Mid month: It's the forced selling
Looking at the deepest discounted banks, the bizarre story of Industry Bancshares, MCB vs CUBI, Repurchases
Good morning,
Brief notes:
Referral program: Colarion has grown steadily since 2016 inception primarily through referrals to both its fund and separate accounts. The separately-managed account option is uncommon and has been particularly popular for individuals and foundations due to performance and fee structure. However there is a tendency for referrals to arrive when bank shares are in favor rather than when they are universally despised, as they recently have been.
To offset this tendency and help take advantage of forced selling described later in this note, Colarion can in certain cases reward referrals. Some state securities laws limit how we can do this. Where compensation is not allowed, Colarion can help referral sources in other ways, including return referrals, or passing along impaired loans for sale that so many are looking for, among other things.
Do reach out if interested in details…
Everyone is a CPI expert now.
Or so it seems. Help me understand higher for longer when shelter is running 6.7% in the CPI survey (30% of the calculation) and zero or below in nationwide rent surveys. Since shelter is the difference between 3% and 2% CPI, is the FOMC goal already baked in the cake? Pardon the question - I never got an economics PHD.
Watching the CMBS fireworks factory cook off: Moody’s writes a regular update on CMBS (commercial mortgage backed security) maturity defaults. The short paper is fascinating because it gives such good data and detail, including how weak office and malls are vs the rest of the field.
The graphic below is particularly good, showing that CMBS office loan maturities are effectively an assembly line of defaults. Dark blue means default.
What’s interesting is these same types of properties exist inside regional banks, REITs and funds, but each of those has a bag of tricks to employ, as referenced in prior 5 Points. Funds in particular seem willing to use the ultimate can kicking device - restructured PIKs.
In contrast, CMBS are managed with a special servicer that has no money on the line. In that case usually the can doesn’t get kicked, it gets crushed.
Onto the five (today six) points…
Year end selling is coming from three sources
Looking through the most-hated pile for bank shares that could 2-3x. INBK, NASB, ISTR, FMBL et al
Industry Bancshares’ bunker mentality led to a billion dollar hole.
How a second lien office loan suggests where the market is too pessimistic on small bank credit.
Billy Beane looks only at data - should we? A study of quantitative vs qualitative investing, through the lens of Customers Bank (CUBI) vs Metropolitan (MCB).
Buybacks: Banks are mostly in the dark on when to repurchase; it need not be so.
1. Year-end selling is in full swing in financials, to the benefit of the cash-rich.
One of the themes of this note is that market structure is crucial in understanding equity price movements. This means that ETF flows, options activity etc. can overshadow fundamentals for extended periods, even years.
Today, notwithstanding some CPI spasms like today, there is structural selling in the financial sector, for three reasons:
Tax loss harvests Bank ETFs are off ~30% this year, triggering a two part sell cycle. First, mutual funds reposition ahead of November 1, as clarified further in this piece. The article quotes a Bank of America study of how losers typically outperform beginning Nov 1. A November 1 buying date seems simplistic - retail and RIAs are currently quite active for Dec 31, and we might wait until closer to New Year’s to take advantage of this.
Redemptions Judging from conferences there are over 100 funds focused on banks, some of them managing over $1bn. Many could have outperformed the regional bank index by 10% this year. Congratulations, but they can expect redemptions for being down 20% and underperforming the S&P / Magnificent 7 by 30%. Heaven help those that underperformed.
This can lead to forced selling of billions of dollars among small- and microcap banks.
RIA flows Blackrock's $100 Billion Model Makers Bet on Large-Cap Tech. How innovative…
You have to own shares of something before you can sell it, but it’s apparent that RIAs favor diverse large-cap portfolios with “safe” narratives that have skewed away from most financials. They are presumably still selling their remaining banks to get in line. The amount of money tied to these model portfolios is likely in the multiple trillions. This crowding into large-cap, unlevered companies is why a company like FICO can trade for 50x earnings or why AAPL or TSLA can show similar revenue / profit growth as Fifth Third Bank but trade at 4x and 10x the multiple, respectively.
In the short run the money may remain in favored areas within financials, like Visa, property insurers, and the two banks RIAs like - JPM and FCNCA.
As inflation eases, we might expect rotation, a segue for point 2
2. Getting dirty to find possible doubles and triples among bank stocks
We have established that many funds and individuals like to sell banks. Market structure is not static however. Depending on macro data, it’s worth considering how today’s most hated banks may rebound. A return to 2022 levels in many cases means 200%+ returns.