One year ago, I explained “How to Profit from the Collapse of Silicon Valley Bank.” At that time, the entire banking sector was under pressure after Silicon Valley Bank (SVB) ran out of money. SVB was a regional bank based in California that catered to the tech sector.
I observed then, “Within a few days, the bank went from being the “go-to” financial institution for many privately held tech companies to non-existent.” I also noted, “Fortunately for the bank’s customers, the Federal Deposit Insurance Corp. (FDIC) stepped in immediately and made good on all their savings.”
Nevertheless, the fallout from the SVB failure was extensive. After trading near $65 in February, the SPDR S&P 500 Regional ETF (NYSE: KRE) fell below $37 by May. There was lingering concern that other regional banks would soon follow suit.
That concern proved true, but on a small scale. A few other regional banks did shut down, but their depositors lost no money. In short, it turned out to be much ado about almost nothing.
I never believed the risk was that great. The dollars involved were too small compared to the size of the economy.
The SVB failure was nothing like the meltdown in the real estate market that sank the stock market sixteen years ago. Back then, almost all the big banks got caught with their hands in the cookie jar.
This time, it was just a few regional banks that got slammed. They made high-risk loans to businesses with intangible assets that aren’t worth much as collateral.
When Wall Street overreacts to an unexpected event, it temporarily throws the financial markets into disarray. Investors panic and behave irrationally.
That’s why I recommended buying a call option on Hercules Capital (NYSE: HTGC) in the aftermath of the SVB collapse. A call option increases in value when the price of the underlying security goes up.
Hercules capital is a small business development company (SBDC). It makes loans to small tech companies that cannot get conventional bank loans. In addition to charging interest on its loans, Hercules also gets an “equity kicker” that pays off if the borrower goes public or is acquired.
When SVB collapsed, HTGC also fell. The assumption was those equity kickers would end up being worthless.
That didn’t make sense to me. I felt removing Silicon Valley Bank from the playing field would give Hercules more bargaining power. It’s not every day that an industry’s biggest competitor evaporates into thin air.
That’s when I made my move.
On March 20 of last year, the HTGC call option that expired in September at the $12 strike price could be bought for $2. For that trade to be profitable, HTGC had to rise above $14 within the next six months.
It took less than three months for that to happen. And two months after that, HTGC traded above $18.
That made the intrinsic value of this option $6, more than three times what we paid for it. Including the remaining time premium, the total return on this trade was more than 300%.
Traumatic events like the SVB failure have long tails. And in some cases, they can influence other companies that have nothing to do with them.
Consider the recent announcement by credit card issuer Discover Financial (NYSE: DFS) that it has agreed to be acquired by Capital One Financial (NYSE: COF). At first glance, this deal looks like a no-brainer.
Discover is a credit card issuer in search of a bank. Capital One is a bank in search of a credit card issuer. Both companies should benefit from the arrangement.
JPMorgan Chase (NYSE: JPM) is the biggest credit card issuer in the United States. Its CEO, Jamie Dimon, does not want this deal to happen even though he tried to engineer a merger of his own with Discover a few years ago.
But now that the shoe is on the other foot, he doesn’t like the way it fits. He knows that this deal would make Capital One a formidable competitor.
A year ago, Dimon led the bailout of Silicon Valley Bank. He twisted a few arms and got several other banks to join him in allowing the U.S. Treasury Department to assign those troubled to loans to their balance sheets.
That won him many friends in high places within the federal government. Now, those same friends will decide if Capital One should be allowed to acquire Discover Financial.
Perhaps they will approve the deal anyway. After all, their job is to ensure that our financial markets are fair and competitive.
But if they do not, we may never know if it is a payback for what happened a year ago. Silicon Valley Bank is gone, but it is not forgotten.
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