A bank can be profitable and still fail, and thrive while in debt. A guide on how to read them
On Friday, March 10, 2023, regulators shut down Silicon Valley Bank, the sixteenth largest bank in the United States with over 200 billion dollars in assets. Just a few days earlier, according to its statements, it was a profitable institution with a long history of growth. It wasn't killed by a loss-making division or an accounting fraud, but by something you wouldn't look for in a classic corporate analysis: the structure of its balance sheet. The bank used client money to buy long-term bonds, rates rose, the bonds lost value, and when depositors started withdrawing, it had to realize the losses. Panic and phone calls did the rest. From the first announcement to the regulator takeover, roughly 48 hours passed.
Key points
Silicon Valley Bank was reporting profits just weeks before its collapse — a routine look at the statements won't warn you before a bank fails
P/E, revenues, or free cash flow don't work for banks — anyone using them like for Apple is analyzing the wrong company
The difference between Bank of America's 2.07% margin and the industry average of 3.31% means billions of dollars — and it has a logical explanation
JPMorgan holds 303 billion dollars in capital, 2.6 percentage points more than regulators require — this waste has its reason
Credit card delinquencies in the US have been falling for seven straight quarters — few know where to check that number for free
This episode illustrates a simple truth: a bank is not a normal company and cannot be analyzed like one. When you buy shares of a sports shoe manufacturer, you ask how many shoes it sells, at what margin, and whether competition is growing. When you buy a bank, you are essentially buying a giant leverage built on other people's money — and the questions must be completely different. How much does the bank earn on the interest rate spread? How much will its clients default on? And will it survive a recession?
Traditional metrics fail one by one for banks. In the usual sense, a bank has no revenue. Free cash flow is practically a worthless number for an institution whose business is moving money around. Debt, which would signal a problem for an industrial company, is a raw material for a bank — client deposits are, in accounting terms, a liability, i.e., debt, yet they are the most valuable thing a bank has. And even profit, that most sacred line of the income statement, can be legally and quietly managed through provisions at a bank.
However, banks are not a black box. They have their own set of indicators that are logical, publicly available, and once you understand them, you will read bank results faster than those of many industrial companies. This is also practically useful: today, July 14, JPMorgan $JPM kicked off the second-quarter earnings season, and its numbers will serve as fresh study material.
So what distinguishes a bank you want to own from one that will end up like SVB?
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