If you are anything like us, you spent last Friday glued to your screen furiously searching for updates on Silicon Valley Bank. Investors and market watchers have been waiting for the Fed’s path of rate hikes to break something and it looks like it finally has.
The reasons for Silicon Valley Bank’s demise have been well covered elsewhere and it was an outlier in the sense that its customer base was so concentrated in one, close-knit industry and largely uninsured, but it remains shocking the 16th largest bank in the US could fail so quickly and without much warning.
There was some warning, though. After getting up to speed on the details surrounding SVB, we went to the BAS Equity Analytics database to see how regional banks rated in our stock selection models and it was not pretty.
Excluding micro-caps, there are 97 regional banks in our rating universe and, strikingly, 90% of them were expected to generate negative alpha last week. This list gives you the full rundown on these companies. Looking at just the largest regional banks that includes the failed SVB and Signature Banks, the expected average alpha of the group was -1.6% and there was a strong correlation between expected alpha and performance from 3/8 to 3/15.
Three banks are at the center of this regional banking crisis. First Republic Bank (FRC) secured a $30 billion rescue package yesterday from a group of the largest banks. This stock earned the lowest in-group expected alpha of -6.1% per BAS’s stock selection ratings and lost a whopping 73% from 3/8/2023 to 3/15/2023.
It is hard to imagine shares of Silicon Valley Bank (SIVB) or Signature Bank (SBNY) are worth significantly more than $0 and there were warning signs on each stock. Both stocks were rated as attractive by BAS’s Recovery Model that predicts stocks expected to do well during a stock market recovery and can be viewed as a “risk-on” model, but both were weak by BAS’s primary, fundamental model that rates companies by key valuation, profitability, growth, and quality metrics. In addition, SIVB looked especially risky as our model that predicts revenue performance during a company’s next earnings report showed a high likelihood of a disappointing report. The combination of our ratings screamed to avoid these companies.
After steep declines, some regional banking stocks are showing improved expected alphas today, boosted by the aforementioned BAS Recovery Rating, but other BAS ratings continue to show that these regional banks carry poor fundamentals, a higher likelihood of revenue misses, stalled momentum, and high interest rate sensitivity. A bet on the comeback potential of these regional banks may seem tempting from a contrarian’s perspective, but is likely not worth the risk. Regional banks have significantly under-performed the broader stock market in recent history annualizing just 2.1% since 2007 against 8.8% for the Russell 3000. That is -6.7% alpha.
We believe that strong investment returns don’t occur by accident. BAS Equity Analytics helped advisors avoid the regional banking crisis by flashing a warning sign on the entire sub-sector ahead of time. If you are an advisor looking to improve your research, stock selection, and portfolio construction, connect with us to learn how you can gain access to our propriety equity ratings to better implement your strategy.
Disclaimer: The illustration discussed herein does not include investment advisory fees or trade execution expenses and is not intended to constitute specific investment advice or that you will achieve the same results. The information contained herein has been obtained from sources believed to be reliable but no representation, expressed or implied, is made as to its accuracy, completeness or correctness. Past performance is not a guarantee of future results. Information contained herein contains forward-looking statements and is subject to significant risks and uncertainties, which will affect the results.
Burney Company is an SEC-registered investment adviser. Burney Advisors Services (BAS) is a division of the Burney Company. Registration with the SEC or any state securities authority does not imply that Burney Company or any of its principals or employees possesses a particular level of skill or training in the investment advisory business or any other business. Burney Company does not provide legal, tax, or accounting advice. Before making any financial decisions, clients should consult their legal and/or tax advisors.