What to Look for in Bank Stocks After SVB

Bank stocks are worth taking a look at after the collapse of SVB, and here's what to look for.

A windowed wall with the word "bank" on it.
(Image credit: Getty Images)

Bankers have to contend with two big challenges. The first is credit risk. If the economy slides into a recession, borrowers may not be able to make payments on their loans. The second is interest rate risk. Rates can turn against banks in a lot of different ways. For one thing, short-term rates can rise more than long-term rates do, reducing the income that’s generated from the difference between what a bank pays for deposits and what it earns from its loans. For another, as rates rise, the value of debt securities the bank had purchased at lower rates falls.

Usually, it’s the first challenge that gets banks into trouble. That’s what happened to them in 2008 as real estate collapsed. But now-infamous Silicon Valley Bank ran afoul of the second challenge. SVB was an unusual institution that held considerably more debt securities, such as government bonds, than it did loans ($120 billion worth of securities but just $74 billion in loans). The bank was also too focused on a single sector — technology companies and the venture capitalists that supported them — and it had vast amounts of demand deposits ($110 billion), which didn’t require SVB to pay interest but could be pulled out instantly using an iPhone.

Because of the way bank accounting works, SVB did not have to take a hit to its profits as its bonds fell in value, but depositors learned of the problem and started demanding their money. Federal regulators intervened, guaranteeing all of SVB’s deposits — even if they exceeded the $250,000 federal insurance limit, as the vast majority did. The intervention prevented SVB’s bank run from becoming contagious.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The management of SVB made a classic mistake by mismatching short-term liabilities (those demand deposits) and long-term assets (such as debt being held to maturity with an average duration of 6.2 years). Most banks don’t do such things.

In my view, SVB was a salutary warning to the whole banking sector — as well as to regulators, who were at fault for not recognizing sooner that the bank deserved extra scrutiny because it grew so fast (SVB quintupled in size in five years). The system itself is sound and is now getting even sounder, but there’s no doubt that banks are going to tighten their lending requirements, which will further slow the economy.

The bigger risk

A much bigger worry than bank runs is bad debt, the first challenge I mentioned at the outset. Let’s take as an example a typical bank: Glacier Bancorp, based in Montana. At the end of last year, it reported that it has $27 billion in assets, composed mainly of $13 billion in loans — $8 billion of which are for commercial real estate — and $10 billion in debt securities, mainly bundles of mortgages. This edifice of assets sits on top of about $3 billion of the bank’s own capital, which is a higher ratio to assets than most banks have.

Even so, imagine if a severe recession were to strike and a lot of Glacier’s borrowers defaulted on their loans while other borrowers got behind on payments. Glacier can seize real estate or other collateral, but the bank is going to have to take a big loss, depleting its capital. Regulators may demand that Glacier raise more, but that will be difficult in a recession.

I have gleaned a great deal of information from Glacier’s annual report on Form 10-K to the Securities and Exchange Commission. But going through such forms is a lot of work, and some questions remain unanswered, such as whether the $172 million that Glacier has reserved for possible credit losses is enough. (It’s impossible to say, because Glacier doesn’t have to reveal the particulars of its loans to the public.)

There are many banks like Glacier that are heavily invested in commercial real estate, which became a troublesome sector after banks ramped up their lending throughout 2022 — despite the fact that more employees are working remotely. As the Washington Post recently noted (opens in new tab), “It seems as if every few days brings news of some big property going into default.” Banks are adding to their loan-loss reserves for commercial loans in anticipation of a mild recession. At the very least, that means lower profits.

Smaller, community banks like Glacier are the backbone of the U.S. economy. Their managers tend to know their customers personally and understand the local business environment. In the wake of the recent SVB fiasco, many investors found these banks guilty of crimes they did not commit. Because of the SVB scare, Invesco KBW Regional Banking, an exchange-traded fund that owns small- and mid-cap banks, fell 21% in March alone.

And community bank stocks could fall more, especially the ones most exposed to commercial real estate. Glacier lost half its value during the great financial crisis of 2008, and the continued lack of visibility into the business of these banks always makes me hesitate. But some bargains are compelling. Not Glacier, which is down only 16% from its high this year, but a bank like Phoenix-based Western Alliance Bancorp, which skidded from $80 at the beginning of February to $36 at the end of March. UBS Securities analyst Brody Preston recommends the stock despite a “relatively cautious view” of the community bank sector as a whole. (Stocks I like are in bold; data is as of March 31.)

Western Alliance trades at a price-earnings ratio, based on a consensus of analysts’ earnings estimates for 2024, of just 3.6. Like most banks, it has losses in its securities portfolio because of higher interest rates, but they are small compared with the bank’s capital, and the proportion of commercial real estate loans is less worrying than that of most other banks. The stock yields 4.1%.

Preston also recommends New York Community Banks, whose stock had dropped nearly 40% from its 2023 high. But the stock has since recovered nearly the entire loss — evidence of what can happen when investors come to their senses. Preston’s third high-conviction buy is Webster Financial, down about 30% from its February peak and trading at a P/E of 6. Webster, the third-largest holding of the Invesco ETF, is based in Stamford, Conn., and yields 4.1%.

Safer bets

Finally, we come to the Big Four, which hold $10 trillion in assets, compared with $3.5 trillion for the other 4,233 banks in the U.S. Seven years ago, the last time I wrote about banks for this column, I recommended all of them. They are, in order of size: JPMorgan Chase, Bank of America, Citigroup and Wells Fargo. The first two roughly doubled in price since my call. Citigroup was flat, and Wells Fargo, buffeted by a scandal, fell by about one-third. I still like all four, especially because they are classified as Systemically Important Financial Institutions and as such must undergo regular stress tests and keep high levels of capital as buffers against the two big challenges. They have attractive dividend yields, ranging from 3.1% to 4.4%.

In one way, these banks have all benefited from the SVB debacle as depositors left smaller banks for the shelter of the SIFIs, which are generally considered too big to fail. The Big Four make up about one-fourth of the assets of Fidelity Select Banking, a mutual fund with a good track record. The rest of the fund’s holdings are in an array of well-chosen institutions, including M&T Bank, a favorite of mine with a dividend yield of 4.4%. Banks are heading into rough waters as the economy slows, but their stocks already reflect tougher times. While they can certainly get cheaper, now is a good time for careful shoppers to start buying.

Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here (opens in new tab)

Related Content

James K. Glassman
Contributing Columnist, Kiplinger's Personal Finance
James K. Glassman is a visiting fellow at the American Enterprise Institute. His most recent book is Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence.