Take Advantage of the Bank Chaos With This Income Play

Banking Industry, Financial Sector

Well, that was unexpected.

The bank run we saw last week at Silvergate (SI) and Silicon Valley Bank (SIVB) was stunning and completely unforeseen.

Unless, of course, you were listening to what I’ve been saying for 18 months: the Fed’s rate hikes make unprofitable, risky companies much less valuable, and fast.

But the vast majority of banks will be completely unaffected by this.

Which gives you and me a great opportunity to snap up some stellar banks at dirt-cheap prices…

Umbrella over a piggy bank

Earlier this year, I spent some time at the Acquire or Be Acquired conference in Phoenix, Arizona, with more than 1,000 bankers and dozens of Wall Street analysts, plus investment fund managers, industry journalists, and private bank investors.

I can promise you that the subject of a bank run never came up.

We did talk at length, however, about the securities issue banks were dealing with this year. Banks that had been buying securities at very low rates since the start of the pandemic saw the value of these securities plummet as the Federal Reserve raised interest rates at a rapid pace to fight inflation.

While the losses on fixed-income securities impacted earnings and accounting measures of book value, they did not impact regulatory capital levels. Furthermore, these losses would be fully recovered if the banks just held the securities to maturity.

So, no one was losing any sleep over the securities portfolio.

Then we saw the deposit run at Silvergate as its crypto industry customers needed to withdraw deposits to pay off their investors. The bank had to sell securities to meet the demand for cash and, by doing so, turned paper losses into actual losses.

Silvergate took losses of more than $1 billion in the fourth quarter of 2022, and the forced selling continued into this year. Last week, the bank threw in the towel and announced plans to liquidate.

On Monday, January 6, the management of Silicon Valley Bancorp was overseeing a bank that was turning 60 this year and had a market capitalization of over $20 billion.

On Friday, March 10, the bank was out of business, with a market cap of zero.

What a wake-up call for the venture capital industry, which has now realized that there was a severe funding shortfall, especially for early-stage companies. Funding for early-stage companies has all but disappeared.

It seems that the reality of what I have been saying for 18 months finally occurred to the residents of Silicon Valley: rising rates make unprofitable, risky companies worth a lot less money.

Warnings of the possibility of losing access to whatever cash they had left caused many early-stage venture capital firms to transfer funds out of Silicon Valley Bancorp to smaller, more traditional banks all across the United States.

Other companies followed suit, and the run was on. Silicon Valley Bancorp had to sell securities to meet demand, turning billions of dollars of paper losses into real losses. The bank tried to raise capital, but buyers were nowhere to be found. And so early Friday afternoon, the FDIC seized the bank.

Bank stocks sold off across the board. After all, most banks have securities losses this year. It was hard to avoid with rates rising as fast as they did. Still, unless the news media sparks a national bank run with breathless headlines foretelling a repeat of 1929, 99% of all banks will be just fine.

Banks are going to have to raise the rate they pay on deposits to keep cash from walking out the door.

That will pressure earnings for the rest of 2023 and into 2024. It will not, however, cause any more banks to close their doors.

The current situation in banking does set up an opportunity for investors looking for a steady income stream with the potential for an eventual significant capital gain of 20% or more: bank-preferred stocks have also been selling off in the past week. This includes preferred stocks issued by some of the safest banks in the country.

Bank of Hawaii Corp. (BOH) is an excellent example of what I am seeing right now. This bank has been around since 1897. When it opened its doors, it had only been four years since Stanford Dole overthrew Queen Liliuokalani to assume control of the islands. Hawaii did not become a U.S. territory until the following year.

The bank has survived countless geopolitical events and economic crises since it opened; it will survive this one as well.

Bank of Hawaii has a preferred stock (BOH-A/BOH-PA) trading with a coupon of 4.38%. Based on the $25 par value, every share receives dividends of $1.09 annually (payments are made quarterly.) Thanks to rising rates and bank-related fears, the stock traded hands last week as low as $17.22. At that price, the shares yield 6.33%.

That is not the whole story.

When the current bank-related fear leaves the market, the shares will trade higher, possibly climbing back above the $21 level where it sold last month—a gain of more than 20%. And, the shares should move higher when the Fed stops raising rates.

If we have a recession later this year or early next and the Fed has to lower rates, Bank of Hawaii preferred shares could easily trade back toward the par value of $25, which would be a gain of more than 40%!

As long as the bank stays in business, you collect more than 6% on your capital.

The risk-reward for bank-preferred stocks is being skewed in a very positive manner, and the Bank of Hawaii preferred is a very attractive issue right now.