Hey Income Hunters,
Traders should never let a good crisis go to waste …
Silicon Valley Bank (Ticker: SIVB) was the 18th largest bank in the US, and in just two days faced a bank run and collapsed.
While SIVB did have a solvency problem, it was more about not hedging its interest rate risk that took them down, a colossal blunder when the Fed was raising interest rates.
The crazy part is the CEO was a board member at the San Francisco Federal Reserve … You would think he knew better.
Aside from SIVB and Signature Bank (Ticker: SBNY) the majority of banks are still solvent …
The large banks, believe it or not, will come out of this crisis stronger than they went in thanks to the Fed.
Today, I share the supporting data on why and a trade to consider …
Banks Are The Multiplier Of Money
For the last 40 years banks have had the greatest business in the world …
They held trillions in deposits at very low cost, with requirements to only hold a small fraction of them at the bank.
And with the deposits …
They lent up to 90% to home buyers at very wide margins.
Think about this for a second. Let’s say you deposit $100: your bank normally holds $10 and lends out $90. Then, the borrower of the $90 deposits at the bank and holds $10, and lends $80 and so on.
This is how the credit that fuels economic growth is created.
Today’s Crisis Is Nothing Like 2008
In 2008, banks had 23-to-1 leverage, which is insane for a bank. The use of derivatives allowed the banks to be over leveraged.
So when loan defaults increased, it didn’t take much for them to become insolvent.
Today, the bank balance sheets are much better capitalized thanks to 2008 bank regulations designed to protect them in crisis.
This time, the problem was simply liquidity in the bond market because bonds make up the majority of the $18 trillion + assets held on the banks balance sheets.
The Fed fully took advantage of the failure of SIVB and SBNY to add as much bank liquidity as needed.
The Bank Term Funding Program gives the banks the luxury of lending their underwater bonds to the Fed while getting the full value paid at maturity.
This was a $650 billion bailout for the Banks.
Depositors Fleeing Small Banks For The Big Boys
Not only has the Fed removed the bond liquidity risk from the banks, but they’ll also see massive inflows of new deposits from the smaller, riskier banks.
The Fed has now become the only funding counterpart the banks need. If depositors pull funds the banks can go to the Fed with their bond assets and get cash immediately …
It’s a Beautiful Thing Being Too-Big-To-Fail (TBTF)… So, with the big bank stock prices discounted by around 15% due to regional bank issues … It’s time to buy!
What’s The Trade?
The SPDR Select Sector Financial ETF (Ticker: XLF) is liquid and holds all the TBTF banks.
XLF dropped 13% in 5 days and filled a gap down at $32 and is now recovering. I have $32 as a strong support level.
I purchased a simple XLF May19 35/37 call vertical spread for $.32 …
So the maximum gain is $2 (strike spread) minus .32 (cost) divided by .32 for a maximum possible gain of 525% …
Banks are even stronger now and are gaining market share … plus there’s potential for the Fed to pause to protect the little guys.
The probability of success here is not bad.
Live and Trade With Passion My Friend,
Griff