Blood in the Streets or a Nosebleed?

Intro

If a perfect scenario for a generalist to lose everything exists, this is it. HOWEVER, that’s why I think there are some cool opportunities. My general thought process is that prefs where insiders are buying the common should be attractive.

Merrill Lynch prefs became BofA prefs after the GFC, so there is a precedence of relative safety versus the common. Insider buying should be a good indicator of a lower probability of government takeover since they will lose their jobs and all money spent on share purchases.

Surprisingly, few regional banks have seen insiders step up to purchase shares and even fewer have prefs outstanding. The only ones I’ve seen are CUBI, PACW, and CFR.

I’ve linked the filings of insider purchases to everybody’s name for ease.

CUBI

Samvir Sidhu, CEO and President, bought $106k @$20.5

Daniel Rothermel, BOD, bought $53k @$10.72

Jay Sidhu, CEO, bought $500k @ $11

The pref’s dividend is transitioning from 3-month LIBOR to SOFR, with SOFR at 4.8%. With a par value of $25 and a price of $19.50 there is a potential 28% return to par and a current yield of 10%. However, the non-cumulative nature of the prefs and absence of a common share dividend pose a risk of dividend suspension. Before the industry deposit concerns and fire sale, the prefs traded above par.

PACW

This is the most exciting one to me due to wave of insiders buying as well as the CFO selling puts (which is crazy considering the bonds opened at 35 cents on the dollar today):

Kevin Thompson, CFO, sold 125 puts @$22.5

William Black, EVP, bought $270k @ $21

Paul Taylor, CEO, bought $500k @$22

William Hosler, BOD, bought $90k @$21

Matthew Wagner, Chairman, bought $300k @ $21

*Note* Matthew Wagner sold $ 2 mm at $26 in December, 22. Curious how much he reloads his ownership to at these prices.

Mark Yung, COO, bought $50k @ $15

Robert Burke, BOD, bought $45k @$22

Stephanie Mudick, BOD, bought $67k @$21

John Eggemeyer III, BOD, bought $380k @$15

Susan Lester, BOD, bought $15k @$15

Craig Carlson, BOD, bought $15k @$15

Christopher Blake, division CEO, bought $100k @$16

Clearly, insiders are confident mass deposit withdrawals are unlikely. The pref has a fixed 7.75% coupon and $25 par which at $14.20, offers a 13.6% yield and potential 76% upside to par. Similar to CUBI, the pref traded above par until the 9th. While the pref is non-cumulative, the common shares have an ongoing dividend and I suspect management will be forced to fight to keep it in place.

CFR

Phillip Green, CEO, bought $1 mm @ $106

Chris Avery, BOD, bought $540k @ $108

CFRPB is a non-cumulative pref with a 4.45% coupon and $25 par. It only traded at $18.55 before the crash, so at $17.60 you still get 5.6% upside with a 6.3% yield. While the current yield is probably close to fair price, it’s worth keeping on watchlists.

Honorable Mentions

TCBI and WAL haven’t seen insider purchases since the crash but deserve to be watched closely.

TCBI

Robert Stallings, director since 2001, bought heavily into the TCBI commons and prefs before the crash: $974k in total purchases across the two issues (increasing shares owned by 30% in 2 months).

It will be interesting to see if he adds to the position or signals a change in the company’s health by reducing holdings.

The 5.75% non-cumulative prefs, par of $25, traded at $21 on March 9th. At $18.85 they are yielding 7.6% and offer 11.4% upside to $21, so they are a little juicier than Cullen/Frost’s pref.

WAL

Citadel (not securities) acquired 5.4% of WAL, which bodes well for the company’s solvency. Even if they are just swing trading, I don’t think they would buy 5% of something eventually worth 0.

Citadel has a history of buying underwater books under pressure. Griffin took Amaranth’s nat gas and Sowood’s credit books off their hands for hefty profits in the not-so distant past.

It makes sense for Citadel to buy the common since the prefs are too illiquid. There’s only 12 mm prefs outstanding with a 10-day volume of 630k. Citadel could not have comfortably bought 5.8 mm shares of the prefs or unwind quickly (WAL has a 9.4 mm 10-day volume), so I’m not worried by them choosing not to be senior in the capital stack.

WAL’s prefs are non-cumulative with 4.25% coupons, but the common has an ongoing dividend. Show me another idea that yields 9.2%, has 83% upside (to $21/share on March 9th), AND places you senior to Citadel.

Conclusion

My main concern is how long it could take for prices to reflect the worst-case scenario.

Obviously this is nothing like the GFC, but it took over a year for Bear to collapse after people saw smoke: how long would another round of failures take? The withdrawal risks from online, frictionless banking haven’t been addressed and it took over a year for real, systematic issues to be fully realized in 08.

The lack of transparency regarding deposit outflows or precedence makes me think there will be lingering risk for a while. Who is to say that prices don’t recover to 80% of pre-crash value and then out of the blue another bank goes to 0 in 13 months? Sure, it’s unlikely we see Americans run banks after seeing increased FDIC protection, but how likely was it that a bunch of VCs would organize a bank run on their #1 supporter over the past 2 decades via twitter and slack? It would be foolish to ignore the fact that we are in an unprecedented situation.

I’m not interested in racing insiders to find the bottom in their shares, I want to see them with added personal risk on top of losing their jobs if the equity is wiped. From there, I think that with proper sizing a basket of these prefs can’t be ignored. Even if you don’t want to risk holding them, it will still be very fascinating to see how these bombed out securities perform over the next 12 months.

Finally, I’ve seen a good amount of people (whose investing opinions I respect) say that generalists should stay away and can’t possibly find alpha here. I disagree, respectfully. Obviously future margins and earnings of banks will be lower, but the idea that you should look away from prefs offering equity-like upside after an industry-wide fire sale doesn’t make sense to me. It’s a lazy or scared take, but both are fine since they don’t prevent making money. The beautiful thing about markets is that the best and brightest won’t look at everything, therefore opportunities exist.

Disclosure: I am currently long PACWP, CUBIPRF, WALPA, and TCBIO. Nothing above is investment advice.