Of all the jobs I thought I would ever hold, portfolio manager of a group of assets composed largely of regional bank preferred shares is one that I never imagined. But maximizing value for client accounts involves a certain amount of opportunism, and in 2023, the regionals are where the - in many cases, ridiculous - yields are.
When Moody's downgraded a list of regional banks today, I had to pay attention. I am not a huge fan of the rating agencies in general, but they are credit rating agencies, and by owning preferred shares, we at Excelsior Capital Partners are essentially creditors, not equity holders in these banks.
I really don't follow the performance of the regional bank stock indexes, like SPDR S&P Regional Banking ETF (KRE) for example, but when Moody's downgrades regional banks, they are lowering their credit outlook, so that is right where we are.
Frankly, the entire Moody's piece is a little squishy for my taste. Moody's downgraded 10 banks by one notch, changed the outlook for six banks to negative and placed 11 other banks on review for possible downgrade. That is confusing. What do those gradations even mean? Don't ask me.
As an active asset manager, I live in a world free of such gradations. You either own it or you don't. The names I choose to own are not included in the 27 banks mentioned by Moody's. That's fine. I did not breathe a sigh of relief, I just went back to work.
Moody's does make a few valid points, though. Thanks to the breathless incompetence of Powell and Yellen, the US Treasury yield curve is inverted, and has been for the longest period since the early 1980s. Thus bank profits are under pressure. No one disputes that. Secondly, the asset values of all banks are being pressured by a downturn in the commercial real estate (CRE) sector. No one disputes that, either.
But how we play defense is to analyze our companies and watch what they do, as well as listen to what they say. Just as I covered the puzzling departure of Tesla's (TSLA) CFO Zach Kirkhorn in my Real Money column yesterday, I have followed regional bank management moves in many Real Money columns since "the business started " with the Silicon Valley Bank fiasco.
Just as Elon's Tesla has built a $90 billion asset pile that Tesla will never be able to earn an adequate return on, there was a phase of Empire-building among regional banks. That phase, post-SVB, Signature and First Republic is now, fortunately, over..
Leaner and meaner balance sheets are in fashion now. When Banc of California (BAC) announced its merger with PacWest (PACW) , the upshot was that the combined bank announced plans to shed liabilities like crazy, mainly through the disposal of brokered deposits. Those "borrowed borrowings" merely served to brighten up a balance sheet that PacWest had already shaved materially by selling two multi-billion dollar-sized chunks of its loan portfolio to private equity firms.
Individual bank management actions are important, and I don't think that was captured in the broad brushstrokes of Moody's note. The fact that our holdings of preferred shares are entirely untouched by the Moody's downgrades/reviews shows that we might know a thing or two about selecting the most attractive companies in which to invest. I would like to think that is true.
Among the regional bank preferreds in order of position size, we own:
That is a solid list and one that reflects an intense level of concentration among its holdings, especially PACWP. Unlike PACWP - which is essentially a merger-arb play for us until the PACW-BANC merger closes, which will likely occur in 1Q24 - the other three names offer currently-floating-rate dividends. That is an immense benefit, as I believe interest rates will continue to rise in the US.
We avoid the empire builders and stick with the value-adders. When it comes to the game of managing a portfolio that is heavily weighted in regional bank preferred shares, that is the only way to live.