Here is a riddle for you. Shares of First Republic Bank closed at $31.21 on Monday and opened at $49.69 on Tuesday – a 59% peak overnight. There was no news from the bank in the hours that followed. So why has the stock moved so much?
The answer: The stock has moved so much because there was no word from the bank in the hours that followed. But also, once the banks start getting into trouble, the stock price naturally becomes incredibly volatile, simply because their leverage on the balance sheet is so huge at that time.
Between the lines: There are many possible futures contracts for a given company, and a stock price can be thought of as a sort of weighted average of each of them, discounted by an equally probabilistic discount rate range.
- At times like these, some banks are beginning to face concerns that they could be taken over by the FDIC overnight and eventually sold to a new owner.
- When this happens, depositors (account holders) are usually unaffected, while shareholders are usually wiped out. The bank lives on – take a blood test on JPMorgan and you’ll find WaMu DNA there somewhere – but that’s no consolation to its former owners.
- In other words: it doesn’t matter what value Signature Bank or SVB end up having for their future owners, whoever they are. All of this value goes to the new shareholders, while the old shareholders remain zeroed.
How it works: When markets closed on Monday, there was a fair chance that federal authorities would review First Republic deposit outflows and process them before markets opened on Tuesday.
- That possibility was reflected in Monday’s stock price. So when Tuesday morning rolled around and nothing had happened, the stock price, no longer reflecting the probability of failure on Monday night, rose.
The big picture: Banks are among the most indebted companies in America – they have far more debt than equity. This is how fractional-reserve banking works.
- Debt is normally a combination of total deposits, outstanding bonds and various other instruments such as repos; Capital is normally assessed using measures such as Tier 1 capital.
- Take a typical boring bank like PNC Bank. Its capital is around $43.5 billion, while its deposits alone – all of which are unsecured liabilities of the bank – are ten times that amount.
The bottom line: Since equity value represents such a small fraction of a bank’s overall capital stack, bank stocks tend to be particularly volatile, especially when market capitalization falls well below value. an accountant.