Ben Mackovak on The Secret Sauce of Investing in Banks | #519

Episode Summary

Executive Summary: Ben McOvack argues that the 2023 bank turmoil was driven less by systemic fragility than by a few badly mismatched balance sheets, extreme Fed tightening, and a two-tier banking system that favors money-center banks. He sees community/regional banks as still investable, with 2024 catalysts including margin recovery, easing deposit pressure, and higher tangible book values.

Main Topics: 2023 bank failures and the March banking panic (Priority: 5/5): McOvack recounts the Silicon Valley Bank, Signature, and First Republic failures, emphasizing how quickly deposit runs and overnight closures destabilized confidence across the sector. Community banks vs. money-center and regional banks (Priority: 5/5): He frames U.S. banking as a two-tier system: too-big-to-fail banks benefit from perceived safety, while community and regional banks lose deposits during stress even when fundamentals are sound. Interest-rate risk and balance-sheet mismanagement (Priority: 5/5): The failures were attributed to unusually poor asset-liability management, thin net interest margins, and large holdings of long-dated securities that were hurt by the Fed’s rapid rate hikes. FDIC insurance, deposit guarantees, and reform (Priority: 4/5): McOvack argues temporary full deposit guarantees could stabilize panic faster and more cheaply than waiting for failures, but he saw little political appetite for reform. Bank valuation, catalysts, and 2024 outlook (Priority: 5/5): He says banks remain relatively cheap versus the broader market, with expected support from declining funding costs, improving net interest margins, and shrinking AOCI losses. Private bank investing strategy and M&A (Priority: 4/5): Strategic Value Bank Partners invests in both public and private community banks, seeking returns through multiple expansion, operating compounding, and mergers/acquisitions that unlock value. Technology, fintech, AI, and crypto in banking (Priority: 3/5): He считает fintech disruption overblown for community banks because core providers spread technology at scale, while AI could improve underwriting and pricing; he remains skeptical of crypto as payments.

Key Arguments: The March 2023 failures were not random systemic collapse but concentrated cases of extreme deposit flight plus poor interest-rate risk management. Community banks were largely spared the panic; deposit outflows mainly hit odd niche banks and some large regionals, while money-center banks absorbed flight-to-safety flows. A temporary guarantee of all deposits would likely have been cheaper for the FDIC and more effective than waiting for failures to trigger confidence loss. FDIC insurance caps are outdated and distort competition, because large banks are implicitly fully protected while smaller banks compete with only $250,000 coverage. Bank investing is still attractive because valuations are low, sector earnings should improve as funding costs normalize, and M&A can create significant upside. Commercial real estate risk is real but not systemically devastating in banks; office is weak, but much of the exposure sits outside the banking system and underwriting remains disciplined. Fintech has not made community banks obsolete because technology is largely supplied by a few core vendors that scale tools across the industry. AI may be the next meaningful efficiency lever for banks, especially in underwriting and loan pricing, where better data could improve margins. Banks can be valued more cleanly using earnings and tangible book value than by tech-style multiples like EV/sales or EV/EBITDA. Risk control matters more than being right on every thesis; banks often have strategic buyers, so downside can be limited if entry prices are disciplined.

Data Points: Bank failures in 2023: 4 - McOvack says there were four bank failures in 2023, including three major March failures and one smaller fraud-related failure. Combined size of 2023 failed banks vs. 2008-2009 failures: Larger than all banks that failed in 2008-2009 combined - He notes the four 2023 failures were collectively larger than the failures in the financial crisis years of 2008 and 2009. Deposit loss threshold: 30% - He says losing 30% of deposits in a short period puts a bank on life support. Deposit loss threshold: 50% - He says losing 50% of deposits is effectively a death sentence for a bank. Net interest margin: 4% - He describes 4% as a good NIM benchmark for banks. Net interest margin pressure level: Below 2% - He says Silicon Valley Bank, Signature, and First Republic were running below 2% NIM, making them vulnerable. Industry cost of funds Q3 2022: 66 bps - He cites the banking industry’s cost of funds before the surge in deposit competition. Industry cost of funds Q3 2023: 244 bps - He says the industry’s cost of funds rose sharply in one year. Cost of funds increase: 4x in 12 months - He emphasizes the speed of the rise as a major industry stressor. Typical bank funding vs Fed funds rate: ~70% of Fed funds rate - He says bank funding costs tend to normalize around 70% of the Fed funds rate. Bank sector valuation: ~10x earnings - He says banks trade around 10 times earnings after the 2023 rally. S&P 500 valuation: 19x earnings - He contrasts banks with the broader market. Bank stock move since autumn 2023: +30% - He says banks rallied about 30% in the couple of months before the conversation. Commercial real estate equity cushion: 30% possible decline still absorbable - He argues many bank CRE loans could withstand a 30% value drawdown without losses due to equity cushions. Bank M&A activity in 2023: Down 60% YoY - He says deal activity slowed sharply after the March banking turmoil. Bank M&A pricing in 2023: Down ~30% - He notes M&A valuations were also pressured. Assets under management: $500 million - He describes Strategic Value Bank Partners as a relatively small but meaningful player in the niche. Bank ownership cap: ~10% (sometimes up to 15%) - He explains regulatory limits that keep institutional ownership capped. Bank universe: ~4,000 total banks; ~300-400 public/ticker names - He estimates the investable universe for community and regional banks. Number of bank boards served on: 9 so far, about to be 10 - He uses board service as part of his strategy and industry access. Zero rate / QE era: ~10 years - He says long-term low rates conditioned banks and investors to expect cheap funding indefinitely.

Pivotal Quotes: "you can't selectively do that" — Meb Faber: He argues deposit protection must be applied consistently across banks, not only to a crisis-era tech bank. "The market hates uncertainty." — Ben McOvack: He explains why bank stock collapses can trigger depositor behavior and self-reinforcing runs. "you can make money investing in banks" — Ben McOvack: He identifies this as a contrarian belief many generalist investors reject.

Implications: The episode suggests banks are still investable if investors focus on underwriting quality, funding-cost trends, and tangible book value. Policy-wise, inconsistent deposit guarantees distort competition and may favor big banks over community lenders.