Wall Street doesn't offer many guarantees. But when it comes to near-guarantees, Federal Reserve rate-raising cycles have a history of eventually breaking things -- at least on Wall Street.
To be fair, not all stock market corrections, crashes, and bear markets following the peak of rate-raising cycles are the fault of the nation's central bank. The COVID-19 pandemic, for example, had nothing to do with the Fed's lifting rates off historic lows throughout most of the 2010s. But rate increases have given way to a number financial crises, including the housing/financial meltdown in 2007-2008 and the savings-and-loan crisis of the late 1980s.
With the nation's central bank raising interest rates at the fastest clip in 40 years -- a move it was forced to make because of historically high inflation -- something was bound to break. That something, unbeknownst to many, was regional banking juggernaut SVB Financial (SIVB.Q), the parent of Silicon Valley Bank.
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The rise and fall of America's banking growth stock
For much of the past decade, SVB Financial was a rarity among bank stocks. In an industry known for slow and steady cyclical growth, SVB stood out with sustained double-digit sales and net income growth. It became the go-to for venture capitalists and start-up businesses.
SVB's ability to grow its deposits was truly jaw-dropping. When 2019 came to a close, its total deposits were approximately $55 billion. By the end of 2022, this figure had ballooned to around $175 billion.
Although some deposits are noninterest-bearing, a bank deposit is effectively a liability. Banks have to pay employees to service their customers, pay rent on the physical locations they operate, and possibly pay interest on deposits, among other expenses. To outpace deposit costs, banks turn to lending.
Under normal circumstances, vetting lending applications and putting deposit capital to work is straightforward. But that's not the case when your deposit base grows by 218% ($120 billion) in just three years. SVB Financial simply didn't have the capacity to soundly lend this much capital in such a short time frame.
Its solution was to purchase an abundance of 10-year Treasury bonds at relatively low yields. The obvious expectation was that interest rates would remain low for the foreseeable future and these 10-year T-Bonds would produce modest yields above and beyond what SVB Financial was paying on its deposits. However, the Federal Reserve raising interest rates at the quickest pace in four decades threw a monkey wrench the size of Texas into this previously well-oiled engine.
Since bond prices and bond yields have an inverse relationship, a rapid increase in bond yields sent the price of bonds notably lower. In other words, if SVB Financial were forced to sell its Treasury holdings at current market rates, it would be taking a sizable loss.
The other problem was that as interest rates rose, it made interest-bearing deposits more enticing for the customers SVB was gaining. Between the end of 2019 and the end of 2022, average interest-bearing deposits grew from $16.3 billion (29.6% of total deposits) to $87.8 billion (50.2% of total deposits). SVB's deposit costs were rising as its balance sheet deteriorated.
When an almost unfathomable $42 billion in deposits were attempted to be withdrawn on March 9, 2023, and SVB failed to raise additional capital, regulators had no choice but to step in and put SVB Financial into receivership.
Image source: U.S. Bank.
The one regional bank stock that's a surefire buy in the wake of SVB Financial's failure
There's no question that SVB Financial's failure is a mess and a big red mark on the regional banking industry. It's also not uncommon for bank failures to come in groups, which is why so many regional bank stocks were clobbered in the wake of SVB having its assets seized.
But for the most part, the banking industry is much better capitalized following the financial crisis in 2007-2008. In short, the vast majority of publicly traded banks are going to be just fine, despite what happened to SVB.
In fact, the SVB Financial fallout could be the impetus that allows you to buy into bank stocks at an advantageous discount. Among the sea of regional bank stocks investors can choose from, there's one that stands out as a surefire buy: U.S. Bancorp (USB -1.49%), the parent of the more-familiar U.S. Bank.
Make no mistake -- the market hasn't made much distinction so far between well-fortified regional banks and vulnerable ones, so the stock could go down some more in the short term. Don't buy thinking this is going to give you a quick return. You'll need to think in terms of years. Fortunately, U.S. Bancorp thinks in years, too.
Dating back decades, U.S. Bancorp has stood out for its relatively conservative approach to growing its business. While a number of money-center banks got themselves in deep trouble with riskier derivative investments, U.S. Bancorp has largely avoided this mess by sticking to the bread-and-butter of banking: loan and deposit growth. It may not be fancy, and it won't deliver the double-digit profit growth SVB Financial was known for, but U.S. Bancorp has consistently been among the top big banks with regard to return on assets.
Here's another key difference from SVB Financial. At the end of 2022, U.S. Bancorp had $13.7 billion in unrealized losses on investment securities available for sale. That compares to nearly $30 billion in tangible common equity, a far more comfortable cushion than SVB Financial had and good insurance that the bank won't have to sell at a loss.
U.S. Bancorp also recently completed the acquisition of Union Bank, the U.S. banking subsidiary of Mitsubishi UFJ Financial Group. Not only does this purchase broaden its reach on the West Coast and add 1 million new customer accounts, but it added $82 billion in deposits -- a significant portion of which isn't interest-bearing. Taking on these low-cost deposits is expected to lift U.S. Bancorp's net-interest margin in 2023.
But the best thing about U.S. Bancorp might just be its digitization trends. Among big banks, none has been more successful getting its consumers to bank online or via mobile app. As of the end of August, 82% of its active customers were banking digitally. Even more important, 62% of total loans sales were completed digitally, up from 45% at the beginning of 2020. It's considerably cheaper for banks when their customers bank online or via mobile app as opposed to in-person or over the phone. As more of its customers shift to digital transactions, U.S. Bancorp has the option of consolidating its branches and reducing its expenses.
It's also worth pointing out that most banks are in a unique position to actually benefit from the Fed's hawkish monetary policy. Even with the growing possibility of a U.S. recession, companies like U.S. Bancorp can more than offset potential loan losses with higher net-interest income on variable-rate outstanding loans.
Because of its rock-solid foundation, U.S. Bancorp often trades at a premium to its book value. But that shouldn't deter investors. At just 7.5 times Wall Street's forward-year consensus earnings, U.S. Bancorp is historically inexpensive, a sign that the market isn't distinguishing between small, vulnerable regional banks and large, well-fortified ones. With a 4.7% dividend yield to boot, it's the regional bank stock investors can confidently buy right now.
