Bank Collapses
The second largest bank collapse in the US just happened over the last week. Silicon Valley Bank formerly symbol SIVB on the Nasdaq.
Timeline
Let’s go through a timeline of the events last week.
Mid last week Moody’s a credit rating agency looked to downgrade the company’s rating. Ratings are used by third parties looking to lend to the bank including major depositors. The lower the rating the more risk so the more interest lenders will charge. Obviously, companies will want to keep their ratings high to keep costs down. The downgrade was due to the bank’s portfolio being severely impaired by rising interest rates. When a bank’s core operation is taking in deposits and loaning out the money as interest rates rise their loans and securities such as treasury bonds decrease in value. Aaron recently went over this interaction recently and I’ll put a link in the description for it.
On Wednesday, March 8th SVB tried to raise capital to stop a multiple-notch downgrade, in other words, a large rating drop. The company was looking to raise $2.25 billion by selling stock, they had a non-committed private placement of $500 million lined up. But this is where the market really took notice.
On Thursday the 9th the stock plunged 60%. The Goldman Sachs bankers who were putting together the deal were hoping to at least get $95 per share for the placement. But as the news spread of the risk, depositors quickly started to withdraw, a bank run. This caused any potential stock placement to fall apart.
Now on Friday, after the mass withdrawal of funds and failed placement, SVB had more deposits than assets backing them, causing the bank to be both illiquid and insolvent.
The bank was seized by the Federal Deposit Insurance Corporation, commonly known as the FDIC. This wipes out any equity holders’ common stock and preferred, and almost certainly but not guaranteed any corporate debt holders. In other words, Wall Street got wiped out.
On Sunday The FDIC guaranteed all deposits past the usual 250 thousand insurance limit, meaning all depositors would be made whole. Only 2.7% of the deposits were insured under the standard limit, meaning that depositors would likely receive less than their whole deposit. At this point, I’ll stress if the FDIC did not due this there would likely be a significant contagion event causing multiple more bank runs and likely a significant financial meltdown hitting the broad market. The FDIC actions do not guarantee no bank runs but lower the likelihood and impact if one were to occur. And just as note this money is not taxpayer money it’s from the contributions banks already put in the FDIC fund.
The FDIC is looking for purchasers to take over the operations, the UK branches were sold to HSBC for a grand total of 1 Pound. Any sales like this will take place will be done by large banks with high enough liquidity to support the deposits and risk along with them. In exchange for absorbing the risk the banks have a potential long-term gain of increasing their own portfolio size and customer base.
There was an additional collapse following SVB, Signature Bank formerly SBY:nasdaq, which the FDIC seized on Sunday before guaranteeing deposits and more banks at risk making it the third largest bank collapse in US history after SVB.
So what was the underlying issue?
As much as I would like to attribute the collapse to Jim Cramer’s Bullish remarks last month.
The collapse was due to fundamental issues.
The biggest issue at play was a duration mismatch between the assets and liabilities. So when banks take in deposits they lend them out for things like mortgages or invest in securities like Treasuries. The treasuries are commonly called risk-free but they are only default risk-free because the change a government will default on them in this case the US government is effectively zero. Loans and investments like this are sensitive to interest rates, the degree of sensitivity is called effective duration. So for banks, if they don’t want to see negative impacts of interest rate changes, they want to match their asset portfolio with their liabilities, effectively money in via interest rate and money out via interest rate changes at the same pace, matching durations is called immunization, and is a common practice, SVB did not do this.
I’ll address a few common comments I’ve seen.
It’s the Fed’s fault for raising interest rates. Frankly, this is just a poor opinion. Bank operations are directly linked to changes in interest rates but there are many, MANY ways to manage this risk. SVB did not have a Chief Risk Officer or CRO for about 8 months after the last resigned in April 2022. The CRO is responsible for managing risks like this. The banks had plenty of warning to reposition themselves, as the Fed warned of raising rates, but simply did not likely to increase short-term income.
The next comment I’ll address was this was due to crypto companies which both SVB and Signature and significant deposits from. This is less of a crypto issue and more of the banks not recognizing their customer business cycles. Crypto companies deposited large swaths of money in the 2021 bull run and have since been using up cash, causing cash outflow from the industry for the banks. This causes the bank’s reserves to fall and causes then increases the sell-off of securities for a loss to meet withdrawal demands. Again, this really is just the banks not managing duration risk.
Lastly, I’ll add that bank risk is not over, at the time of recording on Monday the 13th, two more banks, the First Republic bank and Western Alliance Bank have both seen their stocks fall roughly 60% and 45% respectively. Both have large unsecured deposit bases like SVB and Signature. Even strong banks can be taken out by bank runs, but the weakest will fall first.
Colin via twitter – Wanting us to look at Tricon Residential. He indicates that it appears to be trading at a discount with an acceptable balance sheet and tailwinds at their back with housing shortages and massive immigration inflows.
YSOT
Slide 1
Tricon Residential Inc. (TCN:TSX)
Price: $10.59
Market Cap: $2.9 Billion
Dividend yield: 3.00%
Description:
Tricon is a rental housing company focused on serving the middle-market demographic. Tricon owns and operates approximately 36,000 single-family rental homes and multi-family rental units across the United States and Canada, managed with an integrated technology-enabled operating platform.
Slide 2
Tricon is focused on the U.S. Sun Belt, which is home to ~40% of all U.S. households and as you can see in this slide from Tricon’s investor presentation – its NOI primarily comes from these high population growth areas.
Slide 3
Recent Financials (Q3 2022)
$USD | Q4 22 | Q3 22 | Q2 22 | Q1 21 | Q4 21 | Q3 21 | Q2 21 | Q1 20 |
Rev. (Single Family) | $180.9M | $170.8M | $155.1M | $138.8M | $124.4M | $115.1M | $107.0M | $99.4M |
Rev. Private Funds | $14.8 | $112.5M | $20.4M | $12.4M | $17.7M | $11.0M | $13.1M | $8.9M |
TOTAL REV. | $195.7M | $283.3M | $175.5M | $151.2M | $142.1M | $126.1M | $120.1M | $108.3M |
Basic EPS (cont. Op.) | $0.19 | $0.65 | $1.51 | $0.59 | $0.37 | $0.80 | $0.73 | $0.21 |
AFFO | $0.28 | $0.11 | $0.13 | $0.11 | $0.12 | $0.12 | $0.11 | $0.10 |
- NOI for the quarter was $73.7M, an increase of 24% from Q4 2021.
- Revenue from single-family rental properties was up 45% to $180.9 million, driven primarily by 23% growth in the single-family rental portfolio and a 9.4% year-over-year increase in average effective monthly rent (from $1,591 to $1,741).
- Revenue from private funds and advisory services was down slightly to $14.8 million, driven by no performance fees being recognized in the quarter as well as a decrease in property management fees following the sale of Tricon’s remaining interest in the U.S. multi-family rental portfolio during the quarter. On this point if we look at Q3 2022 revenue from private funds and advisory services, it was $112.5 million, which was inflated due to the accrual of performance fees earned from the sale of Tricon’s remaining 20% equity interests in the U.S. multi-family rental portfolio following quarter-end.
- Adjusted Funds from Operation (AFFO) was up 143% to $88.7M or $0.28 per share, from $36.5M or $0.12 per share for Q4 2021.
- As of December 31, 2022, Tricon held $204.3 million in cash and Debt & leases of $5.7 billion, providing a net debt position of $5.5 billion and a trailing net debt to FFO multiple of ~23 times. Looking at the debt, 71% is fixed rate, while 29% is floating rate.
- Valuation metrics – Trades with a trailing price-to-AFFO multiple of 12 times.
Slide 4
Gary Berman, President & CEO of Tricon. “As we look ahead to 2023, we remain focused on growing our single-family rental portfolio so we can serve thousands of more families who are in need of high quality, relatively affordable rental housing. Our guidance for 2023 reflects a gradual acceleration of acquisitions over the course of the year, albeit at a slower pace than 2022, as well as strong same home NOI growth largely offsetting the impact of higher interest expense in our FFO profile. We are encouraged by the resilience in our January operating metrics, the emergence of “green shoots” in the debt markets, and stability in the resale housing market that all point to another year of strong operating performance.”
CONCLUSION
To conclude, I do think that Tricon is an attractive business, operating in high population growth areas, trades with a reasonable P/AFFO multiple, pays a nice dividend yield and has a reasonable balance sheet for a REIT.
Slide 5
However, if I was to choose between Tricon or the REIT we have in coverage which focuses on the Sunbelt region, I would personally pick the one we have in coverage, because:
- It pays a better dividend yield.
- Trades with similar valuation multiples
- Has a more attractive balance sheet
- Is projecting similar growth rates for 2022, and growth per share is anticipated to be stronger.
Tricon | REIT in coverage | |
Dividend Yield | 3.0% | 3.8% |
Payout | 32% | 63% |
P/AFFO | ~12x | ~12x |
Net Debt-to-FFO | 23x | 16x |
Debt Fixed | 71% | 90% |
Proj. Growth 2023 | ||
Total Rev. | 6.75% | 6.0% |
NOI | 6.75% | 7.0% |
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