In this podcast, Motley Fool senior analyst Jim Gillies discusses:
- The reasons he's a fan of AerCap Holdings' secondary offering.
- Why shares of SVB Financial Group are plunging. (This was recorded before trading was halted.)
Plus, Motley Fool producer Ricky Mulvey talks with investigative reporter Marshall Zelinger about Xcel Energy and the fundamentals of being a monopoly.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on March 9, 2023.
Chris Hill: With all due respect to A Tale of Two Cities, we're coming to the table with a tale of two capital raises. I said with all due respect, Motley Fool Money starts now. I'm Chris Hill, joining me today, our man in Canada, Motley Fool senior analyst Jim Gillies. Good to see you my friend.
Jim Gillies: Good to be seen, Chris.
Chris Hill: We've got two companies under the umbrella of raising capital. I think it's accurate to say you are horrified by one of these moves and you are excited about the other. Let's start with the horror movie first. Shares of SVB Financial Group are down 45% today, as you and I are having this conversation. This is a company formerly known as Silicon Valley Bank. What is happening that is sending the stock down to this much in a single day?
Jim Gillies: Nothing good. Quite often of course, when you see a stock just get taken behind the woodshed, the first question is, is this a buying opportunity? I'm going to humbly suggest, this is not a buying opportunity and you might want to give this one some thought. I always call them Silicon Valley Bank, even though I know they did change the name, so Silicon Valley Bank. They have announced this morning, I believe it's about 1.75 billion in a stock offering, which is probably contributing to the pounding the stock is getting right now another 500 million in preferred stock because their balance sheet had a smoldering fuse on it for a while and it pretty much looks like it's blown wide open.
It's also sold 20 billion or so of available-for-sale securities designated available for sale on its portfolio. They can take a near 2-billion-dollar loss on that, I believe this quarter. But the reason they're doing this, and I want to shout out there's a great Twitter follow, Raging Capital Ventures who had this one pretty much pegged back in January. This Twitter participant identified the biggest issue with Silicon Valley Bank isn't the loans necessarily, it's making the start-ups, some tech firms had free money, years of zero interest rate policy, free money, Silicon Valley, so any idea could get floated basically. But it's rather a lot of their portfolio, their investment portfolio is held in what are called held-to-maturity mortgages.
The average yield on those mortgages is somewhere well below 2%. It's about 1.6%, 1.7%, I believe. We're going to go back to school here a little bit, Chris. The central axiom of financial theory. I'm sorry, Fools. But the central axiom of finance is that interest rates and asset values and by the way, mortgages are assets if you hold them, if you're the bank. Central axiom of finance and interest rates and asset values are inversely related. That means rates up, asset prices down, rates down, asset prices up. What happened in 2022 again with interest rates?
Chris Hill: They went up.
Jim Gillies: Yeah. A little bit or a lot?
Chris Hill: A lot.
Jim Gillies: Yeah. The value of those mortgages on Silicon Valley Bank's balance sheet, again, those are the assets, so they are down a lot because interest rates are up a lot. The estimated losses on this held-to-maturity portfolio looks to be north of $16 billion, and that's of the most recent December '22 balance sheet. Well, the problem is Silicon Valley Bank had about $12.5 billion of common equity, another 3.5 billion I think of preferred equity. But the point is, if you realize or recognize these losses on this held-to-maturity portfolio, you wipe out the entirety of your equity position and we have a word for that, and that word is insolvent. Banks that are insolvent, well, the share price does a lot worse than what it's doing today and it's not doing great things today. I'm not done.
Chris Hill: I know, but that's why I want to interject. Because you said something early on that I think is important, is that while you and I are having this conversation, somewhere out there, there's more than a couple of investors who are looking at this. They are looking at this and they're saying point down 45 percent. I don't have to put a lot into this. But something you had mentioned to me earlier today is that, you said this is going to sting them, Silicon Valley Bank, for a long time to come.
Jim Gillies: For years. This one's going to leave a mark and it might do more than that. I don't want to be a doomsayer or the apocalypse is upon us because worse companies have survived worse than this but this is not good. They're stuck with this giant portfolio of held-to-maturity loans, mortgages that they basically went in at a market top, they're not going to get bailed out. There's going to be no Fed pivot. Rates are not going back to near zero. In fact, rates are continuing to go in the wrong direction for Silicon Valley Bank here. But the good news is, the accounting rules don't force them to mark-to-market the losses on these things. Meaning it's shoring up their balance sheet.
But the bad news is, you can't sell any, because the second you sell one, you got to revalue all of them, so they're stuck. That's what today's equity sale and preferred stock sale is about, they're bolstering the balance sheet. But even if they avoid the worst-case scenario, which is insolvency and bankruptcy, given that you've now got this bigger equity base, returns on equity, like the ability to make money for Silicon Valley Bank, I think is going to be impaired for a while. As you say, it's down about 45% today. We haven't even talked about things like, banking is often about perception. If you lose confidence in the bank, what's your first move? You're no longer confident in your bank, you tend to go, you've heard of a bank run, people tend to say, "Crap, let me get my money out." The risk here as well is that their troubles as they blossom out, accelerate maybe a bit of a run on deposits.
If your money is with them, maybe people start going, "I'll take my cash back." We haven't even talked about some of the venture bets that they've met that they made with people's deposits and whatever in their capital, of course, it's bank so they run levered. I'm not sure what their leverage ratio is, but if you were to tell me it was 10:1 wouldn't shock me. They could be risking losing some deposits. They could be risking some of those venture bets they made with people's money. I don't know if you've looked at what's happened to tech stocks past couple of years, not great. Some of those might be blunt. This has a non-zero potential to cascade and cascading is not good. Even those things down about 45% as we speak, I am not going anywhere near this thing for a very long while, probably ever.
Chris Hill: Then let's move on to one that, as I said, you're more excited about, AerCap Holdings is doing a secondary offering. What is it about this opportunity? More than most things I feel like there's a pretty big delta on secondary offerings. There are times where people are like, this is amazing, this is brilliant, I love this, and there are other times where it's just a big red flag that's waving. What is it about this secondary offering from AerCap Holdings that has you excited?
Jim Gillies: Well, we just had the big red flag waving with Silicon Valley Bank, so yeah, AerCap, they're not only doing a secondary offering, they've upsized it. They were originally going to offer 18 million shares, I think they have about 250 million shares outstanding. They've upsized it to 23 million shares, and they've given the underwriters an option for another 3.5 million, 3.45 million. AerCap is the world's largest aircraft lessor. They work with pretty much every airline and this is a great secondary offering because AerCap is not receiving one red cent from this offering. Now that sounds counterintuitive.
Chris Hill: Yes, it does.
Jim Gillies: This is a happy dance event, Fools. AerCap was already the world's largest lessor in aircraft lessor in late 2021. They were already the world's biggest and then they just supersized it and put everyone else. In a leasing business, bigger means more clout, means you can negotiate lower rates. Debt is like raw material for lessors so don't get terribly worried when you see a leveraged balance sheet for these types of companies because they've got assets on the other side, in this case, those are aircraft. They're very adept at running the aircraft through good times and then selling them above book value when some of the gloss shine comes off these things. It's an aircraft that's obviously it's a little more complicated than that, but they're very astute with valuations and so AerCap is already the largest lessor in the world. Then in late 2021, they bought the aircraft leasing portfolio, GE Capital Aviation Services, GCAS, from General Electric.
And when they did so, they gave them 111.5 million shares and paid $24 billion in cash notes to GE for the portfolio, this was big. Now that the debt or the cash stuff was just basically they were refinancing the debt that GE backstopped the planes with and they moved it over to AerCap back debt that it's not really. They didn't go find $23 billion in cash under the couch cushions. But it's a point that they gave 111.5 million shares to GE when they bought them in November of 2021. Now, the selling shareholder in the secondary is not AerCap, although AerCap's arranging it, it's actually GE. We have pricing, it's $58.50. Basically GE, they got 111.5 million shares in the deal.
They're now filed to sell 23 million. They've given another 3.45 million to an underwriter's option, which I'm pretty sure will probably be fully filled. AerCap themselves are buying $500 million worth of stock, which is about 8.8 million shares from GE at $56.89. This is AerCap buying 3.5% of themselves back. We like companies that buy back their stocks and meaningfully willing to reduce their share count. They're buying 3.5% of themselves back at a discount both to the offering price on the larger thing that GE is trying to get out of and it's about 15% below what it was last week. No. 1, I expected this, that this was going to happen not because I've got working crystal ball, but because this follows the playbook of what AerCap has done in the past.
The last time we had a large major aircraft leasing portfolio being sold in distress from a company was some insurance company called AIG. About a decade and a bit ago coming out of the credit crisis, AerCap bought AIG's leasing portfolio. That's I think the transaction that made them the world's largest at that time, they bought that from a distressed seller. They again, used leverage, debt, and they issued a whole lack of shares to AIG. Then over the several years what happened over the next seven, eight, nine years is that the ample cash flows that AerCap generated, first, pay down some of the debt associated to the deal until they got down to a leverage ratio where they are comfortable. Again, debt is raw material for a lessor, so they're always going to run leveraged.
But they got down to a level where they are comfortable and then they switched the cash going from paying down debt to buying back stock and including they helped AIG, who was holding aircraft stock, they helped AIG sell a bunch of the shares that they'd given to AIG in the deal back then, as well as they always participated buying some of that stock back. Something like I think over the next eight or nine years of following the AIG deal, AerCap repurchased about 80%-85% of the shares they'd given to AIG in the first place. And that only stopped because we ran into COVID and they turned off the buyback engine. But basically, to paraphrase Battlestar Galactica, all of this has happened before and all of this will happen again. It's exactly the same playbook being run on the GE thing.
This is the first thing I wrote back in December in Hidden Gems Canada where AerCap is a recommendation. We got it not at the COVID-inspired low, but pretty close. We're pretty happy about that. I said, "Presuming it runs the same playbook as when they acquired AIG's portfolio a decade ago, expect AerCap to pay down debt until hitting a certain leverage ratio." I gave the number I said, "Which they just hit as of Q3 2022 and then likely turning to use its ample excess cashflow to start buying back the shares issued as part of the GE deal." They're doing exactly that, this is the first step. They're getting out from under the overhang of having GE owning about 46%, 47% of the stock. This will not be the last time AIG helps out GE to get out from under the overhang. This company, AerCap, is a tremendous capital allocator. They've consistently proved that and I think the best is yet to come. Silicon Valley Bank, eh, AerCap, awesome.
Chris Hill: You had me at ample excess cash flow. Jim Gillies, always great talking to you. Thanks for being here.
Jim Gillies: Thank you, sir.
Chris Hill: When you're a monopoly, you get some guarantees that other businesses don't. Marshall Zelinger is an investigative reporter for nine years in Denver, recently covering Xcel Energy. Ricky Mulvey caught up with Zelinger to discuss how the utility company negotiates rate increases and the fundamentals of being a monopoly.
Ricky Mulvey: You've been following Xcel for a couple of weeks now. Starting off, why are Xcel and utilities in general monopolies?
Marshall Zelinger: Because it's legal. That's my journalistic answer. We've had that question asked by many viewers. You compare to phone companies, cable companies, now internet companies. One answer I got from someone just talking to me casually off the record is, it's a monopoly because when energy companies came to be, you needed uniformity. I don't even know why I tried to say that word. You needed it to be uniform. Otherwise, you would have wires and cables from general sources going across alleys and across streets, and then it would be whose line is whose? The government solved it for phone companies and for cable companies, now, internet and satellite and all that. But when it comes to utilities, it seems to be the simplest thing is that you've got your one-stop shop.
Ricky Mulvey: That's the start of it. But recently a lot of people who pay utility bills have seen their prices go up dramatically. How have you seen Xcel enjoy being a monopoly in your reporting?
Marshall Zelinger: I'll be more down the middle. I don't know that they enjoy it. They have record profits. I think that's where that question gets to. In 2022, it was revealed through their filings and their fourth-quarter reporting for financials was revealed almost 1.74 billion in profit over eight states. Their 10-K financial filing that I saw two weeks ago showed in Colorado alone where we're reporting from, 750 million of that came from Colorado, and that was higher than the previous year. I should pull that number up to make sure I'm getting it right because I feel like the year before was 660, so maybe 750 might be high, maybe 730 or say 727, maybe it's 727 million because I want to be accurate on that. While I stall, I'm going to make sure I am accurate on that. But nonetheless, the bulk of their profit comes from Colorado, and Xcel covers eight states in all.
Ricky Mulvey: I appreciate you being down the middle, but I think one benefit that they gained from being a monopoly, perhaps not enjoyed, but benefit is that when they go about a capital improvement projects, when they make an investment into a new building facility, that sort of thing. You've reported that they get a guaranteed rate of return on those investments, which is unlike a lot of other businesses.
Marshall Zelinger: Sure. Whenever the utility and we'll just talk Xcel here, goes to the Public Utilities Commission, the state regulators. It is built into, I think it's state law that it's built into that you're going to have some sort of return on equity, or that that's allowed. Generally speaking, it was 9% or 10%. The experts I've talked with say that's trending a little down lately. I will say in all my reporting, the one thing that I guess consumers benefited from was that Colorado's territory for Xcel had the lowest return on equity. It was in the 8% range versus other parts of their territory, which were 10%. What that means is, basically, whenever they build something, transmission lines, power stations, wind farm, solar farm, coal plants, they finance it on the front end.
They're out money on the front end. But they also have investors that help with that and in return, the customers are paying them back for that investment, as they love to say the word "investment" and you can't see my air quotes as I say that now. We as customers pay them back for that investment plus, and that's that return on equity. It's like we're going to build this thing, we're going to finance it on the front end. It's going to benefit you. You're going to pay us back for it and thanks for the 8% to 10% that we're going to get back in the long run. As someone said to me, hey, wouldn't you love to be able to invest in something and be guaranteed 8% to 10% all the time.
Ricky Mulvey: You also looked at their relationship with the Colorado Utility Commission. How does Xcel go about asking for rate increases and asking rate payers to pay things like their legal fees to ask for more rate increases?
Marshall Zelinger: That was interesting. That legal fees part which I'll get into is in the eighth of my now 18 stories on this topic since the end of January. Base rates are complicated. Base rates are something that's on your bill that supposed to be every two years it seems is when your base rate changes. But there's also another line item on your bill that's supposed to take into account the price of fuel right now, the price of gas and so that changes quarterly. The base rate includes everything they build, basically all their employees, anything that they buy that is used and useful is the term that was reiterated yesterday as the state lawmakers took a closer look at utility rates. Anything that goes into your business that gets included in the base rate and gets added that plus return on equity.
But there's the other part that, hey, if gas prices suddenly went up and they had to pay more than they expected, they'll come back and say, we need to add this extra line item on your bill that covers the cost dollar for dollar for that fuel. Xcel will argue recently they've also gone back and said, hey, we didn't pay as much for fuel as we thought we were going to have to. We were going back and having that line item lowered because that's dollar for dollar and since we paid a lesser amount, you're getting to pay that lesser amount also. But it's a really complicated process, and I set out on this journey by doing a "what is on your bill" story. What is each of these line items mean? Why is it on your bill? Two stories that I thought I was going to do and then move on to other things and that opened up this Pandora's box of viewer questions and educating people on something that you wouldn't think we need so much education on something that we pay every month.
Some of us do it blindly not knowing what we're paying or why we're paying it. It's amazing how people have learned what we're all paying for, including those legal fees among the, hey, we're building this plant, we're buying this truck, we're paying our employees, Xcel got the Public Utilities Commission, they asked for $2.2 million in legal fee reimbursement for outside legal help that it hired to argue why it needed higher gas rates. The PUC ultimately said yes to 2 million of that 2.2 million. When you divide that over every customer, it's not a lot but come on, they hired outside help to argue for why they needed to charge us more and they got paid back for that outside help.
Ricky Mulvey: Did you get any color on what those negotiations look like? I mean, there has to be some discussion from 2.2 million to 2 million.
Marshall Zelinger: A lot of it I have learned is you're drowning people in paperwork. It is a lot of documents. Think of it as a court case. It's evidence produced on paper instead of actually hearing from people. I think there are testimony that happens along the way, not in front of the Public Utilities Commission itself, but I may be speaking out of turn, but I think it's the ALJ is the judge that is basically a mediator-like judge that handles these types of things for the Public Utilities Commission. So that when the PUC ultimately makes a decision, it has all the evidence from all sides and there's a proceeding that takes place ahead of that, that flushes a lot of this out.
What I think happened with that legal fee, it's in a document that says it wasn't quite every line item of what all the costs were and that's why it got reduced from 2.2 million to 2 million because there were arguments made from the public defenders of the consumer, the Office of Utility Consumer Advocate. They made the argument, hey, Xcel didn't provide enough paper to say, this is exactly why we're asking for this much money. It didn't say this lawyer did this for this long and some of that was missing, I guess. That's why it got reduced from 2.2 million to 2 million.
Early March here, there's a new committee at this state capital of six lawmakers that are looking into rising utility rates. In the first meeting it held, it asked about this $2 million and the Office of Utility Consumer Advocate, which is again the public defender of the consumer, argued, look in base rates customers already pay Xcel for its employees, which includes lawyers on staff. Why are they just hiring more employees and why are they hiring out legal help when they have in-house legal help? Oh, by the way, your bill pays for in-house and out-of-house legal help.
Ricky Mulvey: Then the other thing that many rate payers pay for that I didn't realize before watching your reporting are things like rebates on solar installations and electric car charging ports. Am I correct? I think I might be wrong. If someone installs in electric car charging port, a ratepayer could be paying for that person's rebate.
Marshall Zelinger: The ratepayer has funded the account that allows that other ratepayer to get that rebate. In a way, it many states have this bag fee when you go to the grocery store in Denver and all of the state, it's a $0.10 bag fee. But in Denver, that $0.10 bag fee goes to a climate fund, and as part of that climate fund, you can apply for e-bike rebates or electrifying your home with EV charging stations or changing out a furnace for a heat pump, things like that. You may or may not pay that $0.10 bag fee.
You may choose to bring your own bag and never pay into that fee, but get the benefit of where that money is going. For your Xcel bill, everybody has to pay into a line item that then funds the same stuff I just talked about. If you have a EV charging station need and you want to get one, you can apply to have it installed and get some credit back from Xcel. But that credit isn't coming from Xcel from the goodness of their heart. That credit is coming from everybody who has to pay their Xcel bill, paying a line item that funds that account.
Ricky Mulvey: Can't choose not to pay it. Marshall Zelinger, I really appreciate your insight reporting on this and thanks for joining us on Motley Fool Money.
Marshall Zelinger: No problem, thanks for having me.
Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.
