My Bank Trade? An ‘Insurance Policy’ on BofA I Hope Doesn’t Pay Off

By Friday, Silicon Valley Bank became pretty much a household name, even by the many who’d never previously heard of, or cared, about it.

The Silicon Valley Bank, the California bank subsidiary of SVB Financial Group (SIVB) , was shut down. The move came from the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as a receiver to the bank.

This was the story that dominated headlines late in the trading week and the main trigger of the selloff in the markets on Thursday and Friday, as well as a significant spike in volatility. Silicon Valley Bank went from being one of the Top 20 largest banks in the country by deposits — with just under $175 billion worth, of which just over $150 billion were uninsured) to receivership in a blink of an eye. SIVB ended fiscal 2022 with just over $200 a share in book value and started last year with a market capitalization of approximately $40 billion.  As of Dec. 31, the bank had approximately $209 billion in total assets and more than $175 billion in total deposits.

This marks the biggest bank failure in the country since the Great Recession.

The bank became just the latest victim of the most aggressive monetary policy in 40 years. After failing to act in 2021, the Federal Reserve who had believed inflation was “transitory” embarked on its current journey of rate hikes in March of last year. The Fed Funds rate now sits at 4.50% to 4.75% with an additional quarter percentage point to half percentage point boost projected when the Federal Open Market Committee next meets on March 21 and 22. Whether the implosion of Silicon Valley Bank impacts the Fed’s calculus at this moment remains unknown.

The blow up of Silicon Valley Bank certainly had major impacts across the market with banks getting hit hard as well as high beta parts of the market like biotech and small caps. Both the Russell 2000 and SPDR S&P Biotech exchange-traded fund (XBI)  are close to testing their lows from last June. Silicon Valley’s primary problem was that it had nearly $60 billion in held-to-maturity (HTM) mortgage backed securities on its books as well as some $10 billion in collateralized mortgage obligations, or CMOs, which represented a huge amount of its overall assets.

When interest rates began to rise, the bank started to take significant unrealized losses on this portfolio. When management came to the conclusion this week that interest rates would remain higher for longer than previously believed, the company sold just over $20 billion of its available for sale securities that were to be reinvested into shorter-duration Treasuries. This triggered a nearly $2 billion loss, which management was attempting to fill by a large capital raise to bolster liquidity. When that and other efforts failed, the FDIC felt it had no choice but to shutter the bank Friday, which further rattled the markets.

The unrealized losses on Silicon Valley Bank’s HTM bond portfolio had come to dwarf its total equity. Other banks haven’t been as imprudent as SVB. However, at the end of 2022, banks held approximately $250 billion in similar unrealized losses on these types of bonds. Bank of America (BAC)  represented just over 40% of this exposure, according to a piece this week in Zero Hedge. Now, I don’t believe this is the start of the next financial crisis (and I am praying it is not).

I do, however, think fears of contagion could last for a bit, which could trigger a further selloff in banks. And if that theme plays out, I could easily see Bank of America moving significantly lower from the $30 level it currently trades at. Therefore, late Friday I purchased a small amount July $30 puts on the stock for $2. At market close Friday, they traded for around $2.20. In contagion fears spread substantially, I could see the shares moving to the low $20s making my trade a tidy profit. If contagion fears proved unfounded, the rest of the market should enjoy a decent rally and I will be happy to live with the loss on my little “insurance policy.”