SEC must Reinstate Temporary Ban on Shortselling Banks
This isn't 2008, but the dynamics warrant immediate SEC action
When Silicon Valley Bank hit the wall in early March, market players quickly scanned the other Tickers to see if any other banks had material exposure to the innovation economy.
While concerns about deposit “flight to JPM/BoA/Citi/Wells” have put pressure on the shares of most U.S. Regional banks over the last ~8 weeks, names such as Comerica (CMA), First Republic (FRC), Pacific Western (PACW, and owner of Square1 Bank) and Western Alliance (WAL, and owner of Bridge Bank) stood out. The analysis wasn’t very complicated: if SVB deposit clients were prepared to withdraw tens of billions in a matter of hours that fateful Thursday, surely other Tech and Life Science entrepreneurs wouldn’t flinch at doing the same: no matter how diversified a bank’s funding sources might be. I don’t have precise figures to quote, but most weeks it seemed as though the shares of PACW and WAL, in particular, performed even more poorly than most of the other so-called “Regionals” that were, temporarily perhaps, hemorrhaging confidence.
In the case of PACW, for example, short interest grew from about four million shares as of the end of February, about the same as June of 2022, to 21 million shares at April 15th. Shoot first, ask questions later.
To have a sense of the relative loan exposure to “innovation economy” Series A-C companies, you can look back at a LinkedIn post I did a few months ago showing where the key market players stood at the time (those that disclosed segmented numbers, anyway). While Innovation-related deposit balances aren’t perfectly correlated to loan draws, none of CMA, PACW nor WAL had much more than about US$10 billion of innovation economy deposits on hand at that time. By comparison, Signature Bank was very exposed on the deposit concentration front — an efficient market likely explains why that former high-flier didn’t last 36 hours following SVB’s demise.
As the weeks have passed following SVB’s failure, most banks have had the opportunity to update investors on their deposit flows and overall financial health; deposit outflows haven’t been scary for this key list of Tech lenders, other than First Republic — which is why it’s no longer an independent entity.
To think that it was only a few months ago that having a “Tech strategy” earned a premium valuation from bank investors, given the sector provided the kind of attractive source of low-cost deposit funding that every bank is looking for.
Yesterday’s expected 25 basis point rate hike by the U.S. Federal Reserve served as an excuse, it seems to me, for short-sellers to further prey on Pacific Western Bank, despite the fact that innovation economy-related deposits make up a relatively small proportion of the bank’s overall deposit mix at ~20%. On April 25th, PACW announced that it earned an adjusted profit of US$89 million for the first quarter of 2023. More relevant given the climate, deposits were actually up by US$700 million during the month of April, post-quarter end. A telltale sign that both investors and clients were confident in the financial future of the bank.
Shares rose ~15%, approaching US$12. That was just last week.
As of this morning, you can pick some up for less than US$4 each. What’s changed? Let’s not pretend that some financial analyst has suddenly discovered that this most recent Fed hike has effectively wiped out PacWest’s equity. Tangible book value per share was US$18.66 as at March 31/23, which was up US$1.66/share during the first quarter of 2023.
When profitable banks trade at book value, they’re usually seen as an appealing investment. At this moment, you can snap PACW shares up at ~21% of TBV. The market is telling us something; but what? Unless we’ve all missed something, this situation seems like a classic Hedge Fund attack.
Once First Republic was toast, it appears that these shorts have switched their focus to the next weakest name in the herd: PACW. By pushing shares down by >50% yesterday, on no new company-specific news, they’ve created a circumstance where the bank appears to be in trouble; even if nothing has changed since last week’s PACW conference call. The investors who hadn’t sold when the stock rallied to US$7.40/share yesterday are now faced with preserving some part of their capital at US$3.50. Given what’s happened to the equity of SVB, SBNY and FRC, some might think that US$3.50 is better than zip, which is what I got for my SVB equity when that once great institution (see prior post “In a matter of hours, decades of brilliance is undone at SVB” March 10-23 ) was seized less than two months ago.
Where to from here?
During the summer of 2008, the Securities and Exchange Commission started to take steps to deal with short-selling, despite the defensible role that the strategy plans in most market situations. At first, the SEC banned “naked” short-selling, which meant that you had to arrange to borrow the shares of an actual company shareholder before shorting a specific stock (see prior post “SEC fills a hole in the rulebook” July 16-08); that made sense to me at the time.
When things got very bleak that September, the SEC took things one step further and banned the short-selling of 799 bank stocks; the UK regulator followed suit. Whether or not it was “too little, too late,” one can debate.
If PACW doesn’t survive the month, you can be sure it wasn’t a function of the quality of the bank’s loan portfolio or its diversified business model. It’ll have resulted from the self-fulfilling impact of a handful of Hedge Fund managers. Once they’re done with PACW, they’ll move on to Western Alliance, and then Comerica, unless they get distracted first by First Horizons (FHN) in the wake of TD Bank’s termination of that acquisition deal earlier today.
The SEC must appreciate the impact that a rolling series of unnecessary bank failures will have on the economy, entrepreneurs, company employees and investors alike. Rather than wait for PACW, FHN, WAL and CMA to get shorted into oblivion first, it’s time for another temporary ban.
If a bank’s business model is unsustainable, that’s up to the FDIC, OCC and Federal Reserve to figure out over the coming weeks and months. Let’s not delegate the decision to the fox as it makes its way around the hen house.
MRM
(this post, like all blogs, is an Opinion Piece)
(Les Garçons Bouchers, Paris, 1950 by Irving Penn)