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Banks



A lot of ink has spilled recently about the banking crisis. Maybe I should not add to the spillage. But I want to make just a few points which I haven't read elsewhere.


1) Talk about which banks are best capitalized, which have the most Tier 1 Capital, the least exposure to interest rates, the most prudent bond investments, etc. is all a bit beside the point. I won't say that it's irrelevant, but it is of secondary importance.


If depositors all come for their deposits at once, a bank will fail, period. No bank, not even the biggest and most well capitalized, can survive such an event. This is true A) for the obvious reason that all of the depositors have left, but also B) because the bank's reputation has been ruined beyond repair. Even if a bank survives a run, it will take years and decades for it to rebuild the confidence of clients. Long before that happens, it will get sold for a pittance to a larger firm.


This is one good reason not to invest in banks. Even when they do everything correctly, they are at risk of death by rumor and innuendo more than any other business which I can think of. The situation is so perilous that banks band together to an unusual degree, lending to each other, helping each other out in times of crisis, such as now, and lobbying together for this or that protection from the government. The healthy banks participate because they know that they might be next, and when that day arrives, they will need friends.


I once looked at banks as important players in the economy, some of which had long, stable track records, which generated healthy returns on equity and paid pretty good dividends. I woke up during the financial crisis of 2008/2009. Now I see investing in banks as a big game of Risk.


2) Still, a good number of healthy regional banks exist, and their stock prices have all fallen by 30% or 40%. My personal favorite is the National Bank of Middlebury (symbol: MDVT). It's not really a regional bank, unless you are willing to consider a 20-mile radius around Middlebury, Vermont, from Brandon to Hinesburg, as a region. But it has a national charter and $500 million in deposits. It's run as a bank should be run, without a "hold-to-maturity" bond portfolio which it can try to ignore while interest rates rise. Middlebury National marked its bond portfolio down by $19 million dollars last year, which impaired the bank's value on paper by 40%, even though it didn't sell a bond. It was entirely a paper loss, and it will be a paper gain of similar magnitude when interest rates descend and/or the bonds mature.


I can't recommend MIddlebury National to you, because it only has 860,000 shares outstanding, of which 282 changed hands yesterday. If you built up an investment of even a few hundred shares, but then wanted to sell, you would never, ever get out.


3) A better tactic, I think, is to buy an index of regional banks. The S&P Regional Bank Index (symbol: KRE) has stock from 144 banks inside, none of which represent more than 4.1% of the portfolio. It has fallen in value by almost 30% in the last month. It pays a dividend of 2.5%. Regional banks stocks have fallen across the board from fear bordering on panic. I understand. The headlines have been abysmal and it is so hard to judge the asset quality of a bank, or to gauge how it will weather an environment of rising rates. A few more will likely fail, and I don't know which ones, so I think that an index approach to investing in this distressed category makes sense.


4) The index won't go up immediately either. It will do so when the market gets a whiff that inflation has moderated, and sees lower rates in the future. Then the market will move quickly - long before we read the news in the paper. Although I dislike banks as investments, I think that they have become under-valued assets which merit some investment, and that this is the best way to do it.


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