Two Banks' Stumbles Underscore Larger Dilemmas for the Industry

Bank stocks are hardly investors’ darlings nowadays, given economic heebie-jeebies, and things only got worse Thursday, as the sector suffered a rout propelled by Silvergate Capital’s flame-out and fresh evidence of weakness at SVB Financial.

This duo are hardly giants on the order of JPMorgan Chase. Still, their troubles stem from deflation of the bullishness that once buoyed financial stocks. Cryptocurrency and startups, in particular, ain’t what they used to be.

The recently announced liquidation of Silvergate, by itself, could be dismissed as a one-off—as it is devoted to funding cryptocurrency companies. Once popular, crypto has taken a pounding, with Bitcoin losing more than half its value over the past 12 months. That hurt, big time. Silvergate was so into crypto that it accepted the cyber currency as deposits. The bank’s stock tumbled 42% Thursday.

The difficulties of SVB and its subsidiary, Silicon Valley Bank, a more prominent member of the banking scene, proved to be a double whammy for bank equities. As of year-end 2022, SVB was ranked as the U.S.’s 16th largest bank by assets. On Thursday, its shares sank 60%, even more than the crypto lender’s.

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The problem: SVB focuses on loans to tech start-ups, amid vanished enthusiasm for technology over the past year. Shrinking deposits from start-ups have harmed its financial strength. The company on Wednesday disclosed a large loss and a plan to raise $2.25 billion in fresh capital by selling new shares, a sign of weakness that spooked Wall Street.

Bank stocks as a whole have endured performance woes, albeit not as drastic as those of Silvergate and SVB. The S&P Banks Select Industry Index, which tracks most U.S. lenders, dropped more than 7% Thursday, the latest in a 19% slide over the past 12 months, which have been very volatile for financial equities.

The Federal Reserve’s campaign to raise interest rates, which began last year, has been a plus for banks. But the prospect of a recession has weighed on them, because borrowers get scarce as the economy plunges. To prepare for bad times, banks have swelled their reserves. Downside: Higher reserves can sap earnings.

The industry’s asset leader, JPM, which reported strong profits for last year’s final quarter, on Thursday saw its stock lose more than 5%.

President Joe Biden released his $6.8 trillion proposed budget for fiscal year 2024. The budget proposes several changes to tax policy to increase government revenue and reduce the federal deficit.

The budget proposal includes increasing the taxes companies pay on stock buybacks to 4%, from its current 1%. This aligns with a commitment Biden made during his State of the Union address on February 7. The tax is intended to encourage investment and to reduce the tax advantage of returning money to shareholders by way of stock buybacks rather than dividends, since buybacks are taxed as capital gains and dividends as income.

The proposal would also increase the corporate tax rate to 28% from its current 21% and move the top marginal personal income tax bracket up to 39.6% for people making more than $400,000 per year. Capital gains would also be taxed as wages for those making more than $1 million per year, meaning the plan proposes a marginal 39.6% capital gains tax for income over $400,000, up from the current 20% rate.

The proposal also commits to closing the carried interest loophole, which allows some asset managers to report compensation tied to an asset’s value as capital gains instead of as wages, which typically reduces the percentage of tax owed on that income.

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Biden also seeks to end the “like-kind exchange loophole” (based on Internal Revenue Code Section 1031), which permits real estate investors to defer paying capital gains taxes by investing the money from a sale into another real estate asset.

The federal budget expires on October 1 each year, though last year’s budget was twice extended into late December with continuing resolutions to prevent a shutdown. Biden’s budget would have to pass a House of Representatives with a narrow Republican majority and a Senate with an even narrower Democrat majority. As a result of the contentious relationship between political parties, large parts of Biden’s budget are unlikely to be considered.

The budget is often considered more of a political document than one that is expected to be adopted. In this case, Biden’s federal spending plan comes as House Speaker Kevin McCarthy, R-California, has threatened to block an increase in the federal debt limit, which is necessary to pay for federal spending Congress has already approved.

Tags: capital gains tax, carried interest, stock buyback, stock buybacks

Two Banks’ Stumbles Underscore Larger Dilemmas for the Industry

Biden Budget Proposes End to Carried Interest, Higher Tax on Buybacks