Fate of the Jewish People")

 

Reading Daniel Gordis’ book has reinforced my belief as to what a miracle Israel is. Against all odds and with all of its fallibilities, Israel remains a hope for the Jewish people and, in a way, for the people of the world.

For the full Amazon URL see: Israel@75 (amazon.com)

There is Something Rotten in REITland

REIT stocks aren't working and they haven't been working for years. The performance of the shares since 2016 have been just plain ugly. Some of this is due to the fact that  underlying real estate values have declined in the office and mall spaces.  The technological disruptions caused by e-commerce and work from home have certainly exacted a toll on those markets. So if you add leverage into the mix, it makes for a precipitous decline in valuations. On the flip side, the industrial sector became a huge beneficiary of e-commerce with values up 75%. However, apartment values, according to Green Street Advisors, are up by about 10% since 2016 and strip retail values are essentially unchanged, while the share prices in those two sectors are down over the eight year period.

As many of you know I have a long history in real estate and REITs going back to the 1970's when I penned my Ph.D. dissertation on REITs. Although I have long since left sell-side research and my stint at running the Real Estate Securities program and the University of Wisconsin, I still have more than a passing interest in the space. Presented below is the performance of what I perceived to be quality large cap names while I was a practicing analyst. I also include the performance of the newer tech related REITs in the data center and cell tower markets who have done far better than the more traditional REITs. (See Table 1) I would also note how well the storage stocks and the Sunbelt oriented apartment stocks have done compared to those REITs focused on the over-owned coastal markets.

Table 1. The Performance of Selected REITs, 2016 High - April 13, 2023

Sector/REIT                 2016 High         Apr. 13, 2023        % Change

Office         

Boston Properties            144                       52                      -64%                      

Highwood Prop.                53                       23                      -57

Kilroy Realty                    77                        30                      -61

SL Green                        128                        23                      -82

Vornado                           90*                       15                      -83

*-Adjusted to the JBG Smith spin-off.

Apartment        

AvalonBay                      192                       170                     -11

Camden Property             91                        104                    +14

Equity Residential            82                         60                     -27          

Essex Property                240                       211                     -12

Mid-America                  110                       147                      +34

UDR                                 39                         40                       + 3

Strip- Retail    

Federal Realty                 171                         97                     -43

Kimco Realty                    32                         19                     -41

Regency Centers               85                         60                     -29

Mall      

Macerich                           96                         10                     -90

Simon Property               229                        109                    -52

Industrial    

Prologis                             55                        122                  +122

Hotel   

Host Hotels                        20                         16                    -20

Storage     

Extra Space                      95                         159                    +67

Public Storage                278                         305                    +10

Healthcare   

Ventas                              77                           44                     -43

Welltower                        80                           75                      - 6

Tech Related       

American Tower            113                         211                     +87

Digital Realty                 113                          92                      -19

Equinix                          391                         709                     +81

Given this rather poor performance of real estate in the public markets, it is puzzling to see that major institutions have just thrown a record $30 billion at the new Blackstone Real Estate Fund. For whatever reason, investors seem to prefer their real estate in a private wrapper rather than a public one. Perhaps some of that money will find its way into taking private several of the REITs mentioned here that are selling well below analyst estimates of net asset value. I recently spoke to someone very knowledgeable in this regard, and he noted that despite the price declines, the stocks are not cheap enough to entice a deal. But should interest rates drop as the markets now anticipate, that situation could very well change.

To me there is one lesson to be learned here. Investors have to be more cognizant what REIT managements are doing with respect to capital allocation, leverage and executive compensation. It seems that there has been quite a bit of leakage between the underlying performance of the real estate and the returns earned by REIT shareholders.

My Amazon Review of Joanne Lipman's "Next!: The Power of Reinvention in Life and Work"

 Reinventing Yourself

Veteran journalist Joanne Lipman has written an important guide to career change and life. Simply put, change is hard, but in the final analysis, it is necessary. Although personal reinvention is small change relative to statecraft, I would like to quote Niccolò Machiavelli here, “It ought to be remembered that there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in success, than to take the lead in the introduction of a new order of things.”

 

She highlights among others how James Patterson gave up his successful career as an advertising executive to become a bestselling author, jazz musician Alan Greenspan became the central banker to the world and mild-mannered White House budget analyst Ina Garten, became the “Barefoot Contessa” of cooking fame. She further discusses how the recovery from trauma forces change upon people. Simply put, they have no choice. In the realm of physical reinventions, she notes how a wallpaper cleanser was reinvented as Play-Doh and how a failed heart medication became Viagra.

 

Her formula for career change is search-struggle-stop-solution. To change careers the process begins with search and the use of wide connections, not necessarily close connections, is most helpful. The exception to that is having a mentor really helps, and it was Ina Garten’s husband Jeffrey Garten, who encouraged her all the way. However, in the case of personal trauma, struggle comes first.

 

My own personal experience through numerous reinventions parallel much of what Lipman writes about. To me the most important aspect is to be open to new ideas and be in the flow where you can capitalize on them. However, sometimes one does not have the luxury of James Patterson, where he kept his day job while writing his novels. Circumstances force us into reinvention. Further the existence of a secure day job can become a security blanket. For example, I walked away from a tenured position in academia for the private sector. I wanted to make it work, so I did not want to have the option to retreat and I did that with a young family. In other words, change can be a risky business.

 

As for my own reinventions I have worked in aerospace, was drafted into the army, became a Ph.D. student and later a university professor, was a political activist along the way, did macroeconomic forecasting, became a leading real estate researcher, and left Los Angeles to work on Wall Street where I met the author when she was a cub reporter.  I wasn’t looking to go to Wall Street, but Wall Street came to me. Thus, being in the flow is what counts. With respect to that my leaving academia was the result of helping a friend find a job. In the course of helping him, I ended up being introduced to my new employer.

 

On retiring from Wall Street, I returned to academia with simultaneous posts at Baruch College, UCLA , and the University of Wisconsin. The most rewarding of which was helping to set up a program for Baruch College students for high profile careers in financial services which hitherto were unavailable to them.

 

Joanne Lipman backs up her anecdotes with serious social science research. Although that slows down the pace of the book, it puts her anecdotes on a firm foundation by turning the anecdotes into data. I highly recommend this book for those who are interested in career change and to those who may be too contented with the way things are.

For the full Amazon URL see: Reinventing Yourself (amazon.com)

Winter Comes to the Bank Stocks

Although the now defunct Silicon Valley Bank is viewed as the poster child for gross duration mismatch of bank asset/liability management, the real poster child is the giant Bank of America. ( See: Shulmaven: Random Thoughts on the Economy and the Stock Market - No. 3) How so? As of yearend BAC was sitting on a mark to market loss of a whopping $108 billion in its held to maturity portfolio up from $9 billion the year before. If those losses were recognized on its books it would slash the the common equity capital on its books by 44%. For tangible book value per common share the reduction would be a staggering 62%.

Now lets look at the numbers.

Common Equity/share  -                        $30.61

Adjusted for Mark to Market Loss -      $17.11

Tangible Book Value/Share  -                $21.83

Adjusted for Mark to Market Loss -       $ 8.33

With BAC shares closing Friday at $28.60 this means that instead of trading at a modest 1.3X tangible book value the shares are really trading at a very high 3.4X tangible book. My guess is that when the Federal Reserve adopts new stress tests it will include the hitherto omitted interest rate risk as a key criterion. If that criterion were included it is highly likely that at minimum BAC would be prohibited from buying back stock and increasing its dividend. In fact the Fed might require the bank to cuts its dividend and increase its equity capital. Why? On a mark to market basis BAC currently has book equity capital/assets ratio amounting to a meagre 5.4% compared to its accounting book value of 9.0%. 

Simply put the bank is way under-capitalized. My suggestion for Brian Moynihan, the bank's CEO, is launch a $100 billion rights offering  by issuing 5 billion shares at $20/share on the basis of 1 share for each 1.6 shares held. Sure it would massively dilutive, but the bank would then be freed up to sell its long term bonds and get on with the business of banking.

Mark to market losses of held to maturity assets is not the only issue facing the banking system. FDIC premiums are going to soar to pay for the Silicon Valley Bank depositor bailout and there are huge embedded losses on the banking system's  commercial real estate loan portfolios. As a result much like in the early 1980s when the money center banks were saddled with unrecognized losses on their Latin debt portfolios, bank stocks will have a long slog ahead of them. Winter is here.