The Banks Most Likely To Go Bust

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Los Angeles’s Far East Bank about to get a large, unscheduled withdrawal (Heat, 1995).

Finding The Banks Most Likely To Go Bust

In a post earlier this month, I mentioned a conversation I had with a bank expert about finding the banks most likely to go bust.

After mentioning a couple of bank trades I’d recently closed for gains of 80% and 200%, respectively, I wrote: To get the tier one capital data for those trades, I used a specialized bank data site.

I just spent close to an hour on the phone with the founder of that site, who is a fountain of knowledge when it comes to banks. He had some fascinating comments about why Silicon Valley Bank went bust, how he knew it was underwater beforehand, and how the current banking crisis is transitioning to a credit crisis.

I’m going to try to get him to put that big picture stuff in writing, so I can share it here, but my immediate concern is identifying new banks to bet against. He suggested a metric to use to identify banks likely to face a “terminal event”:

  • Start with banks that have tapped out their federal assistance programs.
  • Rank them by their underwater AFS (available for sale) and HTM (held to maturity) securities as a percentage of tier one capital.

The good news is he is going to provide me with a spreadsheet that does just that later this week. The bad news is that I’m going to have to pay for it, as his time is expensive, but I think it will be worth it for us.

Getting Into Trouble

In the first version of that post, I mentioned the name of the website and the bank expert. A couple hours after the post went live on ZeroHedge, I got an email from him asking me to remove his name from my post, so I did. He has a lot of bank clients that pay him a lot of money, and they didn’t like the idea of him “trashing banks”, he said. So I apologized and removed his name and the name of his website from the post.

Nevertheless, he reneged on our deal.

Getting The Data

Fortunately, his site listed its source for its bank data, the FFIEC (Federal Financial Institutions Examination Council) Central Data Repository’s Public Data Distribution web site. The other piece was figuring out which banks had exhausted the Federal Reserve’s new, post Silicon Valley Bank collapse assistance program, The Bank Term Funding Program (BTFP).

As you might imagine, the Federal Reserve isn’t going to advertise which banks have tapped out their lifelines, but as the banking expert explained, there are a couple of hints to look for in the data:

  • A big increase in “other borrowed money” in Q1. This will likely include loans from the BTFP, or,
  • An increase in pledged loans or pledged securities in Q1. This will likely be assets that were pledged to the BTFP as collateral for the bank’s loans from the BTFP.

Putting It Together

To build the list, I had my analyst start with all the regional banks in America that are publicly traded and also have options traded on them (since we’re going to bet against them using options). Then I had him indicate which ones had likely exhausted their BTFP resources based on the two hints above. Next, I had him total each bank’s AFS and HTM securities, and determine how much of each was under water, and divide those amounts by each bank’s tier one capital. I’ve included a link to the spreadsheet in the full version of this post, so you can see all the data yourself, and following that, I’ve posted a few trades I just opened based on the data. Before we get to that, a few cautions.

A Few Cautions

  1. We don’t know for certain which banks have exhausted the BTFP.
  2. I haven’t double checked all the data in the spreadsheet myself, but I had the Chartered Financial Analyst who put it together add supporting links for all the data, so you can double check it yourself if you want.
  3. Interest rates are a wildcard here, because they help determine which bank securities are underwater (the prices of bonds and other fixed income securities move inversely with interest rates). If interest rates come down significantly in the next few months, it will take a lot of pressure off of these banks.

With that said, below is the data, followed by my initial trades based on it… [subscribers can Read the rest here; nonsubscribers can use the instructions and FFIEC link above to build their own list]. 

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